A "short sale" is one method of avoiding a bankruptcy and/or foreclosure when you no longer can afford to financially carry your home and the value of your home is less than the outstanding mortgage(s). Essentially, it is a negotiated arrangement with the lender or lenders to allow the home to be sold for less than the mortgage debt. In some instances, the Lender may require the homeowner to pay off some of the deficiency (i.e. the amount of the mortgage debt that will not be paid by way of the sale of the home) but that still may be less objectionable than the foreclosure or bankruptcy options. If you are considering selling your home on a short sale basis, you should seek both legal advice and have a discussion with a tax professional about the ramifications of a short sale.
If you are considering buying a property that is being sold as a short sale, there could be drawbacks. For example, you will need to have flexibility on the timing of the closing of the purchase. With the number of foreclosures facing many lenders, the process of accepting or rejecting a short sale request can and usually does take several months.
Although every lender will have its own procedures for acting on a request for a short sale, the following is an outline of the typical requirements:
Contact the Lender
This initial process will give you or your representative a taste for how difficult this process may become. You may have to make many phone calls before locating an individual with whom you can make contact and render a decision. With many of the larger lenders, it may not even be possible to get to someone who can render a decision until the required documents are reviewed by clerical personnel before giving the file to the person who renders the decision (called the “negotiator” in most cases).
Proposed Settlement Statement
Lenders almost always require an estimated closing statement that shows the sales price you expect to receive and all the costs of sale, unpaid loan balances, outstanding payments due and late fees, including real estate commissions, if any. This should be prepared by a real estate attorney with experience in determining the extent of the closing costs.
Hardship Letter
This statement of facts that should describe how you got into this financial bind and make a plea to the lender to accept less than full payment of the mortgage loan. Loss of employment or financially debilitating illness in the family are usually acceptable reasons for a Lender to allow a short sale, but different lenders have many different criteria that will allow for a short sale approval.
Proof of Income and Assets
Lenders will want to know the full extent of your assets. You should also obtain your credit report to see what assets and/or liabilities are shown in case you have to explain some of these to your lender after it obtains its own credit report. It is essential to be truthful and honest about your financial situation and disclose assets since the Lender will want to see copies of all your account statements.
Comparative Market Analysis (Appraisal)
In the likely event that one of the reasons for requiring a short sale is the loss of value of your home, this fact should be substantiated for the lender through a comparative market analysis (CMA). Your real estate agent can prepare a CMA for you or you may have a licensed, professional real estate appraiser do a formal appraisal. In any event, the information provided should include a listing of similar homes in your vicinity that have been active on the market and the price obtained for both pending sales and sales that have occurred for the past six months. Your real estate broker can be very helpful in this process.
Purchase Agreement & Listing Agreement
Having a prospective purchaser under agreement is an obvious prerequisite for any short sale. Ordinarily, you will have to be selling the property via a real estate agent in order for the lender to have confidence that the sale price is the highest price obtainable at the time. As a result , the lender will be looking for copies of both the purchase agreement and the listing agreement with the real estate agent. Your real estate agent should be prepared to renegotiate his/her commission in order to minimize the lender’s loss. Your offer and purchase and sale agreement MUST contain a clause to the effect that your obligation to sell is subject to the lender’s approval of the short sale.
Letter of Authorization
If you are working with an attorney or other professional, lenders will require you to authorize that person to be your contact. The letter should include the following: property address, loan reference number, your name, date and your real estate agent's name & contact information.
Tax Implications
As most of you are aware, one of the more daunting issues facing a "short sale" work out with mortgage lenders has been the spectre of the property owners' tax liability for any portion of a mortgage loan debt that is "written off" by a lender. One of the few effective actions that the Federal Government has taken in the wake of the great increase in foreclosures is to provide relief to property owners entering into short sales or undergoing foreclosures in the form of the Mortgage Forgiveness Debt Relief Act of 2007.
This Act has many limitations but must be considered as a factor in strategizing any sale (and many refinance transactions) of a primary residence with mortgage financing that is upside down. Many knowledgeable homeowners that found themselves in that situation have dreaded the thought of receiving a 1099 from their mortgage lender after a foreclosure or a short sale. The possibility of a stiff income tax liability after suffering a loss on the sale of a home looms like salt about to be rubbed into a wound. Under the Act, a 1099 issued for 2007 to 2012 in connection with a primary residential mortgage deficiency may bear no tax consequences under the follow conditions:
- The property must be the principal residence of the owner.
- The debt must have originally been in connection with the purchase, construction and/or substantial improvement of the principal residence. In other words, if the mortgage covering the residence resulted from a refinance, only that portion of the deficiency arising from the original debt applicable to the purchase, construction and/or substantial improvement of the property will be subject to the tax exception.
- The loan has to be secured by a mortgage on the primary residence This exemption will not apply to second homes or investment properties. In our practice, we have often encountered many situations in which homeowners in financial trouble have had their bargaining positions severely compromised by the threat of tax liability on the forgiveness of debt income. We have great expectations that we will be able to better assist these troubled homeowners over the coming two years as a result of the Act. Please feel free to contact us if we can provide any assistance to you or your clients.
