Short Sale Basics
What is a Short Sale?
A short sale occurs when a lender accepts less than what is owed on the mortgage. The homeowner sells the mortgaged property for less than the outstanding loan balance, and turns over the proceeds of the sale to the lender. Lender’s are willing to approve short sales because they already own an tremendous amount of real estate and because there are costs involved when foreclosing a property. A short sale is simply the most economical solution to a problem.
Who qualifies?
Simply put, anybody who is “under-water”in their home, in that they owe more than what the property is worth. Typically lenders want evidence of a hardship or financial difficulty on behalf of the borrower. Examples of hardship include relocation, loss of job, inability to keep up with mortage payments, inability to sell your home due to market conditions, loan balance higher than market value, death, divorce, and many more.
Either to avoid foreclosure, or because you are so far “underwater” on your home that you have little incentive to continue making payments. One of the worst things that can go on your credit report is a Foreclosure. Not to mention that losing your home in foreclosure due to the inability to keep up with your monthly housing expenses is one of life’s most unpleasant experiences. Most people do not realize that a short sale is often a better option than foreclosure. Your goal with a short sale is to sell your property in a timely manner, relieve yourself of any further financial obligation to your lender, and avoid having a foreclosure on your credit.
How will a short sale affect my credit?
When you miss mortgage payments your credit will be negatively affected – period. However a short sale itself will not affect your credit nearly as much as a foreclosure, a deed-in-lieu, or a bankruptcy. Furthermore, restoring your credit after a short sale is often a much easier task than after foreclosure or bankruptcy. Exactly how much your credit score will be impacted is difficult to predict as this will vary from person to person. However, some credit experts suggest a short sale will result in a FICO loss between 75 to 100 points whereas a foreclosure will result in a FICO loss between 200-280 points. Under a short sale situation, you will likely be able to secure a new home loan in about one to two years after the transaction. Alternatively it can take as long as five to seven years to secure a new home loan with a foreclosure.
Why don’t I just file Bankruptcy?
When faced with foreclosure, many people immediately think bankruptcy is the best option to solving their problems. If your home is the only debt creating an uncontrollable situation for you then a short sale is most likely your best option vs. a bankruptcy. If you have other uncontrollable debt than a bankruptcy might also be needed in addition to a short sale. Please know that filing bankruptcy will consolidate your debt and can wipe out your liabilities, but it might not save you from eventual home foreclosure. It is very possible to come out of bankruptcy and still face foreclosure, thus reflecting BOTH BANKRUPTCY and FORECLOSURE on your credit. If you need to file for bankruptcy and know you’re eventually going to give your home to the bank, a successful short sale will eliminate the foreclosure. You can conduct a short sale while in the bankruptcy, but it might take more time and more paperwork. If you are filing bankruptcy and a short sale is the best process for your home, it is often best to close the short sale transaction just before the bankruptcy or right after the bankruptcy protection is lifted.
Bottom line, if you have questions about bankruptcy, consult a qualified bankruptcy attorney. If you have uncontrollable debt other than your home, a bankruptcy might be needed in addition to a short sale.
Why will the bank “forgive” my debt?
Simply put, banks are not in the business of owning homes. Banks currently own a record number of homes due to the huge increase in recent foreclosure activity, and asset managers are innundated with the amount of REOs they are managing. Furthermore, the foreclosure process also cost banks time and money. Think of a short sale transaction as a pre-foreclosure. You are just securing a buyer prior to your foreclosure sale date, if one is already set. A bank will typically accept a short sale because they deem that foreclosure will incur higher losses. Banks understand losses from loan defaults are just part of the business they are in. A short sale transaction allows a bank to cut its losses and move on.
What is a deficiency?
A deficiency is the loan loss realized by the bank when it accepts less money than what it is owed.
How do banks handle a deficiencies?
Forgiveness – Believe it or not, some lenders will fully forgive the deficiency.
Promissory Note – A lender can issue the borrower a promissory note which specifies that the borrower must pay back all or a portion of the amount owed over an extended period of time (i.e. 15-20 years in the form of monthly payments at 0% interest).
1099 Tax Form – Frequently the lender will choose to issue a 1099-C to the borrower for the deficiency amount. This is considered loan forgiveness in the eyes of the IRS. When you file your tax return for the tax year in which your debt was written off, the IRS will require that you report the amount on the form as income. The bank basically considers their loss as your gain, therefore making this “gain” taxable. Fortunately, most homeowners are exempt from federal tax due on mortgage debt forgiveness du to passage of the Mortgage Forgiveness Debt Relief Act of 2007.
Cash Contribution – Depending on the borrower’s circumstances, sometimes the lender may just ask for a negotiated cash settlement at the time of closing. This can range anywhere from $200 to $5,000.
Read frequently asked questions about short sales!