Real Estate Short Sale Guide

Are there short sale tax ramifications)?

Before the current credit crisis, there were bigger short sale tax consequences as the IRS could consider debt forgiveness as income. An individual usually recognizes income when a debt is settled for less than the outstanding balance. The amount is included as income in your tax return and is taxable by the IRS.

The Mortgage Forgiveness Debt Relief Act of 2007 (enacted on 12/20/07, effective from 1/1/07 to 1/1/10), the bank is required to send you a 1099-C for the amount forgiven. The amount forgiven should be shown in box 2.

Here are the basic criteria under The Mortgage Debt Relief Act of 2007:

• Debt must have been debt incurred to acquire, build or substantially improve your principle residence. Debt from a 2nd mortgage or HELOC is not eligible.
• Cancelled debt up to $2,000,000 (Married) or $1,000,000 (Single) is eligible.
• Cancelled debt from investment property and 2nd home is not eligible.

Debt used to refinance your home qualifies for this exclusion, but only to the extent that the principal balance of the old mortgage, immediately prior to the refinancing, would have qualified.

The forgiven debt must be reported on Form 982 and be attached to your tax return. It can be downloaded at IRS.gov or call 1-800-829-3676. If you call to order, allow 7-10 days for delivery.

For those new to the real estate short sales, there is a mystery between selling your home as a short sale and preserving your credit rating. It’s an important and valid question.

Short Sale Basics

Short sales happen with the lender agrees to accept less than the amount owed on the mortgage because there is not enough equity to sell and pay costs of the sale. It used to be where lenders would not consider a short sale until you were late on your payments, but that has changed.

Short Sale Impact on Credit Score

Trying to predict the exact outcome of your credit score is quite difficult since your credit is affected by many variables and the FICO score is a constantly evolving process and changes over time. Also, your credit rating is composed of three different credit reporting agencies: Equifax, TransUnion and Experian.

Does a short sale affect your credit? First off, let’s compare two other alternatives to a short sale: foreclosure and bankruptcy. Based on reports and experience, a short sale is about 100 to 200 points less damaging to ones FICO score compared to a foreclosure and 200 to 250 less damaging than Bankruptcy. Short sales impact credit scores by not the actual short sale but the months of late or no payments made on your mortgage. The less number of late payments, the better your “short sale credit report”…to a degree. Not only is the FICO score reduction a factor to consider, but the length of time the credit is negatively affected.

A foreclosure will remain on a credit report for about 7 years, while a short sale will stay less. In addition, Fannie Mae has recently changed their underwriting policy for purchasing mortgages from banks. The wait time for a new loan with Fannie Mae is just 2 years but for another bank it’s 5 years after a foreclosure sale.

Typically, it will take about 18 months to 2 years before you can quality to buy a house again which is much better than the alternative of foreclosure.

Short Sale Hurt Credit

A short sale can hurt your credit score so you make sure when you negotiate with your lender on the details of the short sale, that they agree as “paid as agreed” or “paid in full” to lessen the impact on what is reported to the credit companies. A short sale where the customer walks away from the debt, will encounter credit damage.

In the end, short sales are a much better option than foreclosure or bankruptcy. Going through foreclosure will make it difficult for you to get a loan for at least 3 to 5 years, where a short sale will enable you to qualify for a new mortgage within just 2 years.
If the property owners needs to take a new loan from the bank to make up the difference the credit implications would be same as taking out a new loan. Sometimes taking out a new loan may even improve a credit rating.

Short FICO Score

Three credit events will severely ruin a FICO score and carry about the same weight:

• Serious delinquency
• Derogatory public record
• Collection filed

Renting After a Short Sale

Due to the current credit meltdown, many landlords are not harsh on those submitting credit that has foreclosure information listed. Although if there is a list of “derogs” over a broad category of obligations, then the credit report can be viewed negatively.

Of course, to avoid a short sale from hurting your FICO score, the best option is to have your lender restructure the loan. Your lender may be willing to make accommodations to avoid taking the property back or taking a greater loss.

Many homeowners who find themselves in a sticky mess with their mortgage(s) may try and opt for a popular option called a mortgage “short sale”. So, what are the details on short sales?

Well, if you are thinking of selling your home as a short sale but are still current on your mortgage, you may not qualify. Before doing anything, call your mortgage servicer and about their short sale procedure. Ask how the short sale will effect your credit versus a foreclosure. If your lender approves a short sale, realize that a buyer can submit an offer but the bank or lender may sit on the offer for weeks. You will need to wait to hear a response before moving forward with the sale since the lender has the final say. Make sure the offer submitted is solid, send proof that the home is worth the sales price and the reason for the hardship (known as a short sale hardship letter).

Can I Purchase Another Home if I Short Sale My Home?

No. A short sale will reduce your credit score to a point that you won’t be able to obtain another mortgage loan. If you purchase now, the home would be considered as an investment property in which you will need 20% down and this new home mortgage will carry a higher interest rate. If you have a second home, the lender will not allow the short sale on the first property. In addition, if you are unable to afford the current mortgage payments, you probably won’t be able to qualify for another mortgage at this time.

If you have fallen behind on your mortgage payments and you don’t see another way to avoid foreclosure, a short sale may be a good option to resolve the situation.

A short sale is where a lender or bank accepts a discounted mortgage payoff that is less than owed in order to sell the home of the financially distressed homeowner. The lender is essentially, forgiving the remainder balance of the mortgage loan. This resolves the problem opposed to simply walking away from the property hoping that the problem goes away. Inaction will inevitability result in a foreclosure vs a short sale.

With real estate short sales, there are pros and cons. Home sellers receive a benefit of avoiding a mess of their credit but they will do so without a cent in profit from the home sale and their credit score will still be hit in a bank short sale. Although, if a good faith effort is made, the lender may help minimize the damage to the credit score.

Remember, that short sales are a negotiated agreement between the owner and lender, so you will be in more control than in a foreclosure process. In foreclosures, the lender has the ability to pursue the seller for a deficiency judgment to obtain the difference between what was owed and what was actually collected. In short sales, the seller might be able to get the bank or lender to accept the sale as “payment in full without pursuit of any deficiency judgment”. The lender may agree to this language since they would prefer a maintained home instead of a home gone through foreclosure that potentially could get trashed.

Rejecting a Short Sale

Short sales can fail if there is no default on the loan or the seller has filed for bankruptcy. Few lenders will consider doing a short sale because negotiating a short sale is considered a collection activity and these activities are prohibited in bankruptcies.

Why Would a Lender Agree to a Short Sale?

A lender will agree to do a short sale to save time and money on their end. Foreclosures are expensive and time consuming for lenders and a short sale may be the lesser of two evils. In addition, the short sales will help the lender look good on paper, as the property will not be listed as an actual foreclosure and will help the bank’s numbers.

Convince the Lender

The lender will need convincing that a short sale must happen. To do so, a short sale package will need to be delivered to the bank. A short sale package includes a short sale hardship letter, value statement, offer or contract, a settlement statement and an authorization letter for a real estate agent to work on your behalf.

The hardship letter will need to explain how the seller’s situation is irreversible and you have no way to bring your mortgage up to date. The seller will need to supply as much evidence and documentation as possible including, evidence of job loss, divorce papers, last two years of tax return, recent pay stubs and bank statements. If there are medical issues, include statements and proof of the seller’s condition.

Finding a Short Sale Buyer

Purchasing a short sale is a big commitment for the buyer since short sales are notorious for not being “short” at all. Responses to short sale offers can take weeks and sometimes months, requiring the buyer to sit and wait during the whole time. If the buyer is in a rush to purchase a house, then they may walk, leaving the seller with no buyer. If the buyer is looking for a good deal and has the time to wait for the lender, then you’ve got yourself a potentially good buyer.

You may be tempted to sell your home using a “for sale by owner” sign but in cases of short sales it is highly recommended getting a real estate agent who has a track record with short sales and bank owned properties. Ideally, you would want someone who has a basic understanding of short sales or works closely with a broker who does. In addition, the real estate agent should have a list of investor and buyers in the area that may be interested.

Short Sale Tax Consequences

In the past, sellers were responsible for reporting and paying taxes a short sale. Since the Mortgage Forgiveness Debt Relief Act of 2007, short sale sellers have a big tax break by changing the way the forgiven amount is viewed for tax purposes. Prior to the act, the amount forgiven was considered as income to the borrower and subject to tax.

Getting a short sale sold can be tricky if you don’t know the ins and outs of the process. It’s quite important to interview, discuss and find a good real estate agent with plenty of experience to execute a successful deal. Here are a few simple steps to get a higher rate of short sale success.

Short Sale Step 1
Find out if the property qualifies for a short sale. The bank will need to following to determine if you qualify:

Hardship letter from seller

Last 2 paycheck stubs

Most recent bank statements

Authorization letter from a 3rd party to contact and negotiate with lender (your real estate agent or attorney)

1099 for W-2 forms for the last 2 years

Last 2 year’s income tax returns

Comparative market analysis showing most recent sales (prepared by your Realtor).

Your third party negotiator can send this information to your lender on your behalf once you’ve signed the authorization letter naming them as your authorized representative.

Short Sale Step 2
List the property for sale with a local Realtor. You need as most exposure as possible for your home to sell. Your agent may want to list the property at below market value to quickly attract many buyers to the table or offer a higher commission to get brokers to show the property to buyers.

Don’t try to list the property too high, especially since you are not expecting to get any of the sale proceeds anyways. The property will just sit on the market and you will lose valuable time. The lender will probably order a broker price opinion from a local Realtor to get an idea on how much the home is worth.

Short Sale Step 3
Submit your short sale package with a copy of the purchase and sale agreement for the lender to approve. The lender will pay for all the seller’s closing costs, HOA fees, back taxes and the broker’s commission.

Short Sale Step 4
Follow up with the lender to make sure they received the short sale package and call them repeatedly until a negotiator is assigned to the account.

Short Sale Step 5
Negotiate the offer with the lender which may take a few back and forths with the buyer and lender before agreeing on terms. Some short sales will fall through because the lender will not accept the buyer’s offer or the buyer walks away from the deal to find another property because the short sale process was taking too long.

It’s quite important for the Realtor to explain the short sale process to the buyer thoroughly so they may understand it can take as long as 90 days or longer. It can be best to work with an investor on short sales because they will typically not be in a hurry.

Short Sale Step 6
If the short sale offer is not accepted, then you will need to find another buyer to start the process once again. The good news is that the lender will have pre-approved a list price that they find acceptable, in which you can offer to the next buyer at the pre-negotiated price. It will speed up the process quickly since the short sale will be pre-approved.

Short sales have been on the MLS for at least a couple years now, but now the banks or lenders are coming up with another way to gain additional money to cover their losses.

A short sale is supposed to allow a borrower to sell their property for less than what is owed on the mortgage, walk away from the home and avoid foreclosure. Lenders are now trying to insert language into short sale contracts to allow them to sue for any “deficiency” or the amount lost by the bank by selling it for less than what was owed on the mortgage. This language can make the homeowner vulnerable by opening the door for collection agencies and court judgments to go after that lost amount.

Recently, real estate agents have seen about 50 percent of short sale contracts including this language. If caught and requested by the real estate agent, most of the time the banks will remove the language: lender may “pursue for a deficiency judgment for the difference in the payment received and the total balance due”.

Attorneys say that such clauses mean that the borrower’s trouble wouldn’t end with the sale of the property, but the lender could sue the borrower for a deficiency at a later date or turn over the unpaid debt to collection agencies after the short sale closes at escrow.

In these cases, it proves having a knowledgeable real estate agent will help in the short sale process. Although, borrowers can still face deficiency judgments at any point on certain types of loans. California law allows special privileges for “purchase money” loans (the original loan used to buy the home). In these mortgages the bank cannot legally sue the borrower for a nonpayment. Thus, a borrower late on a purchase money loan cannot face a lawsuit, even if no money was put down. But if the borrower refinanced the mortgage or has a home equity line of credit, the borrower can be sued for unpaid amounts following either a foreclosure or a short sale.

If the borrower can negotiate a short sale the bank may issue a contract that says it will agree to sell the property and release the borrower from the “trust deed”, the contract stating the borrower must pay back the loan in full.

Just watch out. The lender may be sneaky to keep any doors open to collect on any deficiencies at a later date.

It may appear that a real estate short sale is an easy way out for your mortgage problems, but you still must be qualified by your lender to your property as a short sale, since the bank or lender is the one forgiving the loss. Here are a few reasons why you may be considering a short sale that would also give you the highest chance of being approved by the mortgage company:

-Your property value has dropped – If you owe much more than what your home is worth today, many people are considering the option to sell their property.
-The mortgage has defaulted or could soon default – When the loan is in default, the lenders will be motivated to work something out. They are open to talking and working out a solution that can work for both parties to determine what will happen to the mortgage. If the mortgage appears to remain in default status, then the bank or lender may be more apt to selling as a short sale.
-The homeowner is experiencing a hardship – If something changed to cause a financial hardship that is either temporary or permanent, the lender would like to know. A loss mitigation specialist can successfully negotiate a short sale based on documented hardship.