What is a short sale? A short sale is a sale of real estate in which the sale proceeds are less than the balance owed on the property's loan.
Due to the financial crisis of 2007-2011, banks are now much more open to accepting short sales. Banks agree to short sales as an alternative to foreclosure in order to mitigate the significant foreclosure fees and to obtain a more expedient disposition of the asset.
The short sale process is also a preferred alternative to foreclosure for the borrower as it reduces the negative impact on the borrowers’ credit report. The net sale amount is also typically more in a short sale, and consequently less taxable income to the borrower, as explained further below.
Sometimes the bank will ask the borrower to sign a secured note for part or all of the deficiency, but often times they will not.
How does a short sale work? In a short sale, the bank agrees to discount a loan balance because of an economic or financial hardship on the part of the borrower. We are, however, also seeing banks approve short sales where the borrower has good income but is sitting on a loss of value on the property. The home borrower sells the mortgaged property for less than the outstanding balance of the loan, and turns over the proceeds of the sale to the bank.
It does not extinguish the remaining balance unless settlement is clearly indicated on the acceptance of offer.
If the bank agrees to a short sale, it will report the account as closed to all major credit reporting bureaus. The bank may report the account as paid in full if it is negotiated and probably will not if it is not negotiated. It may request that you pay the difference if you don’t get a negotiated waiver.
Otherwise the bank writes off the remainder due on your mortgage as a loss and sends you an IRS Form 1099 for the difference.
If it is your primary home, the IRS usually considers the amount on the 1099 as income that is not taxed due to the Mortgage Debt Relief Act of 2007, and if it is a secondary or investment house you will probably be taxed on that amount.
Up to $2 million of your mortgage debt can be excluded from IRS taxation on your principal residence. Up to $1 million applies for those married filing separately. Check with an accountant or the IRS for the most up-to-date details.
Banks often have loss mitigation departments that evaluate potential short sale transactions. The majority have pre-determined criteria for such transactions, but they may be open to offers, and their willingness varies. A bank will typically determine the amount of equity (or lack thereof) by determining the probable selling price from an appraisal, or Broker Price Opinion (BPO).
The wide array of parties, parameters and processes involved in a short sale makes it a relatively complex and highly specialized real estate transaction. Not surprisingly, short sales have a somewhat high failure rate and sometimes do not close in time to prevent the home being foreclosed or repossessed.
The key is to hire a real estate agent who is skilled in navigating all aspects of a short sale.
What is the process for a short sale?
The bank will need the borrower's two most recent months' bank statements, two most recent pay stubs (or income/expense reports, if self-employed), borrower-signed approval to release information to your real estate agent, fully executed purchase contract, preliminary HUD-1, IRS Form 4506-T Request for Tax Return (specifying a request for the past two years), signed hardship letter and any additional documents as required.
All documents must be submitted to the bank at the same time. Once all received, the bank reviews the documents, orders a home valuation, reviews loan status and payoff information and then assigns a short sale specialist to the file. The specialist then analyzes information and negotiates an offer to be presented to the investors of the loan.
Either the bank will approve the contract, reject it or counter in the terms. They will then notify your real estate agent. The real estate agent then must negotiate with all parties to the contract and the borrower and buyer must either accept, walk away or counter the bank’s position.
If the terms are all agreed to, the file then is assigned a closing officer by the bank who works with the borrower's real estate agent to close the transaction.
How long does the short sale process typically take?
Anywhere from five weeks to four months, with four months being more likely. However, in some instances it can take longer.
What are the credit implications for doing a short sale? Short sales do sometimes adversely affect a person's credit report; however, not near to the extent as foreclosures do. Under Fannie Mae Guidelines after a foreclosure, the borrower is not eligible for financing for seven years. After a short sale is reported to the borrowers’ credit reporting agencies, the borrower can be eligible to obtain credit to purchase a property after two years, but it’s limited to a maximum loan-to-value ratio of 80 percent. After four years, the borrower is limited to a maximum loan to value ratio of 90 percent.
Short sales are identified on a credit report as “paid in full” with a “settled for less than owed” remarks code, and the mortgage trade line indicates any recent delinquency.
What can the borrower do to obtain optimal results from this process? Gather bank-required documents prior to receiving the contract. Attempt to have preliminary discussions with the bank. Seek to release any loans other than the primary. Use a real estate agent that is experienced in negotiating and closing short sales. The agent should also have the appropriate designations such as LMC (Loss Mitigation Certification).
Make sure that your agent also does the following: Have both borrower and buyer sign a short sale addendum that protects both parties in the event one or both are not in agreement with the bank's short sale arrangement; negotiate a contract sales price that agrees with the comps (comparative neighborhood sales prices) otherwise, the bank may just reject the short sale and not even counter; and include in the contract that the buyer inspect the property before the contract is submitted to the bank.
Since the bank typically will not cover any repair costs, these costs must be factored into the buyer's purchase price analysis. Borrowers can also have the house pre-inspected and request up front that the bank report the account as paid as agreed, if possible. This will eliminate the negative reporting on your credit report. Under the new HAFA (Home Affordable Foreclosure Alternative) program guidelines, if the borrower is less than 60 days overdue on their mortgage payment, they will no longer be required to verify their income. This opens the door for applicants whose income was previously too high to qualify for a short sale.