Q: What is a Short Sale?
Answer: Short Sales occur when borrowers sell their property for a sales price less than the amount owed to their lender(s) after all sales expenses, including brokerage fees, are taken into account. In order for this to take place the lender(s) must accept a discounted payoff; meaning the bank(s) get paid less than the full loan amount owed. In a short sale, the homeowners get complete relief from all of their mortgage debt.
The end result is your home is sold, the mortgage is satisfied (paid off) and you avoid a foreclosure or a bankruptcy in the event of hardship.
Q: What are the Benefits of a Short Sale?
Answer: When a Short Sale is achieved, there will not be a foreclosure. A Foreclosure damages credit up to 7 years and bankruptcy up to 10 years. Many experts believe that a foreclosure is much worse than a bankruptcy.
Q: How will I know if I will qualify for a short sale?
Answer: Call our office and we can tell you over the phone whether you will likely qualify. The overwhelming majority of our clients are approved for a short sale because 1) we know how to submit the short sale package in such a way that the lenders will approve them and 2) we have a tremendous amount of experience with short sales and negotiating with the lenders.
Q: How will a short sale affect my credit?
Answer: This is a great question as there is a lot of misinformation on the internet about this topic. A short sale is recorded on your credit report as “debt settled for less than the amount owed”. This typically will result in much less of a hit on your credit compared to a foreclosure or late payments on your mortgage. We say ‘”typically” because it affects everyone’s credit differently. The more established your credit, the less of an impact it will have on your score.
The reason you often hear and read that a short sale will drop your credit 100 points or more, is because, many people who do a short sale, stop making their mortgage payments. If you stop making your mortgage payments for 4 months, regardless of whether you do a short sale or not, this will have a significant negative impact on your credit. In other words, it is the missed mortgage payments that have the big impact on your credit, not the short sale itself.
With this said, if you are already behind on your payments, you have already incurred the majority of the hit that a short sale will have on your credit. Doing a successful short sale at this point will insure that your debt is settled with your lender.
If you are current on your payments and can stay current throughout the short sale process, you will save your credit to a large extent.
Finally, if you do stop making your mortgage payments, you can consult with a good credit repair agency that can assist you and advise you on how to repair your credit in the shortest time possible. We would be happy to refer a good and reputable credit repair agency if you decide to employ this service.
Q: Will I have to pay federal taxes on the money my lender loses in the short sale?
Answer: There are several different scenarios with regard to whether or not you will owe federal income taxes on the loss the lender takes in a short sale.
When you do a short sale, your lender is agreeing to settle the debt on the property for less than the amount they are owed. The IRS therefore allows them to write off this loss, which is why your lender will send you a 1099-C after the short sale.
The IRS considers “debt relief” to be income for tax purposes. In other words, if your lender writes off $50,000 on your short sale , they will send you a 1099-C for that amount, and you would include that when you file your income taxes. The “C” stands for “Cancellation of Debt” and the law says cancelled debt is taxable as income.
There are however a few exceptions that most people who do a short sale qualify for that exclude them from having to pay taxes on their short sale.
Thanks to the Mortgage Tax Debt Relief Act that George W. Bush signed into law in January of 2008, homeowners who do a short sale on their primary residence, and have a purchase money loan (in other words, they have not pulled cash out of their home with a cash-out refinance) pay no taxes on the loss that their lender incurs in a short sale.
Homeowners who have pulled out cash from their home but have put that money back into their home to “substantially improve” their home, also are excluded from taxes on the short sale.
All other short sale scenarios – if you pulled cash out on your primary residence but spent it on something other than upgrading your home or if you are doing a short sale on a second home or investment property – result in a taxable event unless you qualify for the “Insolvency” exclusion.
The IRS does not require you to pay taxes on the loss the lender takes in a short sale if, at the time of the short sale, you are insolvent. Insolvency means your debts (including your mortgage) exceed the value of all your assets. In other words, if, at the time of the short sale, you have more debt than you do money or assets, you are considered insolvent.
Many people who find themselves facing a short sale are in exactly this situation and are thus excluded from paying taxes on a short sale. We recommend you check with your CPA or accountant or go to the IRS website and look up IRS Form 982, which is the IRS form for debt relief and short sales. The IRS gives an explanation of “Insolvency” on this form.
Finally, the time period for The Mortgage Tax Debt Relief Act was originally only slated to go until the end of 2008, however it was extended to the end of 2012.
UPDATE: On January 3rd, 2013, President Obama signed The American Taxpayer Relief Act which extends the deadline of the Mortgage Tax Debt Relief Act to December 31st, 2013.
Q: Can my lender go after me for the money it loses in the short sale?
Answer: The point of a short sale is to get out from under the debt of the mortgage. This is why your lender will send you a 1099-C after the short sale. The “C” in “1099-C” stands for “Cancellation of Debt.” Your lender cannot write off their loss on their corporate taxes, send you a 1099-C so you have to pay taxes on the loss, report the short sale as a “settled debt” on your credit and then turn around and go after you for the money.
If you hire and inexperienced short sale agent or negotiator who does not negotiate a full release from your lender, then, yes, you could be liable for the money the lender loses in a short sale or end up being forced to sign a promissory note to close the deal.
We do not ever recommend that our clients sign a promissory note or close escrow without a full written release from their lender(s).
Q: What if I have a first and a second loan on my property with two different lenders (or the same lender)?
Answer: Many people that we do short sales for have a first and a second loan, often with two different lenders. For the short sale to reach a successful close of escrow, both lenders have to approve the short sale and agree to settle the debt.
It is important to note that both lenders have a vested interest in doing this. The lender with the first loan does not want to foreclose, and therefore is willing to give a little money to the second in order to get them to agree to the short sale.
The second lender will get nothing if the first forecloses, so with the attitude that something is better than nothing, they will agree to take a fraction of what they are owed in order to avoid getting absolutely nothing.
Q: How will I know that I am being released from the debt?
Answer: It will be stated clearly on the bank’s short sale approval. Your lender will state in plain English (though in different verbiage depending on the lender) that they are “releasing the lien”, “accepting a short payoff to satisfy the lien”, “reporting the sale as a settled debt to the reporting agencies”, “issuing a full satisfaction of the mortgage”, “not pursuing a deficiency judgment”, or some other variation that states they are settling the debt for less than what they were owed.
Further, your bank will issue a 1099-C to you, the borrower, after the short sale, confirming that the debt has been written off and is settled. Your lender cannot write off the debt, issue you a 1099-C & then go after you for the deficiency.
Q: What are the advantages of a short sale vs. letting my home go to foreclosure?
Answer: The primary advantage to doing a short sale vs. walking away and letting your home go to foreclosure is that in a short sale the debt is settled and you no longer owe the bank any money. If your home goes to foreclosure, you may still be liable for the deficiency in th.
A secondary (but still very important) advantage is that in a short sale, your credit takes much less of a hit compared to a foreclosure. The impact on your credit will vary depending on how established your credit is at the time of the short sale or foreclosure.
Finally, Fannie Mae & Freddie Mac revised their guidelines in August of 2008 with regard to how they view borrowers who have filed bankruptcy, gone through foreclosure or done a short sale. Through these new guidelines, they are in effect severely penalizing those who go the route of foreclosure or bankruptcy, and rewarding or encouraging those who do short sales, which they view as the borrower doing the responsible thing in light of the circumstances.
Per recent Fannie Mae / Freddie Mac guidelines, borrowers who file bankruptcy or go through foreclosure have to wait up to 7 years to buy another home.
By contrast, the new guidelines stipulate only a 24 month waiting period after a short sale, so borrowers who do a short sale can buy again in just 2 years.
Q: How much will a short sale cost me?
Answer: A short sale costs the seller nothing – the lender pays all closing costs, escrow fees, commissions etc. The lender may also pay any outstanding property taxes. In fact, you may be eligible to receive cash back after performing a successful short sale with your lender. These seller cash incentives range from $1,000 to as high as $10,000 and are being paid by Lenders, the U.S. Treasury (HAFA), and FHA (HUD) to Short Sale your home (versus being foreclosed on). You can use this money you receive at closing for moving and relocation costs (or to just get back on your financial feet).
Q: How long will a short sale take?
Answer: The short sale process typically takes about 4 months, start to finish. It can take longer depending on how backlogged the lender is. You can live in the property for the entire duration of the short sale or you can move out whenever you wish.
Q: Do I need to be behind on my payments to do a short sale?
Answer: No. This is a common misconception. You do not need to be behind on your payments or have been late on a payment to do a short sale although the lenders are more motivated to do the short sale if you are not making payments.