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Your Home as Collateral
When you bought your home and took out a mortgage, that mortgage was a special type of debt called secured debt. The home is the collateral that protects the interests of the lender. The debt is secured, unlike credit card debt or personal loans, because the lender has the option to sell the house at foreclosure in order to recoup their money.
Unfortunately, this system doesn't always work out the way it should. If home values fall, one could end up owing more on the house and having a larger mortgage balance outstanding than the house is actually worth. This happens most often when individuals put down a very small down payment or in situations where the monthly mortgage payments were not decreasing the balance owed. An example of this would be an interest only mortgage.
Regardless of why it happened, when you end up owing more on the house than it is worth, you have a major problem if you need to move or sell your home. After all, if you cannot sell your house for what you owe on it, you'll still owe the balance due.
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Selling Your Home For Less
If you find yourself in a situation where your house is worth less than you owe, selling the house below mortgage value may be your only option. This may leave you wondering when this is a good idea, and what you are supposed to do in that situation.
While the position you are in is not the ideal one, there are times when it makes sense to sell your house, even if the offer you receive is for less than the balance owed. For example, it may make sense to sell your house for less than what is owed when:
- You are in danger of being foreclosed on, and you aren't getting any other offers. This is referred to as a "short sale."
- You need to move, for instance, because of a job, and you have the cash to pay off the balance on the existing mortgage.
In most other situations, it is usually a better idea to try to remain in the house and make your payments until the real estate market improves or until you have paid off enough of mortgage that you are no longer "upside down" on the balance owed and can actually recoup the mortgage costs through a sale.
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Understanding Short Sales
Typically, when people are selling a house below mortgage value, they are doing so through a short sale. This alternative to foreclosure essentially involves getting permission from the lender to sell the house for an offer equal to or less than the amount of the mortgage balance. The entire proceeds of the sale are paid to lender, and they forgive any remaining debt.
A short sale has a few distinct advantages over foreclosure for both the homeowner and lender:
- It is less damaging to one's credit history than a foreclosure.
- There is no risk of a deficiency judgment, which is a court action allowed in some states that entitles the bank or lender to seek to recover from the borrower any outstanding balance after the home is foreclosed and sold.
- The lender does not have to act as a real estate agent or deal with trying to sell a house.
When you do opt for a short sale, the lender has to agree to the sale. You have to find a buyer- usually by using a real estate agent that specializes in short sales - and the lender has to accept the offer. While this seems like a lot of work, it is generally preferable to eviction and foreclosure proceedings.
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- Image from Morguefile
- A Much Needed Road Map