UNDERSTANDING SHORT SALES
Most Common Questions Asked
by Buyers and Sellers:
Click Here for the Audio Version of this Q & A Page.
What is a Short Sale? A short sale occurs when a seller needs to sell their property for less then is owed on the mortgage(s) and the lender takes less money than what is owed to them. In most cases the homeowner needs to show a HARDSHIP of either financial, medical, job related, such as a job relocation, to approve a short sale. Most times the balance from the short sale is forgiven by the lender or the balance is negotiated as part of the short sale. Each short sale scenario is different, as the lenders decision depends on the sellers financial picture, market value of the property in relation to the purchase offer price, the lenders investors requirements and their own Foreclosure ratios.
Why Would a Lender Accept a Short Sale? A short sale has a better return on investment to the lender than a foreclosure. They are able to cash out of the loan faster than a foreclosure process. Plus they do not have the legal fees which are normally attached to a foreclosure.
As a Homeowner, Why Would I Choose to Attempt a Short Sale? Lets face it.
Bad things happen to good people. There are many reasons why homeowners find themselves in a position of default... change in mortgage payments, loss of job, health issues, etc. When you get behind on your mortgage payments, the lender will start the foreclosure process, no exceptions. If the foreclosure takes place, you have ruined your credit for a period of up to 10 years. You can expect your credit score to go down about 200 points or more, making it impossible to make any future purchases using credit. A foreclosure is usually a required disclosure you must make on any credit or job application.
The lender may also file a deficiency judgment against you. A deficiency judgment can arise if the lender sells your home at auction for less than the mortgage debt. The lender then holds you responsible for the unpaid portion of the loan. The lender may take legal action to pursue payment, such as garnishing your wages. A short sale is usually listed as settled debt, and is much less harmful to your credit. You can expect a decrease in your credit score of approximately 50 - 75 points*.
Is it True I will be Given a 1099-C by the IRS, and Will Owe Taxes on the Unpaid Loan Amount? This has been a major concern for homeowners who choose to do a short sale. Previously, the IRS had the ability to consider the forgiven loan amount as earned income, and you could be taxed on that income. However, recently the House Ways and Means Committee voted to remove the phantom income tax that previously haunted distressed homeowners on primary residences. When you complete a short sale, the lender is required to report that loss to the IRS. If this is your primary residence the IRS can not tax you on the deficiency anymore (please see the link for more information.
http://www.whitehouse.gov/news/releases/2007/12/2007 1220-6.html )
Contact your accountant or attorney for further information on 1099 issues in a short sale.
The Lenders and the IRS are 2 separate areas you have to deal with. As far as the lenders they may ask any borrower to sign an unsecured promissory note before the bank will approve a shortsale. Lenders may also pursue a deficiency judgment against borrowers and attempt to collect the amount that was short. If a lender is asking you to sign an unsecured security note, you better believe if you go into foreclosure they will probably file a deficiency judgment against you and it will be for a much higher amount. If the property is not the borrowers primary property, and the borrower is truly insolvent and their debts are higher than their assets, there is a good chance that the IRS will not tax them as income on the deficiency amount if their taxes are filed properly.
Who Should Handle our Short Sale? The most important thing to consider when deciding to work out a short sale with your lender is to use a qualified professional to handle the process and negotiations. If the processor is not experienced in the short sale process, the deal can be over before it begins. A professional Real Estate agent will need to list your home on the market as the first step. Be sure they are aware you are attempting a short sale, and that they have experience working with short sales and experience working with a loss mitigator.
What is the Short Sale Process? Your home is listed by an experienced short sale real estate agent, who prices the home according to market value yet being aggressive in price reductions if no offers are submitted by buyers. Remember, the goal is to bring in a quick offer and to prevent you from going into foreclosure. Once an offer is received, an entire package is presented to the lender, and the negotiations begin.
Will the Lender always accept a Short Sale Offer? Unfortunately, not always. However, the more complete and detailed the short sale package submitted to the lender, the better the chances of getting an approval. The key is a good Short Sale Realtor listing the property, and to use a qualified and experienced short sale coordinator or negotiator & use a team of experts to handle each and every obstacle which could be encountered. Doing a short sale is always a better solution than a Foreclosure.
I have heard that Less Then 20% of All Short Sales Submitted actually close is that True? Yes that is true. Many people who try to negotiate a short sale have no idea what they are doing. There are several reasons a short sale never closes. People do not know how to keep the buyers interested through-out the process, lack of knowledge, not submitting complete packages, and the list goes on. Experience and training is the Key to completing a successful short sale. Between 75% to 80% of all short sale submissions never get in line for processing because of errors in the submission package either being incomplete or incorrect documentation.
If I Have Missed Mortgage Payments do I have any other Options besides a Short Sale or a Foreclosure? Absolutely!
--- Reinstatement- If the reason a homeowner missed payments was temporary and it has been resolved. This is a one time payment of all delinquent funds in full.
--- Forbearance or Re-Payment Plan- If the issue that caused the homeowner to miss payments was temporary and the homeowner is not able to make a onetime reinstatement payment, they may qualify for this. The lender allows the buyer to pay the missed amount over a period of time or they place the missed payments on the end of the loan.
--- Deed-in-Lieu of Foreclosure- Friendly Foreclosure; homeowner essentially gives the deed back to the bank.
--- Mortgage Modification- If the homeowner does have the means to come close to affording their mortgage payments, the lender(s) may allow them to modify their mortgage.
I Have Two Loans; Can I still do a Short Sale? Yes! (*note a line of credit/HELOC is a 2nd mortgage)
Will Banks Consider Short Sales on both Primary as Well as Investment Properties? Yes. Owners of investment properties/2 home properties that sell through a short sale may be liable for the debt-forgiven amounts that the lenders will send via a 1099.
Is a Short Sale Right for Me? Mortgage lenders are increasingly willing to work with borrowers faced with a financial hardship to accept a discounted payoff on a mortgage. If you are faced with a hardship, and are unable to meet your obligation on your mortgage, your lender would prefer to settle the matter with you as opposed to taking the property through foreclosure. As you consider the option of pursuing a short sale, remember your lender is looking to limit any potential loss on your loan. By completing a short sale, your lender has arrived at a solution that is, for them, much better than a foreclosure.
What Sort of Hardship Would My Lender Consider Legitimate? To some extent, that will depend upon the mortgage company considering the short sale request. Generally, as long as the hardship is real and the mortgage company believes the loan is likely to become delinquent as a result, the short sale request will be processed by the Loss Mitigation Department. A big key to getting Loss Mitigation to accept a hardship is to submit a strong hardship letter. The hardship letter sets the tone for the entire file.
*Very Important Note- If you have a FHA/VA Loan, if you have filed for Bankruptcy or are going to file for Bankruptcy, or if you have PMI Insurance you will need to let your real estate agent know before ever listing your property, as you may not be eligible for a short sale.
Why Use a Transaction Coordinator? Because Real Estate Agents should spend their valuable time assisting all aspects of the transaction not on hold; with the Lenders. Transaction Coordinators have direct access to many lending institutions and can expedite the short sale process.
What about My Credit? The big key here is to avoid foreclosure. By nearly any measure, a foreclosure is the most damaging event a credit status can encounter -- worse than bankruptcy. In the course of getting your short sale approved you may miss your mortgage payments, and these will show on your credit.
By avoiding foreclosure, you will likely be able to resume normal borrowing (car loans, credit cards, consumer goods and such) relatively quickly. Your credit will recover much quicker from the credit dings of a few late mortgage payments, if you keep your other accounts current. Always stay on top of your consumer credit. So, consider allocating your funds to meet basic necessities (food, utilities, household needs, auto expenses and such) first.
Beyond paying for necessities plan to pay other bills to keep as many accounts current as possible. Keep "Necessary Accounts" current when deciding which credit bills to pay. If you are using a credit card to temporarily pay for necessities, you want to be sure to not jeopardize the availability of that account. A short sale may be just one part of a larger effort to get through a tough period. I want to help make it possible for your credit to recover quickly.
About Deficiency Judgments: If Tom owes me 50k and doesnt pay me, then I have two choices: 1) I can write it off (thereby forgiving the debt) and that were HR 3648 may apply; or 2) I can go after Tom and pursue a judgment. A judgment is only the result of a court order. A deficiency may mean one of two things: 1) it may either be a court order which is a judgment or 2) the bank/lender gets the seller to sign a voluntary unsecured promissory note before they will approve the short sale. Something you should know: 1) this promissory note is negotiable. The lender is asking for it, but this is a part of the negotiation process. Deficiency Judgments can possibly be wiped out in a foreclosure. For more info on the 1099s and The Mortgage Forgiveness Debt Relief Act, go to http://www.irs.gov/individuals/article/0,,id=179414,00.html
What Are My Possible Tax Consequences? Pertaining to the IRS -- If the borrower does not qualify for the tax exclusions above then he/she may be required to pay taxes on the cancelled amount. The IRS defines the amount your borrower is short; as having been cancelled;. It is required for the lender that allows this debt cancellation to issue the seller a 1099 for the cancelled amount and the seller is required to claim this amount as income.
Are the IRS and the Lenders Separate Pertaining to the Loss in a Short Sale or Foreclosure?
Yes -- the IRS determines additional taxes that may be owed because of a 1099 that the lender must submit regarding the deficiency amount, and then the lender does have the right to pursuit a deficiency judgment against the borrower to collect the shortage.
The lender has this right if its a short sale or if it a foreclosure. In most cases the amount of deficiency in a foreclosure will be much greater than with a short sale. Usually the borrower will be better off doing a short sale .
All sellers need to work closely with their CPA/Accountant to run tax scenarios using these new tax incentives to determine if 1099 income from short sale can be offset with losses from previous or future years.