Banks Tempt Underwater Home Owners with Cash — Would You Take It?

A short sale might be worth more than avoiding a foreclosure on your credit report. For some, it means cold hard cash.

If your lender offered you as much as five figures to move out of your home because you couldn’t make your mortgage payment, would you do it or wait for the lender to foreclose?

The answer would seem to be a resounding “hell, yes.” But many people sit tight.

When Bank of America offered short-sale incentives of $5,000 to $20,000 to 20,000 Florida home owners late last year, only 3,000 home owners expressed an interest in participating.

One reason? Folks can often live rent-free while the foreclosure process winds its way through the red tape.

But, a cash “bonus” paired with a short sale that lets you avoid a foreclosure on your credit history can be a sweet deal.

An incentive payment might be as little as $3,000 via the federal government’s Home Affordable Foreclosure Alternatives program. But private lender programs offer 10 times that much, depending on where you live, which short sale program you use, and which company holds your mortgage, says BusinessWeek.

“Banks are nudging potential sellers by pre-approving deals, streamlining the closing process, forgoing their right to pursue unpaid debt, and in some cases providing large cash incentives,” Moody’s Senior Credit Officer Bill Fricke told the magazine.

Of course, incentives have their catches. You have to:

1. Help the bank sell your home. In a short sale, you find someone willing to buy your home for less than what you owe on the mortgage and your lender agrees to take the sale price.

2. Move on without a fight.

3. Probably live in a state where it takes years, rather than months, for the bank to foreclose. In those areas, it’s cheaper for the bank to pay you to do a short sale than to pay the cost of a multi-year-long foreclosure.

If you bank makes an offer and you bite, these four steps will ensure the smoothest possible process:

1. Make sure the lender can’t come after you later to collect any shortfall between what you owe on the mortgage and what you’re selling your home for. Some, but not all, states prohibit that.

2. Talk to an attorney and a tax adviser so you know what will happen financially after the short sale. If you sell now through the end of 2012, the tax rules for short sales say you won’t owe any income tax on $1 million (singles) to $2 million in forgiven mortgage debt (married couples). Those tax rules, part of the Mortgage Forgiveness Debt Relief Act, expire at the end of this year and only apply to your primary residence.

3. Hire a REALTOR® experienced in short sales to handle the transaction. Look for an agent who’s earned the SFR (short sales and foreclosure resource) designation.

4. Figure out where you’re going to move and sign a lease now because your credit score will likely drop if you stop paying your mortgage and short sell your home. A low credit score can make it difficult to get a rental home.

By the way, you can ask your bank if it’s willing to work with you on a short sale, but asking for an incentive too? That’s not how it works. Banks choose you for an incentive program, and how they decide isn’t clear, though they’re less likely to offer cash in states where it only takes a couple of months to foreclose.

So would you take the cash and short sale, or hold out?