Avoiding Foreclosure: Short Selling on an Interest-Only Loan

Avoiding foreclosure with a short sale not only offers the chance to get out of debt, but you also stop the damage to your credit history and keep a foreclosure off your record. An interest-only mortgage poses specific challenges, and the following information should help you deal with them.

What Is a Short Sale?

In a short sale, you approach your lender with permission to sell your home before you go into default on your mortgage loan and face the likelihood of foreclosure. If the lender agrees, the home is sold and the proceeds are applied to your mortgage loan balance. In most cases, that amount will be less than the balance. While there is no obligation to forgive the remaining balance, the lender usually agrees to wipe out the whole debt with whatever the sale of the home brings.

The advantage to the lender is avoiding the long and costly foreclosure process in which he ends up with the home to sell against the loan balance anyway. The advantage to you is avoiding foreclosure and getting out of debt.

The Impact of Interest-Only Mortgages

Your monthly mortgage payment has three components: interest, principal reduction, taxes, fees and insurance. With an interest-only mortgage loan, you are not reducing the principal. Typically, it is assumed you will refinance an interest-only loan with a traditional loan at some point.

In a short sale, having an interest-only loan means there is a greater balance to pay off with the proceeds of your home. If your lender accepts your short sale request, you need to work to get the most money for your home so that the remaining balance, for which you can be liable,  is less.

Watch the Appraisal

A lender will conduct an appraisal of your home to determine current market value. Lender's are interested in moving prudently but quickly and often will accept a low-end appraisal in hopes of selling the home. Once appraised, they usually will accept an offer of 90 percent of the appraised value.

Make sure the home is properly appraised. Get your own appraisal if you have to, but at least compare what similar homes in the market have been selling for. An artificially high valuation will make selling harder and make avoiding foreclosure harder. An artificially low valuation leaves less of your balance paid off.

Value-Added Steps

You can take steps prior to appraisal to improve the valuation of your home and improve your chances of avoiding foreclosure. Houses headed toward foreclosure often look like it. Homeowners who fear losing their homes begin to neglect them. Maintain your yard. Invest in paint if you need to. Make your home as attractive as you can without spending too much. In the sales process, take your real estate agent's advice as to preparing your home to be attractive to buyers.

 Smart First Moves

Even if a short sale is the best plan for avoiding foreclosure, the lender cannot approach you about it. Before you approach the lender, look at your loan documentation on your interest-only mortgage. Know how much you owe and how far behind your are. (You are still liable for unpaid interest if you have missed payments.) Be prepared to show your lender what he can expect to get out of your home, what the financial circumstances are that make a short sale necessary for you and what you will do to help the sale.a