When a homeowner defaults on their mortgage, typically after missing 3 – 6 payments, there lender will initiate the foreclosure process. Foreclosure is the legal and professional proceeding in which a lender obtains a court-ordered termination of a mortgagor’s equitable right of redemption. In layman’s terms a foreclosure is the legal process a lender must go through in order to take back a property after a homeowner has defaulted on the terms of their mortgage. Banks are not in the business of owning properties, and therefore every bank has some type of Asset Management department specifically for liquidating non-performing assets. So, as a homeowner, foreclosure doesn’t necessarily mean all hope is lost. One of the ways a lender can liquidate a non-performing or bad asset (mortgage) is to allow a homeowner to Short Sale their property.
Simply stated, a Short Sale is when a lender agrees to accept an amount (payment) which is less than the full pay off balance of a mortgage. A lender will consider a Short Sale if that lender feels it is in their best financial interest. The average cost a lender faces by foreclosing on a property is estimated to be around $50,000. If you consider attorney fees, court fees, property depreciation, missed mortgage payments (including interest, insurance and taxes), property maintenance, and vacancy, you can easily see why a lender is willing to accept a Short Sale as oppose to foreclosing on a property.
The qualifications for of Short Sale may vary, depending on the lender. However, the majority of lenders will consider a Short Sale if:
• The homeowner is facing a legitimate financial hardship (Ex. Loss of Job, Divorce, Relocation, etc.) and can no longer afford their monthly mortgage payments.
• The homeowner’s property is over-leveraged (a.k.a. negative equity); meaning their property is worth less than their current mortgage. (Ex. Home is worth $150,000 and Mortgage amount owed is $200,000. In this example the property would be over-leveraged by $50,000)
• The homeowner has missed several mortgage payments. Contrary to popular belief, a homeowner may still be eligible for a Short Sale even if their mortgage payments are current. If the homeowner can prove they are no longer able to make their mortgage payments, due to a financial hardship, their lender may still consider a Short Sale.
Once a homeowner believes they meet the requirements for a Short Sale, they should begin to gather the necessary paperwork. Many times the homeowner’s lender has a Short Sale package with the requirements available on their website. Each lender is unique, but to submit a complete Short Sale package the following will be required:
1). Authorization to Release – required by lenders to release information about your loan to 3rd parties (Ex. Lawyer, Realtor, Negotiator, etc)
2). Hardship Letter – it’s a letter provided by the homeowner that explains their current situation and gives the lender a better picture of what’s really going on and why they should accept the Short Sale.
3). Financial Form – this form will show your lender your monthly income and monthly expenses to see if the homeowner is truly experiencing a hardship.
4). Last two months bank statements
5). Last two years taxes (W2’s and/or 1040 with schedules)
6). Last two months pay stubs
7). Listing Agreement – many lenders require that your home be listed with a Realtor
8). Purchase Contract – to get your file assigned to an negotiator a offer will need to be made on your home
9). Proof of Funds – in order for your buyer to be taken seriously they will need to provide a proof of funds letter
10). Hud-1 Settlement Statement – this document is required by every lender and shows the lender, when everything is said and done, what the NET amount they will receive from the transaction.
To many homeowners a Short Sale, if handled correctly, can begin the road to recovery. However, it is a very complex process and should ONLY be handled by an experienced professional! I’ve seen many instances where a homeowner has been led to believe that once the Short Sale is completed they have nothing more to worry about and they can get into a new home within 6 – 12 months. Below you will find the answer to the most commonly asked question about Short Sales that I encounter.
Are there consequences to doing a Short Sale?
The simple answer is, yes. If someone tells you otherwise, then they’re either inexperienced in handling Short Sales or not being truthful. However, if the Short Sale is handled correctly these consequences are reduced to a minimum. A completed Short Sale will ALWAYS be better than allowing a property to go into foreclosure! Some of the consequences may include Deficiency Judgment(s), Promissory Note(s), Tax consequences, and negative reporting to the homeowner’s credit. A brief explanation of each will be found below:
• Deficiency Judgment– A deficiency occurs when the sale of a homeowner’s property, whether from a Short Sale or Foreclosure Auction, is less than the full payoff amount of their mortgage. (Ex. Payoff of mortgage is $200,000. Amount received from sale of property is $150,000. $200,000 – $150,000 = $50,000.) In this scenario the homeowner would face a possible Deficiency Judgment of $50,000. A lender can legally pursue a homeowner for the Deficiency amount. By letting a property go into foreclosure a homeowner is almost certain to be pursued for the difference. By using a competent and experienced company the deficiency amount can, in most cases, be waived!
• Promissory Note – A promissory note is an agreement between a lender and homeowner to repay some or all of the losses from the sale of a property. Usually, 2nd lien holders look to pursue promissory notes, because 2nd lien holders are completely wiped out if the property goes to foreclosure. Many 2nd mortgages are HELOC’s where the homeowner is withdrawing 10’s of thousands of dollars in cash, in which the lender is unable to recoup otherwise. (Note: If a property has two mortgages, the 1st and 2nd lienholder must agree to the Short Sale.)
• Tax Consequences – (Disclaimer: This is not to be construed as legal advice. Please consult a competent tax professional for current laws and regulations in your state.)
When a lender waives pursuing a deficiency and forgives the debt owed, by law, they must issue the homeowner a 1099c for the year the debt was forgiven. The homeowner is required by the IRS to report the debt forgiven as taxable income. (Ex. If the lender issues a 1099c in the amount of $50,000, this amount would have to be reported as income to the IRS) In 2007 the Bush Administration passed a bill called the Mortgage Forgiveness Debt Relief Act. In Short, if a homeowner is deemed ‘Insolvent’, meaning the homeowner’s total liabilities were greater than their total assets, they would be eligible to have the debt canceled.
The IRS form which is needed is IRS form 982. (This is not legal advice, please consult a tax professional.) There are certain stipulations to be considered act the homeowner must met, one being that the property homeowner’s primary residence. Although a good tax professional may be able to assist with the debt cancellation on an investment property. In all situations a homeowner should consult a competent tax professional that specializes in this area.
• Credit Consequences – Be very wary of anyone who says that a Short Sale will not affect your credit. This is simply not the case! A foreclosure will typically drop a homeowner’s credit score by 200 – 300 points. It’s been argued that a Short Sale will only drop a homeowner’s score by 80 – 100 points, but this is widely debated. In actuality, the determining factor will depend on how the lender decides to report the sale to the credit bureaus. As far as credit is concerned the main benefit a Short Sale has to offer, as opposed to foreclosure, is that a homeowner can qualify for new financing within 24 months. Now, if that homeowner’s property goes into foreclosure they will not qualify for conventional financing for 5 – 7 years.
The bottom line is that a Short Sale will always be better than just walking away from your home and letting it go into foreclosure! Do yourself a favor and ONLY deal with a professional that truly understand this difficult process!