Debt relief is not as simple as it seems. Consider, for example, what happens when mortgage lenders give struggling borrowers the go-ahead on a short sale.
Short sales can happen when your house is "underwater," meaning you owe the lender more than the house is currently worth. A short sale seems to offer a painless way out of the deal.
Say your real estate agent presents a contract from someone willing to buy the house for $50,000 less than the mortgage balance. Your lender -- after months of delay -- approves the sale at that price, and now you can hardly wait until settlement so you will be relieved of that mortgage debt.
Think again. Do you have anything in writing from the lender saying you are completely released from your mortgage obligation?
I did not believe it when I first heard that mortgage lenders were not only unwilling to release short-sale sellers from the unpaid balance of their mortgage debt but were actually turning over the deficiencies to debt-collection companies. But this was confirmed by e-mails from lawyers and real estate brokers all over the country.
A lawyer in Spokane, Wash., wrote: "Having researched the issue, I found that no lender has ever expressly released the borrower from liability on the note in writing. That fact alone makes me wary, despite assurances by a number of short sale facilitators 'not to worry' because no lender has ever come after the borrower for the deficiency."
And a lawyer in California wrote, "Lenders are selling these debts to collection agencies, and they are actively trying to get payments."
Let's take this example: The house in which you live has a mortgage balance of $400,000. Your real estate agent has presented a contract to sell for $350,000, and you believe that is the fair market value of your house. You sign the contract, with a contingency that it is subject to approval by your lender. Your agent warns you that lenders are taking a long time before deciding to approve or disapprove short sales, but finally you are told it has been approved.
You go to settlement and subsequently get a form from the lender stating that $50,000 of debt has been canceled. This is Internal Revenue Service Form 1099C, which all lenders must send to the IRS and to the borrower for any canceled debt of $600 or more.
Because this is your principal residence, you are exempt from the obligation to pay income tax on the canceled debt. But are you really off the hook with your lender?
This is a significant legal question that remains to be tested and decided by the courts. The question is whether the lender's statement (contained on Form 1099C) that the debt has been canceled really mean that the borrower no longer owes the money? Common sense would say yes. But the law is not always that simple.
Should homeowners continue to engage in short sales, knowing they may still owe money to the lender? There is no quick answer.
Are you selling because you are moving to another state or because you are worried that your lender may foreclose on your home? Have you exhausted all other avenues? Are there government programs that can help tide you over until your house increases in value or you are able to resume making the mortgage payments? Have you talked with your lender about modifying the terms of your mortgage so that you will not face foreclosure? Have you considered filing for bankruptcy relief? These are questions you should answer before pursuing a short sale.
And if you really need to sell, have you or your attorney requested that your lender sign a statement that you will be released from any shortfall after the short sale?
Or do you want to be that test case in a court of law? A definitive ruling on short sales has yet to occur. Thus, at least you will understand that there is a risk if you enter into one.
And once you sign a contract to sell, it will be too late to change your mind.