If you’ve taken out a large mortgage, and perhaps refinanced to cover remodeling or other expenses, you may find yourself unable to keep up with your mortgage payment after a layoff, divorce or illness. More and more people are finding they need to sell their homes for less than they owe on the mortgages, known as a short sale.
Selling short is definitely better than foreclosure, which stays on your credit record for ten years. But it’s best to try to work things out with your lender before going through the embarrassing and laborious process of selling your home on a short sale.
Tax Issues
Before you put your home on the market for a short sale, it’s best to talk with a tax advisor about possible tax repercussions. It’s likely the IRS will consider the difference between the value at which you sell your home and the mortgage balance as income on which you’ll have to pay taxes.
An exception to this rule is if you can prove that you were insolvent that your debts were bigger than your assets- before your mortgage lender agreed to a short sale of your property. A tax advisor will be able to tell you for sure whether you’d be considered insolvent by IRS standards.
If you can’t prove you’re insolvent, and the tax bill on a short sale would be more than you can pay, you may have to let the mortgage lender foreclose, or declare bankruptcy.
Be Upfront With The Real Estate Agent
If you find selling you house for less than you owe on the mortgage is an option short of foreclosure or bankruptcy, you’ll want to find a real estate agent who understands your situation. Agents typically take a much lower commission on short sales, and it often takes much longer to actually close the sale once the seller accepts an offer. But many agents sympathize with financial problems brought on by unexpected circumstances, and may want to help.
Convincing Your Mortgage Lender
The buyer will need your help in negotiating a short sale approval with your mortgage lender.
Your bank will have to be convinced that you deserve to be approved for a short sale. You’ll need to tell your mortgage lender about your financial hardships, including layoffs, divorce or medical issues.
While this may seem obvious, now is not the time to rack up the purchase of luxury items, like fancy cars or jewelry. Your lender will see these debts on your credit report and become convinced you’re a loose spender who doesn’t deserve a break.
It may also be necessary to provide the lender, either directly or through the buyer or buyer’s agent, documentation of your financial hardship, such as pay stubs, bank statements and so forth. While this may seem like an invasion of your privacy, try to think of it as the fastest way out of an otherwise overwhelming debt.
Short sales take much longer to close than more conventional sales, so plan accordingly. If it works, you’ve avoided bankruptcy and an ugly mark on your credit report. If it doesn’t work, you’ll know that you’ve done everything you could to avoid foreclosure and/or bankruptcy.
What is a Short Sale?
- Homeowner sells for less than what is owed on the loan
- Lender accepts the amount as payment
- Seller escapes foreclosure, but receives no funds
- Lender does not report foreclosure to credit bureau
In a short sale, a financially insolvent homeowner who is facing foreclosure sells his home for less than the value of his loan. The lender accepts the sale as payment in full for the loan.
A short sale gives a homeowner a way out of foreclosure and is potentially financially advantageous for lenders. We call this a WIN-WIN.
The seller won't get any money out of the deal, but they will avoid the emotional toll of foreclosure. This is fair. If the lender is losing money, the seller shouldn't be making money.
The seller won't have "foreclosure" on his credit report, though it will show the missed mortgage payments.
- Foreclosure is an automatic 100-120 point hit to a credit rating and stays on the report for 7-10 years
- Lender could report the short sale in a number of different ways. There could be a 40-50 point hit for the short sale. (NOT AS BAD AS FORECLOSURE!)
Homeowners default on their loans because they are unable to make their monthly payments. There are numerous market-based and personal reasons for why a homeowner might default. Six possible reasons for default are as follows:
1. Obtained a subprime loan
2. Adjustable-rate mortgages (ARMs)
3. Zero down loans
4. Loss of income
5. Unexpected medical or home repair bills
6. Market shift with price declines
What is Foreclosure?
A legal process in which a lender takes the title or forces the sale of a property as a result of the borrower's failure to comply with the terms and conditions of the mortgage.
The timeline for foreclosure will vary from state to state and from lender to lender. However, it typically begins with the homeowner's first missed payment.
If the homeowner doesn't send a payment or make payment arrangements16-30 days after the first missed payment, the lender will begin adding late charges. In an attempt to collect, the lender may call the homeowner and send collection letters.
Approximately 45-60 days after the missed payment, if no other payments or payment arrangements were made, the lender will notify the homeowner the loan is in default. Usually the homeowner will have 30 days to send the missed loan payments plus late fees to avoid foreclosure.
After about 90-105 days, the lender will send the homeowner a Notice of Intent to Foreclose. This notice initiates the legal processdings of foreclosure and is usually publicized at the courthouse or in the newspaper.
Depending on the state, the home will be offered at auction after 150-415 days.
Again depending on the state, after the home has been offered at auction, it may go into a redemption period. In the redemption period, the homeowner can buy back his home if he can pay the lender the entire loan plus additional fees that have amassed. Not all states have a redemption period. In states that do have a redemption period, it is typically 150-415 (or more) days after the homeowner's first missed payment.
The home becomes Real Estate Owned (REO) by the lender if it doesn't sell at auction.
3 Myths and Truths -
- Myth #1 Lender want to foreclose on delinquent homeowners
- Truth Lenders are in the business of loaning, not owning!
- Myth #2 Financially distressed sellers have worked through their options with their lenders
- Truth Financially distressed means stressed. These sellers may not realize there are positive options, and they could be avoiding creditors
- Myth #3 Short Sales are hard
- Truth If you can do a mortgage loan application you can complete a short sale
Do you Qualify?
Facing foreclosure does not automatically make someone a good candidate for a short sale. If a homeowner has money or assets elsewhere, the lender will not be interested in negotiating a short sale. Remember a short sale will usually cost the lender less than a foreclosure, but the lender is still losing money
The homeowner should be able to demonstrate a hardship that caused him to miss his payments. This information will be added to the short sale proposal. The homeowner will write a note about what happened and will compile the supporting documentation. If the homeowner's loan rate adjusted, obtain copies of the loan statements. If the homeowner ecountered medical issues, gather copies of those bills. If a spouse died, request a copy of the death certificate
The homeowner must be financially insolvent. The homeowner must have no means of meeting the loan obligation and must have no other options
The market value of the home must be less than the loan amount
A short sale is not for people who simply regret bad financial decisions