South Atlanta Househounds

What is a short sale?

A short sale is when a mortgage company accepts a discount on the note to avoid a possible foreclosure action.  Instead of buying from a seller, the property is purchased directly from the lender for a discount.  When a homeowner can’t meet their financial obligations on the property lenders are sometimes willing to accept less than the full amount due, commonly referred to as a “Short Pay” or “Short Sale”. 

Do all lenders approve all short sales?

No.  A homeowner needs to prove they deserve a short sale and that it is in the mortgage company’s best interest to do so.  First the homeowner must prove that they can not meet their obligation and it is “incurable”.  If you have any assets such as vacation property, boats, extra cars or retirement funds expect that the banks will not approve a short sale.  Also a short sale is not always a quick sale so waiting too long before exploring this option would result in the bank declining your request.  Some lenders will only consider a short sale if it is presented with an offer, which in many cases is simply putting the cart before the horse. 

What are the negatives?

To begin with they are complicated and time consuming.  For the homeowner an extensive package must be prepared to prove that you are worthy to do a short sale.  After all that work, you are relieved of the financial burden but you walk away with nothing.  The payout to the homeowner in a short sale is zero.  For the buyer it is a tedious process of make an offer, wait, wait, wait and see.  The really bad news is that the success rate of short sales is under 50%, even when the offers are fair. 

So what are the benefits?

The homeowner avoids foreclosure and the massive credit damage that goes with it.  Also they often can control the timing of when to move and there are no costs to the homeowner.  The sales costs, commissions, title and escrow fees are all paid by the lender.  So long as the short sale is negotiated correctly, the homeowner gets a full release from the lender and is not financially responsible to repay any loss to the mortgage company.  As for the buyer, they traditionally get the property at a discount.  FHA and VA have a limit of 82% of the fair market value of the property.  Lastly, the mortgage company gets a new loan. 

Is there credit after a short sale?

Homeowners who complete a short sale with the lender do far less damage to their credit rating than those who go through foreclosure.  No doubt that short sales, deed in lieu of foreclosure and foreclosure all affect your credit score, but short sale and deed in lieu let  you avoid “debt discharged due to foreclosure” on your credit reports.  Having a foreclosure on your credit report reduces your FICO score by an average of 250 points and takes three to five years before you can get a mortgage at a reasonable rate.  The effect of a short sale on your credit score is 80-100 points and is recorded as “pre-foreclosure in redemption”.  After the sale, the mortgage may show up as “discharged” on your credit report.  People who complete a short sale may qualify for a mortgage at a reasonable rate in as little as 18 months. 

How debt forgiveness works and your tax consequences

In a short sale the mortgage company has three ways to handle the negative balance. 

1. They can attempt to collect the deficiency balance from the seller after the property has closed.
2. They can require the seller to sign an unsecured promissory note for the deficiency balance.
3. The can agree to cancel the entire deficiency balance.

While option 3 seems the clear choice, the IRS considers any canceled mortgage debt ordinary income.  That means that the deficiency balance is taxed at the same rate as your salaries and income.  Additionally the IRS requires lenders to file a 1099-C form stating the amount of canceled debt to the IRS and to the seller.  The state of Georgia also considers cancelled debt as ordinary income.  I’m in the real estate business, not taxes and as such I suggest you get professional tax advice on this issue.  They can help you to convince the IRS that the amount of the 1099-C should not be considered ordinary income.  More information can be found here.

Let’s wrap this up

In the end you loose your house but not your credit.  Be prepared to do a lot of work.  Some of the items you’ll need to present or prepare are:  a budget, pay stubs, banking statements, hardship letter with supporting documents, mortgage payoffs, two years of tax returns, W-2’s and a cover letter to wrap up all the information.  Some of the items your agent will need to prepare are:  marketing plan, CMA or BPO, copy of listing agreement, sales contract, addendums, disclosures, title report, MLS sheet and the HUD-1 net sheet.  Undertaking a short sale is an extensive process and should not be attempted without guidance from an agent experienced in the short sale process.  

Five things you should never do if you fall behind on a mortgage

1. Don’t “Do Nothing” – The sooner you start to communicate with your lender the better.  It is surprising the number of people who just sit back and accept what comes.  When you let this happen the damage to your credit can make it very difficult to get another mortgage for a very long time.  The mortgage companies are in the mortgage business, not in the home ownership business and as such don’t want to foreclose unless it is a final option.  Mortgage companies are increasingly willing to work with homeowners, but you have to communicate with them.  Many folks wait until they are too far behind to contact their mortgage company and at that point it’s too late. 
2. Don’t Pay Upfront Fees – You don’t need to pay upfront professional or consulting fees to get the help you need.  Let me clarify that if you need a lawyer or accountant you should hire one.  Just don’t get bamboozled by a company that claims they can fix all your financial worries for a fee.  Understandably these companies are out to make a profit, but if your in financially challenged state already, don’t put salt on the wound.  Working with your mortgage company should be your first path.  You can also get lots of advice from realtors or hire one who get’s paid after the sale is complete. 
3. Don’t Sell Your Home At A Huge Discount – Unless foreclosure is less than 42 days away you still have time to explore your options.  If your home has equity in it, that belongs to you.  You should speak with a real estate consultant or agent to try and see if they can help you get your equity out of the home.  Remember that if someone is pushing you hard to get you to sell your property to them then it’s probably because the deal they are proposing is very favorable TO THEM.
4. Don’t Let A Buyer Deal Directly With Your Mortgage Company – The buyer’s goal is to negotiate a low (probably very low) price with the lender.  The buyer will ask the mortgage company to accept a discounted payoff.  To begin with it can drag on for weeks and then the buyer may still decide not to buy your house.  They can also present information in a way that makes it very difficult for you to resolve the loan situation later.  You need someone to look out for you and having an agent is your best bet as they have a fiduciary responsibility to you, not the buyer or the mortgage company. 
5. Don’t EVER Deed Your Property To A Third Party Without Confirmation Your Loan Is Paid Off – If you deed your property to a third party then they control that property. but what if they don’t make your mortgage payments.  Just because you no longer own the property does not mean you are no longer responsible for the mortgage obligation.  The mortgage company made the loan to you and until it is paid off you are primarily responsible for that obligation.  If you give up control of your property and the new “owner” does not pay your loan you could be in serious financial trouble.