4 Options for Selling Your Underwater Home for Less Than What You Owe on the Mortgage

When you owe more on your home than it is worth, we say that your home is underwater or upside down. The difference between the home’s value and your loan balance is called negative equity.

If you owe more than the house is worth and want to sell it, there are ways to do it, but you can’t just sell it and hope for the best. When your house is sold, the closing attorney will contact your lender to get the loan payoff amount. If it is more than you are getting in the sale, they will stop right there until they know how you intend to pay the difference.

Your plan needs to be in place before you start selling a home with negative equity. There are several ways that you can deal with this situation. The first thing that you need to do is a little homework so that you are making the best decision based on accurate information.

The first factor to consider is your loan. How much do you actually owe? If you haven’t looked at your balance recently, you should look at your most recent statement. If that’s not available, you can access this information online.

The next item to research is your home’s value. Use actual data, not hearsay. Contact one of professional real estate agents in your area. If they know that they have a chance to list your house when you sell, they should be willing to pull some comparable sales for you. Based on those sales you should be able to get a good estimate of your home’s current value.

A good question to ask the agent is, what is the market doing? Are values moving up, down, or are they stagnant? Has the market dropped sharply since you bought your home? If so, how long do they think it will take for the market to recoup the loss in value?

The third thing that will impact your options is your personal financial position. Do you have other assets? Do you have a stable income? How long have you worked at your job? If you’ve been downsized or laid off from the job you had when you qualified for your loan and you’re doing something completely different now, this may affect your choices.

As you’ll see, all of this information will help you as you consider your options.

#1. Do a Short Sale

When your lender agrees to release its lien on your house without being paid the entire loan payoff amount it’s called a short sale. They are settling for a lesser amount and can often forgive you the difference.

This became a common process after the recession of 2009 and the downturn in the US housing markets.

For a lender to consider a short sale, the property will need to be clearly underwater by an unrecoverable margin, and the borrower will need to be clearly unable to catch up and keep up with the loan payments.

If this sounds like your case, you will want to read the section coming up where we go into short sales in great detail. Jump to this section now.

#2. Compensate the Difference With Personal Funds

If the difference between your loan payoff and your home’s value isn’t too large, you may want to pay the difference yourself.

Your review of your financial situation should include listing any assets that can be converted to cash. Non-qualified investment accounts can be used for this.

Personal items including boats, recreational vehicles, cars, and jewelry should be listed at current values and considered for liquidation as well.

If your credit is good, you could consider a personal loan. To see if you can afford this option, take your replacement monthly housing cost and combine it with the new loan payment. If the result is higher than the original mortgage payment that you had trouble paying, this may not be a good option for you.

#3. Increase the Property Value

If your broker lowered your home’s estimated value because of needed repairs, this might be an opportunity for you.

Sometimes a home’s value will catch up with the market if it is in better condition. It’s not unusual for the value increase to be more than the cost of repairs. Get your broker’s help in making these calculations.

A house but in good condition is also more marketable. It will get more showings which lead to a quicker sale. Historically, the quicker your home sells the higher the sale price will be.

If the difference between your property’s value and your loan payoff is not too large, this might be a good solution. Making repairs might help you to close the gap between value and loan balance enough to pay the difference yourself as discussed above.

#4. Build More Equity Before the Sale

If the market values in your area are stable or improving, then you may want to stay in your house for a while. If you are able to continue making your mortgage loan payments, this will enable you to build more equity before selling your home.

Have your broker collect sales from the same month a year ago. This will tell you if your home’s value is increasing or declining. See how long the sold properties had been on the market. Days on Market (DOM) can be an indicator of an improving real estate market.

While your market value is gradually increasing, making your loan payments will reduce your negative equity.

Mortgage loan payments are called Principal and Interest (P&I) payments. Part of your payment goes to pay down the principal, and part of it pays the interest owed. The interest portion is calculated on the remaining principal balance.

This means that every payment you make reduces the amount of interest in your next payment. That increases the amount of principal being paid, and so on. Every month the amount of interest owed goes down, and the amount of principal being paid goes up.

To build equity more quickly you should pay any additional amount that you can whenever you can. This will apply directly to the principal and significantly speed up the reduction of your loan balance.

Make a list of every way you can think of to increase your payments. Put every idea on the table. Consider taking a temporary second job, or working more overtime at your current job if that’s available.

If you can stay with family or friends temporarily, or if you can rent somewhere for less than your mortgage payment, you should consider renting your home to tenants. If you apply the money you save each month to your mortgage payment, it will shorten the time until you can sell your home.

The combination of rising values and a decreasing loan balance will bring your equity in line with your loan balance much more quickly.

How Does a Short Sale Work?

A short sale is a specific procedure to sell your home for less than you owe the bank, with the bank’s permission and often without having to compensate for the difference. The bank, or mortgage lender, is involved throughout the transaction and will dictate a lot of the process.

Foreclosures are time-consuming and expensive for the lender. They create legal costs for the lender and, in some cases, court costs as well. Auctions often result in low offers and the lender winds up keeping the property. Then they will have to sell it for themselves. That results in marketing costs, commissions, and the costs of maintaining the property.

Sometimes lenders are better off getting the loan and the property off their books as quickly as possible. If so, they may agree to let you sell the house for less than what you owe them, to get the proceeds from the sale and to forgive the difference. This is a short sale.

In order to determine whether they will consider a short sale, your lender will have to examine your financial situation and your home’s value. You will have to provide the lender with updated personal financial information and they will have an appraisal done on your home.

If you don’t have the ability to make your payments and the deficit between your loan and your home’s value is more than you can pay, then you may qualify for a short sale.

Some lenders will approve you for a short sale in advance and your home will be marketed for sale as a short sale property. Other short sales occur when you approach the lender with an offer or contract with a buyer.

The eventual sale price on your home will have to be approved by the lender at their discretion.

Closing costs are sometimes passed on to the buyer, or they may be taken out of the lender’s portion of the sale proceeds.

A short sale doesn’t always let you off the hook completely. A lender will try to reserve the right to seek a deficiency judgment against you and come after you for the amount they lost in the deal.

This is one of the reasons why the typical homeowner needs professional help in navigating a short sale (we’ll discuss it in more detail in one of the next sections of this article).

5 Benefits of a Short Sale

#1 You Avoid Foreclosure with Its Expenses and Credit Damage

Perhaps the most important benefit of a short sale is that it enables you to sell your house before it goes to a foreclosure auction. The foreclosure process is confusing and stressful, it’s expensive, and it will badly damage your credit for a long time. When possible, it’s best to avoid it.

One of the seller’s expenses that a short sale would eliminate is the cost of a foreclosure attorney. It would be very difficult for you to go through foreclosure without legal help. Foreclosure attorneys don’t charge a one time fee like a closing attorney. They bill by the hour and their work will take a long time.

#2 You Don’t Pay Closing Costs

Another financial benefit to the seller in a short sale is that there are no closing costs. This includes the expense of realtor commissions. The lender, or possibly the buyer will pay those costs.

#3 You May Get Relocation Assistance

You may also save money when you move, compared to a foreclosure. In a short sale transaction, the lender may be willing to provide you with up to $3000 credit for relocation assistance. This is one of the things that should always be discussed in your negotiations with your lender.

#4 You Don’t Have to Compensate the Negative Equity Amount

The most critical point that should be included in your negotiations is for the lender to waive their right to seek a deficiency judgment against you. Without this, they can hold you responsible for the amount of money that they lose in the sale of your home.

#5 Short Sale Is Simpler and Less Stressful than a Foreclosure

A short sale takes less time and is much easier for the average borrower to understand than foreclosure. Most of the steps that are required for a short sale are the same things that are done for an ordinary sale of your home. Marketing, showings, appraisals, etc.

You and the lender are working together for your mutual benefit. This relieves you of the stress of having a foreclosure forced upon you. You can start moving forward with your life.

Lenders like short sales. The quicker they can get a non-performing loan off of their books, with the least amount of expense, the better it is for their financial position.

To read in more detail about the whole short sale process from the beginning to the end, see our article Step-by-Step Short Sale Process and Timeline for Home Sellers.

2 Consequences of a Short Sale

#1 Tax Consequences

We have an entire article Tax Implications of a Short Sale explaining this subject in detail, including in what cases and how the tax due can be minimized or eliminated. So here we will only discuss the main points.

When your lender receives less than you owe them in order to sell your house, the amount they lose is considered canceled debt. The lender will have to report it to the IRS. Since you used that money and didn’t pay it back, the IRS considers that to be income which is subject to income tax.

If your financial troubles have forced you into bankruptcy, or if you prove to the IRS that you are insolvent, the canceled debt will not be taxed. Otherwise, it will be considered taxable income to you.

This can also happen if your home doesn’t sell for its full value in foreclosure. And even when doing deed in lieu of foreclosure. If you are interested to learn more about the pros and cons of all these options, we compared them in the article Short Sale vs. Foreclosure vs. Deed in Lieu: Difference, Pros & Cons.

A professional tax advisor should be consulted to determine how this may affect your individual tax situation.

#2 Credit Consequences

For more detailed information about credit impact of a short sale, read our article How Long Does a Short Sale Stay on Your Credit Report and How Bad Does It Hurt It?. And here, we will make a short overview.

A short sale of your home is an event where you did not meet your obligation to pay a debt, so it will negatively impact your credit score. The results of the short sale will be present on your credit report for up to 7 years.

Your credit report will not say that you had a short sale. What it will show is that the loan was not fully repaid.

Even if the lender waived their right to obtain a deficiency judgment, your credit will be damaged. Your credit report will show a zero balance on that account, but it will say something like “settled for less than the amount due”.

Most lenders will not be willing to make a loan to someone soon after they went through a short sale of their property. Depending on the circumstances, it may take you from 2 to 6 years before you could qualify for another mortgage loan. Still, much less than after a foreclosure or deed in lieu.

A big factor will be whether or not your financial downturn was sudden or if it was one of a long list of late and unpaid bills.

If it was sudden and was caused by a one-time event in your life, like an illness or an unexpected job loss, your resulting credit score may not be hurt as badly. It also may not keep you from borrowing again for as long a period of time.

However, if your history shows a chronic problem with finances, then recovering your credit will take longer. In that case, you should seek the help of a credit counselor to rebuild your credit.

What’s the Best Way to Start a Short Sale Process?

If you think that you can benefit from a short sale of your home, you should immediately schedule a free consultation with a short sale processing firm.

Short sale processing companies, also known as short sale negotiators, are professionals that handle processing short sales, often at no cost to home sellers. Instead, they get paid by the buyers who are often real estate investors looking for short sale properties often sold at better prices than normal listings.

We have an entire article explaining in detail what short sale negotiators do for sellers. But let’s go over the main benefits of using them here.

First of all, they know how to protect your interests. We’ve discussed delinquency judgment waivers and relocation assistance. These are things that your processor can negotiate for you.

An experienced short sale processor can explain the entire process including what you should and shouldn’t do. This can help you to avoid mistakes as you move forward.

Someone who has been through short sale scenarios knows what the lender is looking for and in what format. They are familiar with requests for mortgage assistance (RMA) forms and borrower hardship letters. They can explain to you how an incomplete lender’s package can hold up the lender’s approval.

But did you know that it may be possible for your processor to convince your lender to report the loan to the credit bureaus as “paid in full”? This would make it so much easier for you to rebuild your financial future.

The lender is more likely to consider helping you if you have helped them by being prepared, submitting complete packages, and meeting all deadlines.

If a short sale processor doesn’t charge you for their service, there is no reason for not getting help. You aren’t losing anything. Instead, you are getting free professional assistance in receiving all possible benefits a short sale can offer and protection of your interests.

Not all short sale processors are free for sellers, however. And not all of them are experienced and professional enough to handle a short sale communication with a lender correctly. If a short sale is processed unprofessionally, a bank can foreclose during it.

If you want to get free help from a top-rated, professional short sale processing company in your location, you are welcome to fill out our form. Shortly after, you will be contacted by one of our partnering short sale negotiators vetted according to our service quality and reputation standards.