Short Sales
A short sale is the sale of a home where the bank or mortgage lender has permitted the homeowner to sell for less than what is owed on the property. Typically, when a homeowner is facing foreclosure, a short sale benefits both the homeowner and the lender. The homeowner is able to reduce some of the damager to his/her credit, while the lender is able to avoid a more expensive foreclosure action. Though this might seem like a magical solution, completing a short sale does present a challenge to the homeowner since banks usually take a significant amount of time to approve a short sale. So much time that by the time a bank approves a short sale proposal, the buyers have usually either lost interest or their financing. The approved short sale is usually valid for only 30 days, so finding a new buyer is challenging given the tight lending environment of today.
Consequences of Short Sales
- Tax Liabilities: The recent Mortgage Forgiveness Debt Relief Act of 2007 limits the amount of tax liability on primary residences. Keep in mind that if you are short selling an investment property or a second home that you are still likely on the hook for taxes on income from debt forgiveness. The other thing a homeowner should keep in mind is that short sales may be subject to capital gains taxes. Further reading is available on tax issues involved with a foreclosure.
- Credit Consequences: In order for a homeowner to get the best result and minimize the amount of damage to their credit they must convince the lender to report the short sale as a “paid as agreed” or “paid in full” to the credit reporting agencies. Otherwise you could be facing a credit score drop of about 80 to 100 points, though compared to a 200-point drop for a foreclosure is not bad. Officially, Fair Isaac Corporation, the company who produces the FICO score, states “the common alternatives to foreclosure, such as short sales, and deeds-in-lieu of foreclosure are all “not paid as agreed” accounts, and considered the same by your FICO® score.” To add more detail, FICO has also published a chart showing how mortgage delinquencies affect credit scores. Anecdotal evidence shows though that there is a definite difference in the damage that your credit incurs when comparing a foreclosure to a short sale, where the short sale may be the better of the two alternatives.
- Loan Deficiencies (Deficiency Judgments): In California, deficiency judgments are generally not allowed, meaning that a lender can not sue a homeowner for any difference between the amount of the sale and what is owed on the home.
Foreclosures Versus Short Sales, Compared
| Homeowner Issues | Short Sale | Foreclosure |
|---|---|---|
| Getting a future mortgage | Will not affect your home loan application. | Must answer “yes” to a foreclosure on the standard home loan application, known as the 1003. This will affect the terms of the home loan offered to you. You will also be ineligeble for a Fannie Mae loan on a primary residence for 5 years and for 7 years on a second home or investment property. |
| Credit Score | Can lower your score by 80 to 100 points, and possibly less if no late payments are reported. This can reflect on your credit score for as few as 12 to 18 months. | Can lower your score between 200 and 300 points, with a residual affect on your score for over 3 years. |
| Credit History | A short sale is not reported as an individual itemized item on your credit report. | A foreclosure remains on your public record for at least 10 years. This can affect your employment options and can bar you from certain security clearances. |
How to Conduct a Short Sale
Short sales are challenging transactions to manage due to the complications of dealing with the lender and in working to get their approval on the sale in a timely manner. Competent help through the use of a real estate agent experienced with short sales is strongly urged to increase the likelihood of success.
Whether a homeowner is attempting to short sale a home himself or with a real estate agent, keep in mind that the sale must be an “arms-length” transaction. The home may not be sold to anyone who the seller has a close relationship with, like family, neighbors, friends, and business associates.
Documents Needed to Start a Short Sale
- Fully executed listing agreement, or purchase agreement contingent on lender approval if a seller has a committed buyer.
- Letter of authorization giving your real estate agent the authority to access your information and to work on your behalf. The letter should include:
- The date
- Your name
- Your signature
- Your Social Security Number
- Loan account number
- Property address
- Your real estate agent’s name and contact information
- Preliminary net sheet which is an estimated closing statement showing the costs of the sale, loan balances, commissions and the expected sale price.
- Hardship letter explaining the reasons why you are in a financial bind that requires you to short sale your home.
- Financial worksheet itemizing all monthly expenses.
- Proof of income and assets.
- Copies of bank statements.
- If the real estate market in your neighborhood has declined in value and that is part of the reason why the sale price of your home will come in short of what is owed to the lender, then you should also prepare a comparative market analysis (CMA). A real estate agent can provide a comparative market analysis that shows the sale price for homes similar to yours that are active on the market, pending a sale and sold within the past six months.
