Short Sales During Divorce: When It's the Best Option

Understanding Short Sales in a Divorce Context

A short sale occurs when a homeowner sells their property for less than the outstanding mortgage balance, with the lender's permission. For divorcing couples who owe more than their home is worth, a short sale can be a viable alternative to foreclosure that limits financial damage and allows both parties to move forward.

When a Short Sale Makes Sense in Divorce

A short sale may be the right choice when your home is significantly underwater, neither spouse can afford the mortgage on their own income, refinancing is not possible due to negative equity or credit issues, you want to avoid the severe credit damage of a foreclosure, and the local market does not support waiting for values to recover.

How the Short Sale Process Works

The short sale process in divorce involves several steps. Both spouses must agree to pursue the short sale and cooperate throughout the process. You will need to contact your lender and request approval for a short sale. The lender will require financial documentation from both spouses demonstrating hardship.

Once you receive preliminary approval, you list the home and accept an offer. The offer is then submitted to the lender for final approval. The lender's loss mitigation department reviews the offer and decides whether to accept, counter, or reject it. This process can take several months.

Requirements for Lender Approval

Lenders will typically require proof of financial hardship, such as the divorce filing, a hardship letter from each borrower explaining why they can no longer afford the payments, recent tax returns and pay stubs, bank statements, a current financial statement showing assets and liabilities, and a comparative market analysis or appraisal supporting the proposed sale price.

Tax and Credit Implications

There are two primary financial consequences of a short sale that divorcing couples must understand. First, the forgiven debt (the difference between what you owe and the sale price) may be treated as taxable income by the IRS. Second, a short sale will negatively impact your credit score, typically by 100 to 150 points, though this is generally less severe than a foreclosure.

Regarding the tax issue, the Mortgage Forgiveness Debt Relief Act has historically provided relief for forgiven mortgage debt on primary residences. Check the current status of this legislation and consult with a tax professional about your specific situation.

Challenges Specific to Divorce Short Sales

Short sales in divorce present unique challenges. Both spouses must cooperate with the lender and the sale process, which can be difficult when the relationship is contentious. Both parties must provide financial documentation, which requires transparency about finances at a time when trust may be low.

Additionally, the lengthy timeline of short sales can conflict with divorce proceedings. Courts may want property division resolved quickly, but short sales can take six months or longer. Your attorney should address this timing issue in your divorce proceedings.

Deficiency Judgments

One critical concern in any short sale is whether the lender will pursue a deficiency judgment for the remaining balance after the sale. Some states prohibit deficiency judgments on short sales, while others allow them. Before proceeding, understand your state's laws and negotiate with your lender for a full release of any deficiency.

Alternatives to Short Sales

Before committing to a short sale, consider whether any alternatives might work better for your situation. These include loan modification, which could reduce payments to an affordable level, a deed in lieu of foreclosure, which may be faster than a short sale, renting the property to cover costs until the market recovers, or bringing cash to closing to make up the difference between the sale price and mortgage balance.

Choosing the Right Real Estate Agent

Not all real estate agents have experience with short sales. Look for an agent who has completed multiple short sales successfully, understands the specific requirements of different lenders, is patient and persistent with lender negotiations, and has experience working with divorcing clients. The right agent can make the difference between a successful short sale and a frustrating experience that ends in foreclosure.

Move Forward with Confidence

A short sale during divorce is challenging, but with the right team and a cooperative approach, it can provide a fresh financial start for both parties.

Need help with your divorce real estate situation? Our specialists offer FREE consultations.