If you have decided you cannot keep your home, a short sale is an effective strategy to gracefully walk away from your mortgage debt and avoid foreclosure. A short sale occurs when a piece of property is sold for less that what is owed against it. Those who are owed (mortgage lenders and any party who may have filed a lien against the property for unpaid debts) must approve the sale of the home. This process takes time and requires excellent negotiating skills on the part of your real estate expert to be able to bring all parties to agreement by accepting a reduced payoff, or a “short”.
Working with a Realtor, a homeowner will write a hardship letter as well as completing a financial workout package provided by their mortgage company and submit the request for approval. During this time, the agent will list and market the home, presenting all offers to the homeowner for review just as in a normal real estate sale. The owner is free to accept, counter, reject any and all offers at this time and this period generally consumes the majority of time involved in a short sale. The financial workout package is received by the lenders. It is reviewed for completeness by a processor. Additional documents may be requested, and some mortgage lenders may request to receive any offer which has been accepted by the homeowner. Other lenders will wait for this request until the process is further along, but in either event, only one offer is presented to the mortgage lender and this offer is chosen by the homeowner alone.
Once all documents have been received, reviewed and approved, it is then transferred to a negotiator. The negotiator orders either an appraisal of the home or what is known as a BPO (broker price opinion). This is done in order for the mortgage lender to establish the fair market value of the home. Once the property’s value is determined, if the mortgage lender has not yet asked to receive an accepted offer, they will do so and will compare it to the fair market value of the home.
The offer will then either be accepted or any of the offer’s terms countered by the negotiator, terms such as the purchase price, the request for buyer’s closing costs to be paid by the mortgage lender, the amount of time requested to close, etc.
One critical facet of the negotiations is in regard to how the remaining mortgage balance is to be reconciled. The mortgage lender is being asked by the homeowner to release its’ interest in the home and accept a payoff which is short of a full payoff. This shorted amount is known as the deficient amount, and unless specifically stated by the lender, the homeowner is still liable for that amount. It is the sole responsibility of the homeowner’s short sale expert to negotiate that this deficiency balance be cancelled or ‘forgiven’.
To be approved, a homeowner must first demonstrate a hardship, or show reason why he or she can no longer afford to keep making the mortgage payments.
Hardships fall into the following general categories: the loss or reduction of income, excessive debt obligations, an illness by the borrower, an involuntary job transfer, marital difficulties, the loss of tenants/renters (investment property).
A short sale includes not only the ability to walk away from an over-encumbered property, but it also allows a homeowner some desperately needed time to live in the home without having to make a mortgage payment. Typical times take four to six months to complete, and during that time, mortgage lenders do want them home to be left vacant. A vacant home poses a risk to the mortgage company. Better that the homeowner remains in and maintains the property until it is sold. A third benefit to is the potential to receive compensation from the mortgage company. Depending on which financial institution owns the mortgage loan along with several other factors, a homeowner who agrees to a short sale can receive monies ranging from $1,500 to $30,000. Lenders call this money ‘relocation assistance’ among others, and the homeowner receives this payment at closing.
Not every homeowner is eligible for a short sale. Since a mortgage lender is being asked to receive a shorted payoff, they utilize strict guidelines to ensure the homeowner is indeed financially struggling and is not simply choosing to ‘strategically default’. A strategic defaulter is someone who chooses to default on a mortgage loan for reasons other than being unable to afford it.
A short sale may not be the best solution for every struggling homeowner and do include serious consequences, the most damaging being the possibility of still owing the mortgage debt once the home is sold. As stated above, the release of the homeowner’s liability for the mortgage deficiency must be specifically stated in the bank approval letter. Without such, a homeowner is left exposed.
In addition, there are credit score implications to consider. Nearly every mortgage investor requires that a homeowner requesting approval for a short sale be at least 30 days delinquent on their mortgage loan. This default will result in a serious drop in a borrower’s credit score. Once the sale is complete and the remaining mortgage debt cancelled, the mortgage servicing company will report the transaction to the credit bureaus with language similar to ‘Debt settled for less than the full amount’. This will also impact a borrower’s credit score. Depending on the original score, a short sale can lower an individual’s score up to 150 points.
A third consequence has to do with the tax ramifications. Any time a creditor forgives a debtor more than $600 of debt, they are instructed to report this cancelled debt to the IRS. The IRS considers any forgiven debt to be income and therefore taxable. In 2007, Congress enacted The Mortgage Forgiveness Debt Relief Act and Debt Cancellation to help struggling homeowners by exempting them from paying taxes on forgiven mortgage debt. Although there are limits to the scope of those homeowners who receive relief, the overwhelming majority of those who short sell their home will not have to pay taxes on the forgiven debt.