Q: My wife and I have both had major reductions in our income over the last couple of years, and are in the process of trying to complete a short sale on our home. We have a contract with a buyer, and my mortgage lender has assigned a negotiator to my file. We submitted all the financial paperwork, hardship letter and other documents they requested, and the bank finally responded after several weeks. But their response was that they would allow the short sale to go through only if my wife and I would sign a promissory note agreeing to pay the bank $20,000 over the next 10 years.

We really can’t afford these payments on top of our other bills and housing costs, but we wanted to do a short sale so that we could look forward to buying a home again in a couple of years. If we don’t agree to the $20,000, the house will be foreclosed on. Should we agree to pay the $20,000?

Q: My wife and I have both had major reductions in our income over the last couple of years, and are in the process of trying to complete a short sale on our home. We have a contract with a buyer, and my mortgage lender has assigned a negotiator to my file. We submitted all the financial paperwork, hardship letter and other documents they requested, and the bank finally responded after several weeks. But their response was that they would allow the short sale to go through only if my wife and I would sign a promissory note agreeing to pay the bank $20,000 over the next 10 years.

We really can’t afford these payments on top of our other bills and housing costs, but we wanted to do a short sale so that we could look forward to buying a home again in a couple of years. If we don’t agree to the $20,000, the house will be foreclosed on. Should we agree to pay the $20,000?

A: This is a very tough decision you face, and one that many homeowners across the country are wrestling with right now. Many lenders have begun to ask short sellers to sign a promissory note to cover some portion of the shortfall (i.e., the difference between what they owe and the net proceeds of the short sale). While this is totally understandable from the bank’s perspective, it has the unfortunate effect of penalizing the homeowners who are trying hard to avoid "walking away" from their homes.

Mindset Management

First off, I commend your efforts to work with the bank on a short sale. For homeowners who are trying to hang onto their homes, the investment of effort it takes to seek a loan modification makes sense. However, I’m not sure the average observer appreciates the level of time, inconvenience and even expense that short sellers go through in an effort to close a short sale — especially given that at the end, you won’t even have the home as a consolation prize. It takes a big man and/or woman to acknowledge that you can’t afford to keep your home, no matter how much you would like to do so, and still devote such energy to getting it sold, knowing you won’t see a dime out of the sale.

There comes a time, though, when your family must make responsible yet solid, sustainable and sensible financial decisions. This can be very tough, in this context, because you have competing goals. While you want to be as honorable as possible in terms of the commitment you made to your mortgage, your home and even your neighbors, you also want to make decisions that empower your family to begin recovering and thriving, going forward.

And know this — foreclosure, while unfortunate, is not the end of your world. In fact, I know several homeowners who would argue that foreclosure was actually, in their experience, for closure.

Need-to-Knows

Critical to your decision should be whether the mortgage you’re seeking debt forgiveness on is a recourse or no-recourse loan. In states like California, for example, purchase-money mortgages are no-recourse loans, meaning that if you default on the loan resulting in foreclosure, the lender’s only remedy is to auction the house at a trustee sale. They cannot come after your personal assets or sue you in addition to or instead of the foreclosure.

In many other states, the lender can take only one action against a defaulting homeowner, either foreclosure or a lawsuit to recoup the loan balance. …CONTINUED

Realistically, though, I am aware of no national lenders who are suing defaulting homeowners instead of or in addition to foreclosure, as a matter of course, because (a) lawsuits are costly and banks would go even broker than they are if they tried to sue every defaulting homeowner, and (b) most homeowners are even broker than the banks, so they are "judgment proof," meaning they wouldn’t have any money from which to pay the judgment even if the bank did sue.

I can’t advise you about what is ultimately the right thing for you and your family to do. I differ from many attorneys and accountants who think that the decision that pencils out the best is always the only decision you should make. Sometimes there are moral and ethical upsides to making financial decisions that don’t make sense to everyone else.

However, I can also say this. If you’re in a no-recourse or one-action state, and you agree to take on a 10-year commitment to pay on a house you cannot even live in any longer, you are essentially forfeiting the protection of the no-recourse or one-action rule, and giving the bank a right to sue you for defaulting on the promissory note, despite the fact that currently they would not be able to sue. And since you are already aware that the payment on the note would be tough for you to make, you could very well be setting yourself up for failure and a lawsuit.

It is true that federally insured mortgage lending guidelines allow a buyer to get a federally insured mortgage only two years after a short sale, but require a five year "seasoning" period after a foreclosure. I would not let this be the deciding factor for you, though. These time frames change frequently, and there are many non-federally insured programs that are and will be out there in a couple of years that will let you buy sooner than five years after a foreclosure.

Action Plan

1. Talk with your real estate agent and/or short-sale facilitator to see if there are any counterproposals the bank might accept to that $20,000 promissory note. Ask if there are closing costs that can be reduced or if the bank would accept whatever small lump-sum payment you can afford to make from your savings, if any, to approve the short sale.

2. Avoid forfeiting the closure and opportunity at financial recovery you might obtain through foreclosure by taking on a long-term commitment to pay a note you cannot afford.

3. If your lender will not play ball, talk with them about a deed-in-lieu of foreclosure, through which you can hand them the keys and the title without the drama and trauma of a foreclosure auction, at a cheaper cost to them.

Tara-Nicholle Nelson is author of "The Savvy Woman’s Homebuying Handbook" and "Trillion Dollar Women: Use Your Power to Make Buying and Remodeling Decisions." Ask her a real estate question online or visit her Web site, www.rethinkrealestate.com.

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