Short Sale Tips and Resources

Find out everything you need to know about short sales on one page. Below you will find links to articles, government assistance and free mortgage help.

 

What is a short sale?

A short sale happens when a borrower sells their property for less than what is owed on the mortgage. In order to be eligible for a short sale, the homeowner must be able to demonstrate a financial hardship that is causing the mortgage to become unaffordable.

For example, if your outstanding mortgage debt is $300,000 and the property is now only worth $150,000, this mortgage is considered to be “underwater.” If you are looking to sell your property for less than your outstanding balance, you will have to supply all of your financial information to your lender so they can determine whether or not they want to sign off and settle the debt for less than the amount owed.

Please keep in mind that the servicer of the loan will be in control of the sale at all times. Even if you have a offer on the table ready to go, your application must be completely processed before they will accept the deal. In many cases the buyer will drop out because of how long this process can take. The realtor on the transaction (or yourself) are required to submit a written purchase agreement with estimated closing costs (estimated HUD) to the mortgage servicer.

Obviously a short sale is not the best solution for a homeowner or the lender. No one wants to have to sell their home for less than what they owe, especially those who have been working hard for years to build up equity. However, this option is much better than allowing the property to go into foreclosure. A foreclosure will completely destroy your credit rating and will remain on your credit property for up to seven years. For most people a foreclosure will make financing extremely difficult for years to come.

How Does a Short Sale Work?

Generally, a loan officer at the bank will negotiate new loan terms upon the request of the lender. While the bank is not obligated to negotiate with the lender, there are several advantages for both parties when the loan would otherwise result in a foreclosure. If you are considering a short sale, however, there are a number of tax implications to factor into your decision. Where the parties are able to reach a short sale agreement, the forgiven portion of the loan may still be taxed as income on the part of the borrower.

What information will the bank need to decide whether to accept a short sale?

Your submission package should include:

1. Hardship Letter – explaining the circumstances that make it impossible for them to pay the full amount of the loan. The seller needs to be able to show true financial hardship. Someone with the assets or the income to pay is unlikely to be considered

2. Proof of employment or unemployment – W-2 forms from employers (or a letter explaining the seller is unemployed).

3. Proof of income – bank statements, two years of tax returns, and other financial documents outlining income and debt obligations. Most lenders will ask if you have an access to a retirement fund, investment fund, 401’s, stocks, and how much is accessible and why if these funds are not accessible has to be provided in a written statement.

4. Comparative Market Analysis or CMA Broker Price Opinion or BPO (Mini appraisal) The bank will need comps or a broker’s price opinion showing the current estimated of value of your home. Be very thorough with your Analysis with Closed and then Active listings. Closed comparable are of course what they are looking for above all, but if you cannot find any sold in the last 3 months in the exact same complex or street/block due to the sluggish market, be very detailed with your analysis and calculate by square footage, age, size, views, frontage and upgrades, amenities et…

5. Listing Agreement or Proof of Listing – The Listing Agreement is a Short Sale: any offer is Contingent Upon the Lender’s Buyer’s Approval. The Listing has to be signed and sealed and promoted on the MLS prior to sending your package for short sale consideration to the Loss Mitigation Specialist. Often the commission will have a maximum stated by the Lender/Investor.

Tip: In preparing the package, be careful about discrepancies between the seller’s income and the income used to obtain the loan. A big gap may indicate mortgage fraud, unless employment circumstances have drastically changed

Other Items you want to include in your short sale package.

Cover Letter
Authorization to Release Information
2 months bank statements
Supporting Hardship Info – HOA liens, medical/disability statements etc.
Repair Estimate for the property
Contract
Net Sheet
First mortgage holder may ask for a payoff amount from the 2nd
Second mortgage holder may ask for a payoff amount from the 1st
Lender may ask for an Initial Title Report
FHA and VA may have their own forms and special requirements as well

How will this affect your credit?

One of the main disadvantages of a short sale is the damage it will do to the seller’s credit score. Not only will this negative mark remain on your credit report for a few years, but a short sale may lead to higher interest rates on future purchases or make financing anything else very difficult for years to come.

A short sale can be reported on a credit user’s credit report in a couple different ways. The amount of points that are reduced from the credit report vary based upon how many days the loan has been delinquent. The shorter the duration of the loan the less of a hit you will end up taking. A short sale that is 60 days or more delinquent could end up being as bad as a foreclosure. Foreclosures can hit your credit report by as much as 200 to 300 points negative. Try setting up a short sale sooner rather than later to save your credit as much as possible.

These is no formula or specific code for a short sale. The facts are that most mortgage lenders will report them as a debt settlement, which will have a definite negative impact on your credit scores.

This is directly from MyFICO.com:

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. This is not to say that these may not be better options for you from a financial perspective, just that they will be considered no better or worse for your FICO score.

Fair Isaac released a report that says credit scores are affected about the same, whether a seller does a short sale or foreclosure. Fair Issac says the average points lost on a FICO score are as follows:

  • 30 days late: 40 to 110 points
  • 90 days late: 70 to 135 points
  • Foreclosure, short sale or deed-in-lieu: 85 to 160
  • Bankruptcy: 130 to 240

How Does the IRS Treat a Short Sale?

A short sale occurs when the mortgage lender (the “mortgagees”) agrees to alter the original terms of the loan by lowering the outstanding balance of the debt. Such forgiveness often takes place in cases of a financial deficiency, or when shifts in the real estate market result in a negative net equity on the part of the borrower (the “mortgagor”). In particular, under a short sale the home owner is allowed to sell their home for less than their outstanding debt and give the proceeds to the lender in return for forgiveness of the loan.

The IRS tax code specifies that a borrower must file a 1099C . Cancellation of Debt form when the forgiven amount equals or exceeds $600. Traditionally, the IRS has treated this amount as fully taxable income on the part of the borrower. The 2007 Mortgage Forgiveness Debt Relief Act (Public Law 110-142, HR 3648), however, amended the tax laws to allow borrowers negotiating the loan on their primary residence to avoid having to declare this debt as income (limited to debts of $2 million or less.) Importantly, this forgiveness stipulation does not apply to rental properties or other non-primary residences that a lender may hold. Previously, only a personal bankruptcy filing could prevent the forgiven debt from being treated as taxable income. With the Debt Relief Act effectively provides an amendment to the original 1986 Internal Revenue Code which allows selective exclusion of forgiven debt from taxable gross income.

Under the conditions of Form 1099-C, there are special circumstances that may affect whether canceled debt is treated as taxable income. In cases where the borrower declares bankruptcy, the debts are fully discharged although the declaration may have broader adverse effects in terms of other financial and tax obligations. Additionally, under certain circumstances the debt is not taxable if a professional accountant has determined that the value of the debt is greater than the appraised, fair market value of the asset in question.

Farm debt is also treated differently according to the law, which is signified by direct farm debt for those who earn over half their gross income directly from farming. If you are seeking to execute a short sale on a residence other than your primary home, but which served as a secondary residence for you personally during the last five years, the Relief Act also provides a graduated scale of gross income reductions.

Depending on the time you physically lived in the home in question, you may be able to deduct a portion of the forgiven amount. It is important to consult with a professional tax attorney or accountant, however, when considering the implications of the law upon your individual situation.