All About Short Sales
What Is a Short Sale?
A Short Sale is when the value of the home being sold is less than the amount owed on the outstanding loan(s).
For example, in 2005 you paid $350,000 for your home and took out a loan for $320,000, but today the home is worth only $275,000. If you must sell the home today the home is only worth what the market is willing to pay. The amount to pay off the loan is still approximately $320,000 minus $275,000 which puts you $45,000 under the payoff amount, not counting any small amount of equity gained during the five years.
Of course, you could wait for the market to improve before you sell your home. Some experts have been estimating the recovery to take 10-20 years to possibly get back to the values of 2005. However, if you must sell your home you do have some options. You could pay the difference to the lender in cash, or you could let the home go into foreclosure. Another option is to pursue a Short Sale.
Can anyone do a Short Sale?
In order for the lender to approve a Short Sale, you must prove to the lender that you have a hardship situation. Such as job loss, chronic illness or injury, reduction in income, increase in interest rate, divorce, or death, for example.
Are there any Credit Consequences of a Short Sale?
Going the Short Sale route can have varied consequences. Usually it will show up on your credit report as a “settlement for less than owed” or a “pre-foreclosure in redemption” and can result in a drop of your credit score by 80-100 points. In many cases the home owners are already behind in their monthly payments - this causes a few ‘lates’ recorded on your credit report and can possibly have some additional effect on the credit score.
Through negotiation with the lender, in some cases, it is possible to get these off your credit report within a few years or less and in other cases avoid having the Short Sale reported to a credit agency all together.
On the other hand, not doing a Short Sale but waiting for the bank to foreclose can have much greater consequences. A foreclosure on your credit report can take much longer to remove - in most cases 7-10 years - and can cost your credit rating (FICO) up to 200-280 points.
If you cannot make the payments and you must sell your home, it is best to cooperate with the lender as much as possible. Avoid foreclosure!
Will I still owe any money after the Short Sale?
The homeowners may still owe the difference between the mortgage balance and the discounted amount as a result of a "deficiency judgment." If granted, this judgment will affect the homeowners and their credit report just as any other judgment.
In order to avoid this judgment you must get the bank to accept "payment in full without pursuit of any deficiency judgment”. Another factor to look out for is that the discounted amount (the difference between the mortgage balance and the Short Sale) may be declared as income on their income tax return by means of a 1099-C Tax Form. Every situation is different and you should contact an accountant, tax advisor, or attorney before conducting a Short Sale.
In the example above you are selling short of what you owe by $45,000. The IRS considers the $45,000 that was “forgiven” by the lender as “debt relief” income. The IRS can use your tax basis on your property to determine your tax obligations.
It is possible to request a “reduction in the tax tributes form 982” due to insolvency. Once again it is best to consult your tax advisor, accountant, or attorney before conducting a Short Sale.
Starting the Short Sale Process
Working with a knowledgeable Realtor is really helpful to guide you through the Short Sale process. Every lender is different - some will want the home owner to call and verbally initiate a Short Sale, whereas other lenders will initiate a Short Sale only after an offer has been submitted on your home. For starters, a Short Sale package will be needed. All the documentation needed to start a Short Sale is commonly called a “Short Sale Package” and is usually submitted by the agent representing the seller. Once again Short Sale Package items can vary depending on the lender(s), but commonly include the following:
- Cover letter (Explaining your hardship situation)
- Sellers Hardship letter to include (job loss, chronic illness or injury, reduction in income, increase in interest rate, divorce, death, etc.)
- Authorization to Release information
- You also need to calculate your estimated closing costs. Include items such as agent commissions, unpaid property taxes, attorney fees, appraisal, escrow, title report, etc.
- Seller’s financial information (investments accounts, retirement accounts, etc.)
- 2 years of w2’s
- 2 months of pay stubs
- 2 months of bank statements
- Comparable sales for the property
- Repair estimate for the property
- Contract
- Net Sheet
- If 2nd mortgage - holder may ask for payoff amount of the 1st
- Lender may ask for initial Title Report
- Some lenders such as FHA and VA may use their own forms and have different requirements.
What to expect during the Short Sale Process
- Getting started - each lender is different, but most require the Short Sale Package.
- Collect your financial and hardship letter information.
- Determine the true market value for the home - a Real Estate agent can provide a ‘market analysis’ to suggest a reasonable selling price.
- Get the home listed so you can submit an offer to the bank.
- Once an offer has been submitted the bank will start the valuation process. This can be a very slow and quiet time that can take 30-60 days with little or no contact from the bank. However, the lender is working by ordering the appraisals or BPO’s (Broker Price Opinions) and comparing local sales for price comparison
- After a typical 30 day window to finalize the sale, it is time for Closing!
Helpful web sites:
WWW.Hud.Gov/Foreclosure
WWW.Realtor.com/shortsale.com
WWW.Realtor.org/shortsales
http://Makinghomeaffordable.gov
WWW.Freddiemac.com/avoidforeclosure
WWW.Hud.gov/offices/hsg/sfh/nsc/fagnsctc.cfm
