Short sales: When walking away isn’t the end

For many unable to keep up with their mortgage payments, a short sale (in which you sell the house for less than what you owe and ask the bank to forgive the balance) can seem like a good alternative to foreclosure. The bank gets some or even all of its money back. The homeowner avoids foreclosure and the credit hit that goes with it. The realtor gets a sale and the commission.

Perhaps that's why, as MPR News' Annie Baxter reported earlier this week, homes offered for short sale outnumber foreclosures 2 to 1. But, as homeowners in our Public Insight Network recently told us, a short sale doesn't necessarily mean a clean slate.

Linda of Woodbury (who asked for anonymity for fear of retribution from her bank) found this out the hard way. In August, she and her ex-husband sold their house for roughly $150,000 less than the value of their first and second mortgages. Her Realtor told them to go through with it, and they did, closing the sale in late August. She says her Realtor persuaded them that the second mortgage holder would be unlikely to come after them for the money, based on his experience.

Turns out he was wrong. A few days after the short sale, U.S. Bank started calling Linda's ex and demanding repayment on their second mortgage--even after they agreed to a short sale to wipe out the first mortgage. They now pay U.S. Bank $50 a month, and the bank agreed to a reduction in the second mortgage amount. Still, she says, "I think it's wrong that they accept elimination of the first mortgage on a short sale, but not the second."

It's a familiar refrain, says Joe Metzler, a Minnesota Mortgage Specialist (a designation conferred by the Minnesota Mortgage Association) with 17 years of experience as a mortgage broker.

The problem, Metzler says, is rooted in consumer ignorance and Realtor obfuscation. He says people considering short sales are often stressed, and don't bother to do the homework needed to figure out whether a second mortgage holder will pursue them after a short sale. Realtors meanwhile don't have much experience with short sales, and have an incentive to push through the sale and persuade the homeowner that the holder of the second mortgage won't come after them.

In September, Metzler arrived a closing with clients only to discover that the sellers were no-shows. They had just found out that the short sale wasn't going to take care of their second mortgage. They sorted it out, but Metzler says it's an increasingly common experience, and a sign that Realtors may not be informing their clients about the implications of short sales.

"There is not a lot of reason to do a short sale in Minnesota," says Prentiss Cox, a University of Minnesota law professor who specializes in foreclosures. He says short sales only make sense for those who have good credit, who want to avoid having a foreclosure on their record, and who are "under water" on their housing debt only when the first and second mortgages are added together.

If you fit that description, and plan on proceeding with a short sale, Cox advises that you:

- Do your homework and learn how a short sale would affect your credit vs. a foreclosure

- Engage the second lender as soon as possible to ask them forgive request forgiveness of the portion of the mortgage that you can't pay off

To learn more, consider this blog post on the risks of short sales from MPR's economics guru Chris Farrell.

Another piece of advice from Joe Metzler: Find a realtor who has handled many short sales--a rare thing given their recent popularity. The National Association of Realtors is looking to educate its members about foreclosures and short sales. In August, the association created the Short Sales and Foreclosure Certification Program (SFR), and will be conducting the first certification sessions at its annual conference in San Diego in November.

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