As foreclosures across the U.S remain prevalent during these difficult economic times, many homeowners who may find their mortgage payments overwhelming are considering pursuing a short sale as an alternative to foreclosure.
A short sale is a sales transaction in which the seller's mortgage lender agrees to accept a payoff that is less than the total balance due on the loan to release an existing mortgage. Generally, lenders do not consider short sales unless the borrower is behind on loan payments. A short sale must be approved by the lender, and not all short sale applicants will qualify. In other words, while a short sale is a preferable alternative to a foreclosure, it is a time-consuming, complex process. Sellers considering whether or not to attempt to short sell their property need to understand the process and some of the issues they may face before exploring the short sale option.
Sellers Pursuing a Short Sale
If the decision has been made to pursue a short sale, the first steps are to contact a real estate agent experienced in handling short sales in your area and notify your lender that you are attempting to short sell the property. But just because you decide to pursue a short sale doesn't mean you'll automatically meet the requirements from the lender. Among other documentation, lenders may request the following to determine if they will consider consenting to a short sale of the property:
Letter of authorization – Includes the property address, name, date, agent's name and contact information and the loan reference number
Hardship letter – Describes the homeowner's need for a short sale (i.e., unemployment, hospitalization, divorce, bankruptcy, etc.)
Proof of income and assets – Including any savings and/or money market accounts, stocks or bonds, cash and other real estate
Copies of bank statements - Must show all deposits and withdrawals done over a period of time
Preliminary net sheet – An estimated closing statement that shows the expected sale price, along with all the costs of the sale, unpaid loan balances and outstanding payments due
Comparative market analysis – Shows the prices of similar homes sold in that area
Tax returns – Up to two years of tax returns
Buyers Purchasing a Short Sale Home
If a homebuyer is interested in a short sale home, hiring an agent with short sale experience can be invaluable for information and expediting the transaction. The agent will also be able to find out information not readily available to the buyer, such as whether or not a foreclosure notice has been filed and the balance of the loan still owed to the lender. If possible, consulting with an experienced real estate lawyer and an accountant who understands short sale tax ramifications before the sales process begins can help save time and money in the future.
Short sales are attractive to buyers because they are often able to purchase a home for less than what it is worth. However, the process requires patience. Even though the seller may accept a potential buyer's offer, the lender must approve the offer before the purchase is completed. In some cases, the lender may ask a buyer to increase the offer, despite the fact that the seller is willing to accept the original offer. If the lender's required offer price and other conditions aren't met, the sale will not close, even after weeks of negotiation.
If a short sale offer is accepted and escrow is opened, as part of the short sale terms, the lender often pays for certain expenses that a seller would normally pay. For instance, the lender may pay for the agent's commission, and thus may be entitled to negotiate the sales commission, which can cause delays in the transaction.
Short Sale Drawbacks for the Seller
Short sales may be more attractive than foreclosure in general, but they do have their drawbacks. First and foremost, a short sale is dependent on a buyer making an offer to purchase the home, the terms of which must be accepted by your lender. If acceptable offers are not received, foreclosure or a deed in lieu of foreclosure may be the only options, if a person is unable to make their payments.
In addition, as in a foreclosure, your credit history score (FICO) will be impacted negatively and there will be a waiting time for your credit to recover—which would also negatively affect the ability to borrow money to purchase a another home in the future.
If a lender agrees to the short sale, the lender may issue the seller a 1099-C (Cancellation of Debt) Form for the difference, which may be taxable as income in the year the property is sold. The seller should work with a tax professional and a real estate lawyer to determine whether he or she is exempt from being taxed on the amount that has been cancelled or forgiven according to the Mortgage Forgiveness Debt Relief Act of 2007.
The Short of it All
Though short sales have become more common these days, they aren't ideal in every situation. If a short sale is a consideration, a homeowner should weigh all of the options and consequences before moving forward. Every situation is unique, and the advice of a short sale real estate professional, accountant and attorney can help save a lot of time, money and headache in the long run.
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