For many underwater homeowners — homeowners that owe more on their mortgage than the house is currently worth — they have a bit of an upper hand with their lenders. Lenders are reluctant to foreclose on these homeowners even if they’re in default, because that would mean realizing a loss on the property: selling below market value, losing money on the mortgage, and incurring all of the costs of foreclosure.
A less costly option for everyone concerned is a short sale. This is a sale that the lender agrees to which is less than what is owed on the mortgage. The lender takes a hit, but does not incur the costs of foreclosure. Additionally, the borrower doesn’t suffer as bad a sting on their credit report. It’s bad, but not foreclosure bad.
Additionally, there was some extra help on the lawmaking front as Congress avoided fiscal cliffery at the end of last year. The Mortgage Forgiveness Debt Relief Act of 2007 was extended another year, through January 1st, 2014. This law will save people foreclosed on, or who go through short sales, or who have their loans beneficially modified, a bit of tax money.
Since a short sale (or loan modification, or foreclosure) is a forgiveness of debt, it is normally taxable as income by the IRS. The Mortgage Forgiveness Debt Relief Act of 2007 made this forgiven debt non-taxable. The law was set to expire at the end of 2012, but it is now in force for another year.
Not there’s ever a good time to go through foreclosure, but this year will be a bit less painful if for no other reason than the additional tax savings.