Which is most embarrassing: Loan Modification, Short Sale, Foreclosure or Bankruptcy?

Most of my recent seller clients have been very concerned about what their neighbors and friends will think about their financial distress. Everybody wants to be able to pay their bills. Nobody wants to lose their home. Going through financial trouble is not fun.

Because it is embarrassing to go through financial trouble most people wait too long before reaching out for help. They burn through their savings and max out their credit cards and hope things will turn around soon. Waiting can hurt you. If you make the right decisions early on it will save you money and aggravation.

My advice is if you have a financial hardship to speak to a qualified professional that specializes in this area and can intelligently explain your options. Start with a Real Estate Broker because their advice is free, but you should also talk to an attorney and accountant. Make sure they specialize in foreclosure, bankruptcy, loan modification and short sale. If you are in Fairfield County CT I can refer you to several excellent attorneys and accountants.

I mention 4 situations in the headline all of which can be embarrassing. A loan modification would probably have the least affect on your personal life. Nobody would have to know about it except you and the bank. The only way the public would find out is if you got too far behind on your mortgage payments and a foreclosure action was started. A loan modification can be a great solution if your hardship is relatively small and you will recover quickly. Most banks are making pretty mild concessions if any. If you qualify you can probably get your interest rate lowered for a few years.

A Short Sale could potentially be embarrassing depending on where and how you live and how your property is advertised for sale. With a short sale you always maintain ownership of your home and you are the ultimate seller. The bank will need to agree to take less than they are owed, but you will be the person transferring title to the new owner. If you live in a small community where gossip moves quickly than people will probably find out that you are doing a short sale. If you get too far behind on your mortgage than a foreclosure action will probably start which is part of the public record. You will have to decide if the benefits out weigh the embarrassment. Click here to learn more about short selling your home.

Foreclosure is probably the most embarrassing and provides the least benefits. It is almost as bad for your credit as going bankrupt and provides almost none of the benefits. If your home will have a foreclosure auction then a sign advertising the auction legally must stay in your front yard and it will be published in the newspaper. As soon as the foreclosure is filed it becomes public record and people can see it online and by going to the court house. The one benefit of foreclosure is that you will get out from under the mortgage, but the bank can still pursue you for any shortfall. They can collect from you through wage garnishment or tapping your bank account for up to 6 years.

Bankruptcy is obviously embarrassing. It is public record so anybody looking can find out, but it isn't widely publicized. The benefit is all or most of your debts will be discharged. So if other debts besides your mortgage were causing the most damage it may be possible to save your house and reinstate the mortgage and even potentially modify it. The down side is your credit is affected negatively for 7 years. If you keep your house though you may not need your credit and most of your friends and neighbors may not find out.

Every situation is different and it makes sense to talk to professionals that know all of these options well and can explain all of the benefits and issues. The sooner you get advice the better. There are steps you can take early on that will save you money and aggravation.

How will a short sale or foreclosure affect my credit score?

A foreclosure is almost as bad as bankruptcy for your credit score. Your fico score could decrease by several hundred points and the foreclosure stays on your credit for 7 years. A short sale is far less damaging to your credit score than a foreclosure. The downside to a short sale is that it is frustrating and time consuming to work with the bank, however if you hire a good Fairfield County Real Estate Broker like Jason Milligan they will take care of most of the details. Short Sell My Home

Generally the way a short sale will appear on a credit report is as some type of settlment. "Paid off for less than than owed", "Paid for less than agreed" or a "pre-foreclosure in redemption". You will also have a few late mortgage payments that show up on the credit report. It is possible to negotiate with the bank about what exactly is reported to the credit bureau's.

Is Debt forgiven in a Short Sale Taxable?

My next post was supposed to tell you why loan modifications are a waste of time, but an attorney friend of mine in Rhode Island was confused about the tax consequences of the bank forgiving the debt shortfall. So tomorrow you will get the loan mod post.

Is debt forgiven in a short sale taxable or tax exempt?

The quick answer is debt forgiven on your primary residence is tax exempt, but you may have to file a form 982 with your tax return. Ordinarily any debt forgiven is treated as income by the IRS. However, H.R. 3648, The Mortgage Forgiveness Debt Relief Act of 2007 makes the debt forgiven on your primary residence non-taxable through 2012, in most instances.(check with a CPA or Accountant)

This is taken from the IRS.gov website:
Update Dec. 11, 2008 — The Mortgage Forgiveness Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualify for this relief.

This provision applies to debt forgiven in calendar years 2007 through 2012. Up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately). The exclusion doesn’t apply if the discharge is due to services performed for the lender or any other reason not directly related to a decline in the home’s value or the taxpayer’s financial condition.

The amount excluded reduces the taxpayer’s cost basis in the home. More details. Further information, including detailed examples, can also be found in Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments.

If debt is forgiven for investment property or on any property other than your personal residence you still may be able to avoid paying tax on the forgiven debt. The lender is usually required to report the amount of the canceled debt to you and the IRS on a Form 1099-C, Cancellation of Debt. The IRS wants to tax the forgiveness of debt the same as income. The IRS views income and debt forgiveness the same. However, if you incurred a loss through the sale of property equal to the amount of debt forgiven you may be able to offset the two and avoid any tax.

It is always best to check with a Certified Public Accountant. This advice is general and should only serve to help you ask your accountant better questions.

Should you short sell your home?

First of all what is a Short Sale?
It is when you sell your property for less than you owe the bank(s).

Why is a Short Sale better than a Foreclosure?
In most Short Sales, the bank releases you from the loan. There is no further obligation to pay. In a foreclosure, the bank can sue you for the short fall. The bank has 6 years to collect the full amount you borrowed, plus fees. As you rebuild your life and income, the bank can garnish your wages and seize money from your bank account. After a short sale, you can repair your credit within a year or two.

What does it cost?
All brokerage commission and attorney fees are paid by the bank at the closing.

Does it have to be my primary residence?
No. Any type of property can be sold through a
short sale.

Tune in tomorrow to find out why loan modification is often a waste of time...