Real Estate Short Sales
A short sale is a sale of a home by a financially distressed homeowner for less than the amount remaining on the mortgage and in which the lender has agreed to forego the remaining debt, so that the homeowner can give clear title.
A short sale allows the seller to avoid bankruptcy, but the lender may post a negative item on the borrower's credit report, which will lower the consumer's credit score, but not as much as foreclosure. Buyers benefit because they can buy property at a lower cost, and, surprisingly, the lender can benefit also; otherwise, the lender would never agree to it. The lender benefits because a foreclosure can cost as much as $50,000 in foreclosure proceedings and marketing costs, and it might be hard to get a better price through foreclosure, after expenses, when real estate prices are falling and there are already many foreclosed properties on the market.
However, a lender would only agree to a short sale if the lender believes that the homeowner is not going to be able to continue making payments, because it would be more profitable for the lender if the payments were continued. A short sale is also unlikely if there is a 2nd mortgage on the house, since it would require that the junior lender forgive all or part of the loan, which is unlikely.
The disadvantage to buyers is that the short sale could take a very long time. If you want to buy a property through a short sale, and you think the property was overpriced when purchased, or if home values are falling rapidly, show the lender an appraisal of the property as well as recent prices on comparable property. If the remaining mortgage is greater than its current value, the lender will have difficulty selling the property through a foreclosure, and so, it may benefit the lender to agree to a short sale.
If you are a homeowner that seriously needs to consider a short sale, then you should gather all the documents together to verify your situation and explain it to your lender. Explain in a letter the reason for your financial stress, and that it is unlikely to change soon. You should also provide pay stubs, tax returns, banking statements, and a list of all of your debts to verify your situation.
If the lender approves of a short sale, then you should get it in writing that the remaining debt will be forgiven. You should also ask the lender to report the item as a satisfied debt rather than settled for less than full balance in your credit report.
The other major consideration of a short sale is taxes. The IRS treats forgiven debt as income. The lender may send a Form 1099-C, Cancellation of Debt to both you and the IRS listing the amount of the debt that was forgiven. The IRS will treat this as income with taxes due, unless you are insolvent, which simply means that your debt exceeds your income, or the mortgage was a nonrecourse loan. A nonrecourse loan is a loan in which the lender accepts the collateral, in this case, real estate, as the only backing for the loan. It cannot sue the borrower for any additional amount. In most cases of a short sale, however, the homeowner probably doesn't have a nonrecourse loan, since it is very likely that that the downpayment was less than 20% of the value of the property. Without sufficient equity in the collateral, most lenders would never agree to a nonrecourse loan. However, most people who would need a short sale would probably be insolvent; otherwise, there would be no need for a short sale.
There is a temporary tax provision that expires after 2012 that allows a homeowner to exclude canceled debt of up to $2,000,000 on a principal residence from gross income. However, the taxpayer must fill out Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness to inform the IRS about the exclusion.
- Getting Cash in Exchange for a Short Sale
- Research looks at how mortgage delinquencies affect scores - Banking Analytics Blog - This blog entry, posted on FICO's website, shows the impact of late payments on mortgages for 3 typical borrowers with initial credit score of 680, 720, and 780. It also points out that a short sale, deed in lieu of foreclosure or other settlement, or a foreclosure will have the same impact on one's credit score, lowering the credit score to around 605 to 675. However, if there was a deficiency balance, then the credit score can drop as low as 570. The post also lists the amount of time it will take to recover to the previous score, where an initial 680 score will take 9 months to recover after being either 30 days or 90 days late on a mortgage payment, whereas someone with an initial score of 780 will take 3 years to recover after a 30-day late payment and 7 years to recover after a 90-day late payment, which is the length of time that the credit event can be listed in the credit reports on which the score is based. Bankruptcy lowers the credit score to about 525 to 560 for all borrowers. However, a 680 score can recover in about 5 years, while the 720 and 780 scores will take 7 years to recover, while a chapter 7 bankrupt will take 10 years to recover, which is the amount of time that the bankruptcy can be listed on the credit report. The time it takes to recover from a short sale, deed in lieu of foreclosure, or a foreclosure is the same as it is for a bankruptcy.