In a real estate short sale, the property is transferred from the Seller to the Buyer for less than the amount of the outstanding mortgage lien(s). Short Sales are one of the options for selling a property that is “underwater.”
Short sales can be a good option for everyone concerned:
- The Seller is able to sell the property.
- The Buyer gets the property they want, sometimes at a below market price.
- The lender doesn’t have to take possession of the house through foreclosure and then deal with maintaining and selling the property.
But short sales aren’t simple to do and they aren’t for everyone:
- Short Sales can take a long time to work through and there are no guarantees.
- Depending on the laws in the state, the owner may still be liable for an unpaid balance on the mortgage.
- There may be more than one mortgage lender, which complicates the deal.
- Not all properties are eligible and the Seller has to qualify for hardship relief.
- The loan debt forgiven by the lender may be taxable as income & will affect your credit scores.
Short sales are complicated and have long term credit and legal consequences. Buyers and sellers both need to have good legal advice from a qualified attorney to insure that they are properly protected. Using a real estate agent who is experienced in successfully doing short sales is also a smart move.
Short Sale Timing
There are millions of properties that are underwater in the US and the banks have millions of short sales in process, so prepare to be patient. Realistically, if it is close to the point of actual foreclosure, there may not be time to finalize a short sale prior to foreclosure.
Loan Balance Payment
State laws determine whether or not a lender can collect a balance due after a short sale. It is therefore important to negotiate and obtain a legally binding release from the lender for any loan balance still due before closing on the short sale. You want to be released from all loans, not just the primary loan.
Dealing with Multiple Lenders
Many properties have a primary mortgage and a HELOC (Home Equity line of Credit) or secondary loan lien. If these loans are with different lenders, you will need to negotiate with two companies. This makes for a more complicated negotiation and may prolong the negotiation process. But you will want to be sure that all loans are cleared as part of the short sale process so there are no liens left to clear up after the deed transfers.
In addition to the usual property sale hurdles, such as, coming to an agreement on price, putting financing in place and getting inspections done, the property owner must complete and submit a Hardship Package to the bank.
This package explains to the lender why the Sellers are asking for a short sale and includes a great deal of financial documentation. Typical hardships include: loss of employment, divorce and major illness, but the bank is not required to approve any particular hardship package – it’s all up to the lender.
If you are the Seller, it is important to provide a complete & timely hardship package. Banks are somewhat notorious for losing things during the short sale process, so keep copies of everything and document when you send it in.
Taxation of Cancelled Loan Debt
Generally, when loan debt is cancelled the amount is taxed as income. The Mortgage Forgiveness Debt Relief Act of 2007 allowed taxpayers to avoid tax on this for mortgage debt forgiveness on their primary residence up to $2 million ($1 million if married filing separately).
This law was scheduled to expire in 2012, but was extended through 2014. Avoiding this tax can be significant financially, so keep an eye on the calendar if you are going through a short sale in 2014.