Questions & Answers: Short Sales

Q: What is a Short Sale?

Answer: A short sale is when the lender agrees to settle the debt owed on the property for less than the amount currently owed.  “Settled” means that the bank  is writing off the debt (which is why you get a 1099 after a short sale for the debt forgiven) and that they are not going to go after you for the money they lost by filing a deficiency judgment in the future.

Q: How will I know if I will qualify for a short sale?

Answer: Simply click here to provide your contact information  and we will immediately begin the qualification process.  I have a very high success rate when helping homeowners avoid foreclosure by pursuing a short sale.

Q: How will a short sale affect my credit?

Answer:   Great question! There is currently 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 usually will result in a relatively minor hit on your credit compared to a foreclosure or late payments on your mortgage.  The word ‘”usually” is used because it affects each person’s credit differently.  The more established your credit, the less of an impact a short sale will have on your credit score.

The main reason you often hear and/or read that a short sale will reduce yoru credit rating 100 points or more is that  many homeowners persuing 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, four months of missed mortgage payments will have a significant negative impact on your credit.  The missed mortgage payments have the big impact on your credit, not the short sale itself.

With that being said, if you are already behind on your payments then you have already incurred the majority of the hit that a short sale will have on your credit rating.  Conductiong 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.  If you do stop making your mortgage payments, there are various credit repair agencies that can repair your credit by removing late payments from your credit report after a short sale.

Q: Will I have to pay federal taxes on the money my lender loses in the short sale?

Answer: There are several different scenarios regarding  whether or not you will owe federal income taxes on the loss that the bank takes in a short sale.

When you proceed with 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 upon the successful closing of your home.

The IRS considers “debt relief” to be income for tax purposes. In other words, if your bank writes off $50,000 on your short sale, they will send you a 1099-C for that amount.  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 conduct 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 proceed with 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 are also excluded from having to pay taxes on the loss incurred by the bank.

All other short sale scenarios – if you pulled cash out on your primary residence but spent it 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 will not require taxes to be paid on the loss the lender takes in a short sale if at the time of the short sale you are insolvent. Insolvency means your debt–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 scenario are in exactly this situation and are excluded from paying taxes on a short sale.  It is highly 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  the term “Insolvency” at this website location.

Finally, the time period for The Mortgage Tax Debt Relief Act was originally slated to go through the end of 2008.  However it has now been extended to the end of 2012.

Q: Can my lender go after me for the money it loses in the short sale?

Answer:  The main purpose 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 you may be liable for the money the bank loses in a short sale or end up being forced to sign a promissory at the table.  It is never recommended 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 2 different lenders (or the same lender)?

Answer: Most homeowners that I help with a short sale have a first and a second loan–often with 2 different lenders. For the short sale to successfully close both lbanks must approve the short sale in writing 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 zero capital.

Q: What is the difference between a recourse and a non recourse loan?

Answer:  In general, a purchase money loan is considered to be a “non recourse” loan, while a “cash out” loan is considered to be a “recourse” loan.  The difference between these two types of loans is that in a “recourse loan” the lender technically has recourse to go after the borrower for the money they lose in a foreclosure.  I say “technically” because  for this to happen the lender has to file a judicial foreclosure.

Q: How will I know that I am being released from the debt?

Answer: It will be stated on the bank’s short sale approval letter. Your lender will state in plain English (though in different verbiage depending on the bank) that they are “releasing the lien”, “reporting the sale as a settled debt to the reporting agencies”, “accepting a short payoff to satisfy the lien”, “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.  Again, your mortgage holder 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 the event that the bank files a judicial foreclosure.

A secondary yet important advantage is that in a short sale is that your credit takes much less of a hit compared to a foreclosure.  As mentioned above, the impact on your credit will vary depending on how established your credit is at the time of the short sale or foreclosure.

Freddie Mac & Fannie Mae  have 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 updated 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 short years.

Q: Are there any advantages to letting my home go to foreclosure vs. doing a short sale?

Answer:  I have yet to hear a coherent argument for letting your home go to foreclosure vs. doing a successful short sale.  Depending on whether you have a recourse or non-recourse loan, when you let your home go to foreclosure you either run the risk of being liable for the deficiency amount or liable for the income taxes on that loss.  Secondly, your credit will drop up to 400 points and you will not be able to buy a home or get any decent credit for up to 7 years.

Compare this with a short sale, in which the lender agrees to SETTLE the debt for less than the amount owed. If you have recourse loan, you may be liable for income taxes on the lender’s loss (just as in a foreclosure) but you will not be liable for the deficiency (and if you qualify for the “Insolvency” exclusion, you will avoid the income taxes as well).

Further, the loss that the lender takes in a short sale will be MUCH LESS than the loss the lender takes at the end of the foreclosure process. The foreclosure process takes months & months, at the end of which the lender has to process the property through its overwhelmed system (another 3 -5 months) and then put the property back on the market–all while the market continues to drop.

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.

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 your mortgage holder 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 tend to be more motivated to do the short sale if you are not making payments.

Q: Should I file bankruptcy? Will it allow me to keep my home? I’ve heard the lender cannot foreclose if I file bankruptcy.

Answer: There are 2 types of bankruptcy commonly used by individuals – Chapter 7 (“Fresh Start”) and Chapter 13 (“Wage Earner”). Chapter 7 enables individual filers to wipe away debts such as credit card and medical bills so they can continue to make their mortgage payments.  Chapter 13 involves setting up a 3-5 year repayment plan to repay your debts. Chapter 13 requires that you are earning a steady income, as you will be repaying all of your debt. Both have a very negative impact on your credit and remain on your credit report for 10 years.

Because of the new 2005 bankruptcy law, which raised the bar for people to qualify for Chapter 7 “fresh start” bankruptcy proceedings, fewer and fewer people pass the “means” test to qualify for Chapter 7 and for this reason can only qualify for Chapter 13 bankruptcy (a 3-5 year repayment plan).  While both Chapter 7 and Chapter 13 can temporarily delay foreclosure proceedings, neither will allow you to keep your home unless you can bring your mortgage current.

In a nut shell (I know this was a long article), it is worthwhile to pursue any alternative besides foreclosure.  I am available to chat at anytime so give me a call or shoot me an email (which is confidential) if you need questions answered or are intersted in pursuing a short sale rather then letting your home go into foreclosure.

OVER 406 BANK OWNED HOMES FOR SALE IN ADA COUNTY

As you probably know, there is a plethora of bank owned homes for sale in Boise, Meridian, Eagle, Kuna and Star.   Banks are motivated to sell and will typically price these distressed homes 10-30 percent under current market values.  Granted, most do need cosmetic work done prior to move-in such as new carpet, paint, lawn maintenanceand other misc items.  However, there are some bank owned property which the previous homeowner has taken it upon themselves to leave the residence in nasty shape by taking a sledge hammer to walls and doors along with pulling all appliances like the range, dishwasher, disposal and microwave (sometimes water heaters and furnaces, too).  Unless you would like to take on the costs, I suggest bypassing some of the bank owned homes on the market. 

It is also important to not look for only bank owned homes.  There are numerous non-distressed homes on the market (fair market sellers) that must sell.  These homes are priced competitively and do not need the improvements that a foreclosed upon home typically does.  With that, it is important to consider the costs of repairs when deciding whether to purchase a home which needs some love (yet is priced lower than the home down the street) or one that is turn key and ready to be moved into.

Bank owned homes will be prevelant in our market through 2010 and part of 2011.  Would you like a list of bank owned homes forwarded to you?  If so, read this article or send me an email with your contact info and I will provide a list of bank owned property currently on the market.

The 7 Short Sale Myths

1)  Short sales rarely get approved.  FALSE

TRUTH:  Although short sales are difficult, acquiring or selling a home as a short sale is not impossible.  More and more short sales are being approved on a monthly basis and the new HAFA guidelines should help making short sales easier to facilitate.  Most importantly, it is essential to acquire the services of a short sale specialist who is experienced and knows the “ins and outs” of short sales along with systems used to make the sale a success.

2)  Banks are waiting for a bailout.  Thus, making it difficult to purchase a short sale or sell your home as a short sale.  FALSE

TRUTH:  Banks have already been bailed out and seem to be doing everything possible to avoid another foreclosure.  More and more banks are pursuing short sales and agents who understand how to process the transaction.  In most cases, it costs that bank 30% more to let the home go into foreclosure rather than approving a short sale.

3)  You must be behind on your mortgage in order to be eligible for a short sale.  FALSE

TRUTH:  In the past it was very difficult to obtain a short sale approval from the bank.  However, the financial institutions mindset has reversed.  Today lenders are looking for verifiable hardship, monthly cash flow shortfall or pending shortfall insolvency.  If you meet any of the mentioned requirements then you are eligible to sell your home as a short sale without being delinquent on your home loan.

4)  Buyer are not interested in short sales and tend to avoid them like the plague.  FALSE (for the most part)

TRUTH:  Some buyers are not interested in short sales due to the lengthy waiting periods–especially when there are time constraints associated with the purchase similar to the First Time Home Buyer Tax Credit or Move-Up Credit.  On the other hand, those that can be patient tend to obtain some very good buys–some which are sold for over 30% under current market values. 

5)  Selling your home as a short sale is an embarrassment.  FALSE

TRUST:  Most sellers would prefer that the community wasn’t aware of the financial hardships at hand.  However, 1 in 5 homeowners within the United States owe more on their home then what it can be sold for.  Even wealthy owners must stop the bleeding at some point.  Those who sell their home as a short sale rather then letting it go into foreclosure should be congratulated.  Check out my recent post which discusses this by clicking here.

6) The bank would much rather foreclose than bother with a short sale.  FALSE!!!

TRUTH:  The myth began in part to collection representatives working for the lender which would often state this myth in an attempt to collect the debt.  The realty is that banks do not want to foreclose on homes–it costs way too much.  An average foreclosure costs the bank 30% more to foreclose than to facilitate a short sale due to the holding costs, insurance, realtor fees and other miscelaneus fees needed to care for and sell the home.

7) There is not enough time to negotiate a short sale before the home is foreclosed upon.  FALSE

TRUTH:  This myth hurts homeowners the most.  The foreclosure process is lengthy.  It can take up to a year (or more) for the home to be foreclosed upon by the bank.  Nearly all banks will postpone a foreclosure with a legitimate contract for a short sale.  A postponement can be obtained within days of foreclosure.