How Does the Second Mortgage Get Paid After a Short Sale?
Short selling a home requires approval from both the first and the second mortgage lender. Short selling a home simply means selling the home for less than the balance of all of the mortgages. This often happens because the home's value depreciated and no longer is worth what it once was. Struggling homeowners may attempt to short sell their homes before they fall into foreclosure. While short selling a home usually costs the lenders less than foreclosing, the second mortgage lender may receive very little, if any, funds from the sale.
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Lien Position
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The title lists mortgage liens in the order they closed. Typically, a first mortgage originated earlier than a second mortgage. The first lien listed on the title of the home must be paid before other lien holders receive funds. Many short sales leave little or no money for the second lien holder. Suppose, for example, the first loan was $200,000 and the second mortgage was $25,000 when the home was worth $250,000, but the house has since depreciated by 20 percent. The maximum the short sale could generate is $200,000. This leaves the $25,000 second lien holder looking for options to recover the loan other than the short sale.
Deficiency Balance
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The deficiency balance are funds still owed after the home sells. If the home sells for less than the balance of the first mortgage, then two deficiency balances may remain after the sale. The homeowner may negotiate to pay off of the deficiency balance with the different lenders. The homeowner is not required to pay off the first mortgage deficiency balance before paying off the second mortgage deficiency balance; she may pay them in whichever order she chooses. Lenders may allow negotiation of deficiency balances to recover some funds rather than none.
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Judgments
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Lenders may sue borrowers for deficiency balances remaining on short-sold homes. This may happen when lenders know the homeowner owns other property to which they can attach a lien. When the homeowner shorts sells an investment or vacation home, he often owns a primary residence. If the lenders choose to sue the homeowner, any judgments received from the lawsuit would be placed on the title of the primary home. When that home sells, the mortgage liens and the judgments are paid at closing, unless another short-sale agreement is approved by all lenders and lien holders.
Forgiveness
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Some lenders simply forgive deficiency balances. However, this may generate taxable income depending upon the status of the property short sold. The IRS defines "forgiven debt" as income, making it subject to income taxes. As of 2011, the IRS allows homeowners a deduction of up to $2 million of forgiven debt, if the forgiven debt was secured by their primary residence.
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