Understanding Short Sale and its Impact on Your Financial Situation
When a homeowner decides to short sell their house, many uncertainties arise, including what happens to their finances and the value of their property. This article aims to clarify some of these critical points, providing insights into the process and its consequences.
What Happens to Your Money When You Short Sale a House?
When you short sell a house, you are essentially asking a bank to accept a loss because the amount you owe on your mortgage is greater than the current value of your property. In such a scenario, whatever money you have in your bank accounts remains untouched. What changes is the value of your mortgage and any shortfall that needs to be covered.
Assuming you do not have any additional assets like stocks, bonds, or savings in excess of what you owe, the process of short sale is straightforward. The bank will attempt to recover as much of the mortgage as possible through the sale of the property. If successful, the sale might cover the borrowed amount, leaving you with nothing.
The Role of Insolvency in a Short Sale
Insolvency, or having more debt than assets, is a key factor in determining eligibility for a short sale. Banks do not readily allow homeowners to claim insolvency just to get out of their mortgage. Instead, you must truly be unable to repay your debts. Banks are willing to absorb a portion of the loss, but they will typically only do so if it is in their best interest.
For example, if a homeowner buys a house for $100,000 with a 95% mortgage in 2003, the initial mortgage is $95,000. By 2005, the market value soars to $150,000, and the homeowner refinances to cover more of the loan, leaving $118,750 in debt. When the market spirals downward in 2008, the house is worth only $110,000. If the homeowner loses their job and cannot afford the mortgage, the bank might agree to a short sale, accepting a loss of $8,750 plus closing and re-selling costs, resulting in a total loss of $12,000. If not for the refinance, the homeowner would have been $10,000 ahead.
Impact on Homeowner Equity
The term "equity" in a home refers to the difference between the market value of the home and the amount owed on the mortgage. If the market value is less than the mortgage balance, there is no equity, and thus no money to recoup.
During the 2007-2009 recession, many homeowners faced the heartbreaking realization that years of mortgage payments had not resulted in any significant equity. In many cases, the accumulated funds went directly to part of the principal of the mortgage, leaving no significant residual value in the home.
Conclusion
Short selling a house can be a painful and complicated process. It requires careful consideration of financial implications, including the potential loss of money and equity. Homeowners must weigh the benefits of short sale against potential long-term consequences, such as damage to their credit score and difficulty in obtaining future financing.
Understanding these concepts can help homeowners make informed decisions and navigate the complex world of real estate and finance effectively.