A short sale is a real estate transaction in which the sales price is insufficient to pay the debt(s) encumbering the property, along with the costs of sale, and the seller is unable to pay the shortage.
A short sale is often used to avoid foreclosure to reduce the effect on credit scores. This allows one to buy a home again in the future much sooner than if one went through foreclosure. It is important to know that short sales, just like foreclosure, will result in a negative credit report against you. A foreclosure usually is more detrimental to your credit rating than a short sale, however, if you have several missed payments, when doing a short sale, your credit can be just as negatively affected.
Fair Isaac released a report that says the average points lost on a FICO score are as follows:
• 30 days late: 40 to 110 points
• 90 days late: 70 to 135 points
• Foreclosure, short sale or deed-in-lieu: 85 to 160
• Bankruptcy: 130 to 240
In a successful short sale, the lien holders agree to release your lien (the mortgage, home equity line of credit, etc.) on the real estate and accept less than the amount owed on the debt. Any unpaid balance owed to the creditors is known as a deficiency.
Even if a lien holder agrees to a short sale agreement, this does not mean they necessarily release you from your obligations to repay any deficiencies of the loans, unless specifically agreed to. Creditors generally require you to prove that you have an economic or financial hardship preventing you from being able to pay the deficiency.
There are many other types of liens and other obligations that may be secured by real estate besides your mortgage loans, such as contractor liens, IRS tax liens, DSHS liens for unpaid child support, HOA assessments or other obligations. The type of debts and type of property will determine what remedies a lender may have if you fail to make the required payments. For a short sale to be successful, all lien holders will need to approve individual applications for a short sale, should they be asked to take less than what is owed.
A short sale in which the debt is forgiven is considered a “relief of debt” and the forgiven debt may be treated as income for tax purposes. The Mortgage Forgiveness Debt Relief Act of 2007 created a limited exemption to allow homeowners to pay no taxes on debt forgiveness; however, the exemption only cancelled debt used to buy, build or improve a principal residence or refinance debt incurred for those purposes qualifies for this tax exemption. For more information on the tax consequences of debt relief, seek professional tax advice and go to www.irs.gov and conduct a search regarding the Tax Relief Act.
The Home Affordable Foreclosure Alternative program (HAFA) was designed to give homeowners alternatives to a foreclosure, which include incentives for completing a short sale. If your home sale can close as a HAFA transaction, you will emerge owing no deficiency. However, it can be very difficult to qualify as a HAFA transaction because all lienholders must agree and often a 2nd or 3rd lien holder won’t agree. For more information on the options available, visit the HAFA program website.
Most large creditors have special loss mitigation departments that evaluate borrowers’ applications for short sale approval. Often creditors use pre-determined criteria for approving the borrowers and the terms of the sale of the properties. Part of this process typically includes the creditor(s) determining the current market value of the real estate by obtaining an independent evaluation of the property from an appraisal or BPO (broker price opinion). One of the most important aspects for the borrower in this process is putting together a proper real estate short sale package. The package should be well organized along with a hardship letter telling the creditor why a short sale is needed. Most agents now work together with real estate attorneys and can help you with this process.
There are many factors you should take into account when considering a short sale on your property: the lender’s policies regarding forgiveness of debt, the tax consequences, your overall financial strength, the lender’s willingness for processing a short sale request, and the number of other recorded liens on the property. It is possible for any one lien holder to prevent a short sale by refusing to agree to negotiate a reduction in their payoff to release their lien. If a Creditor has mortgage insurance on their loan, the insurer will likely also become a third party to these negotiations as the insurance policy may be asked to pay out a claim to offset the Creditor’s loss.
Short sales can have a high risk of failure from inability to obtain agreement from all parties or they might not be approved in time to prevent a scheduled foreclosure date.
Although the time to process short sales has decreased, it can still take several months to a year for the process to be completed.
A short sale is a very complex transaction that involves numerous issues as well as legal and financial risks. We advise our clients to seek the advice of an attorney and tax professional before proceeding with a short sale, however we are happy to answer any preliminary questions you may have and offer free seller and buyer consultations to review your circumstances.
Kerstin G. Brooks
Brooks & Heinze Team
Skyline Properties, Inc.