A-to-Z Short Sale Guide for Homeowners in 2019
Short sale is one of the solutions to avoid foreclosure. For a homeowner it’s usually a last resort, and for a buyer it’s an opportunity to purchase a home with a discount. This article gives general information on what a short sale is, how it works and its pros and cons for homeowners.
If you are looking to buy a short sale residential property, we offer you our other guide: Buying a Short Sale Home.
Everything You Should Know About Short Sales
- Your current mortgage balance exceeds the “as-is” value of your home.
- Monthly mortgage payments are becoming increasingly more difficult, or outright impossible to pay.
- You can no longer keep up with the monthly expenses or required maintenance the home needs.
- You’re physically and emotionally drained.
At this point, your ideal situation would be to just get rid of the home, along with any expenses/headaches that are associated with it.
The question then becomes: is this even possible? The answer is: YES. If your situation qualifies, a short sale can be your knight in shining armor.
What Is a Short Sale?
In real estate the term “short sale” (sometimes also referred to as “quick sale”) is defined as a sale of a property in which the lender (a mortgage company or a bank) agrees to allow the seller to sell the home for less than what is owed on the current mortgage balance. The lender agrees to take a loss on the property. This transaction does not get recorded as a foreclosure against the owner’s credit. Short sale is one of the common ways to stop foreclosure at the last minute.
How Does a Short Sale Work?
As stated above, the basic meaning of a short sale is when the owner’s lender agrees to take a loss on the property, by accepting less than what is owed on the current mortgage balance.
For a better understanding, let’s take a look at this example:
Due to a recent hardship, John can no longer make his monthly mortgage payments to the bank. On top of this, John’s home is currently worth less than his mortgage balance.
After consulting with a
John’s current mortgage balance owed is $100,000. The “as-is” value of his home is $70,000.
After receiving an offer of $70,000 and submitting it to the bank, they agreed to let him sell the home for the $70,000 that it’s worth.
As a result, John was able to avoid the looming foreclosure, as well as restore his piece-of-mind.
Step-By-Step Short Sale Process for the Seller
In this article we will give you an outline of the short sale process for sellers. For more information read our guide Step-by-Step Short Sale Process for Home Sellers where every step is discussed in detail.
1. Contact a
2. The processing company will reach out to your lender and initiate the short sale process. This includes ensuring you are eligible for a short sale, and submitting the required hardship/financial documents to lender.
3. The processing company will assign an expert, local real estate agent to list your home for sale.
4. An offer is received and submitted to your lender for review.
5. The lender conducts an appraisal of the property to determine its current “as-is” value.
6. Based off of the appraisal, the lender accepts or counters the offer.
7. Once a price is agreed upon between the buyer and lender, the lender officially accepts the offer and sets a closing date.
8. Settlement Day! You can breathe a sigh of relief and write an awesome testimonial for your
What Happens if I Short Sell My Home?
How Will a Short Sale Affect My Credit?
Before deciding to do a short sale, it is highly advised that the seller contacts a licensed credit professional to discuss the potential implications.
A short sale will result in a negative impact on your credit. However, it is less of an affect than a foreclosure would have.
The actual decrease in your credit score after a short sale will depend on how high or low your score was to begin with.
For example, if your score was in the 750-850 range, a drop of around 120-150 points may be likely. However, if your credit score was in the 650-700 range, you may experience a decrease of around 60-100 points.
So, what does all of this mean?
A drop in a borrower’s credit score resulting from a short sale can make borrowing again from lenders more difficult. The lower the credit score, the higher the interest rates and down payment.
Prior to a short sale, a borrower with a 750 credit score would get a favorable interest rate on a mortgage. Let’s say a 30 year fixed mortgage at 3.75%, for the sake of the example. After this borrower experiences a short sale, their score may decrease to somewhere around a 600. In this case, some banks will consider this person a “subprime” (riskier) borrower. That same 30 year fixed mortgage may turn into a 4.75% interest rate.
Be aware also that if you have a “subprime” score to begin with, a short sale may result in a lender not granting you another loan for 2-5 years.
For instance, if the borrower’s credit score is a 550, prior to the short sale, he or she will typically not have a sufficient enough score to qualify for a mortgage in the near future.
Once a short sale is completed, the verbiage on your credit report will read “settled for less than the full amount”, or some sort of variation. This lets future financiers know that you at least made an attempt to resolve as much as the debt as possible, rather than just letting the property go into foreclosure.
How Long Does a Short Sale Stay on Your Credit?
A short sale will stay on your credit for an estimated 3-7 years. The range will depend on numerous factors, including your immediate action steps, whether or not you seek help from a credit professional, and your current debt-to-income ratio.
Let’s take a look at this example:
Ray was underwater on his home and decided to perform a short sale. He has a solid credit score of 650. Once the sale was complete, Ray’s score dropped 150 points, leaving him at 500.
Determined to qualify for another mortgage in the near future, he hired a professional credit counseling agency to work on his score. The credit repair company was able to guide Ray through the process, allowing him to qualify for another loan 3 years later.
Are There Tax Implications with a Short Sale?
Before deciding to do a short sale, it is highly advised that the seller contacts a licensed tax professional in their applicable state to discuss potential implications.
The tax ramifications differ widely and are dependent on whether the home is used as a primary residence or an investment property, along with other factors.
When the lender chooses to waive their right to collect a deficiency judgement (come after the excess funds you owe), they will issue you a “cancellation of debt” tax form.
This tax form is called a 1099-C. According to the IRS, mostly any outstanding debt that is canceled, forgiven, or discharged is considered as capital gains and becomes taxable income to you.
The 1099-C document is broken down into several sections, including the creditors & debtors contact information, the date of the event, the amount of debt discharged, interest accrued, description of debt, fair market value of the home, etc.
Here is an example of where a 1099-C would apply:
Paul was just approved for a short sale on his property. His overall mortgage balance was $200,000 and his house sold for $150,000. The deficiency balance was $50,000. The bank chose to waive their right to collect the deficiency balance from Paul. So, they issued him a 1099-C, because the excess $50,000 was now considered taxable income.
In the case above, Paul is happy to accept the 1099-C. He would much rather the 1099-C than have to deal with possible judgments, wage garnishments, etc. resulting from the $50,000 deficiency balance.
Will I Be Able to Get Another Mortgage After the Short Sale Is Completed?
Your credit and financial history will be impacted by a short sale. However, it will be affected to a lesser extent, compared to a foreclosure.
As a result, you will be eligible to purchase another home in a much shorter time frame, compared with if the property was foreclosed upon.
You can usually expect the average waiting time to be around 3-7 years. This will depend upon a few factors, such as your action steps to improving credit, paying bills on time, and deciding on whether or not to consult with a credit counseling company.
Loan options after a short sale will vary, but they are out there.
Here are two potential loan options, after experiencing a short sale:
A Non-QM mortgage stands for non-qualified loan. These loans do not meet the requirements of the Consumer Financial Protection Bureau’s qualifications on Qualified Mortgages.
These loans have more flexible underwriting requirements, which make good options for those who experienced a short sale.
Government-Backed Loans Such as Fannie Mae & Freddie Mac
A government-backed loan is a mortgage that is subsidized by the government. Lenders are often able to offer borrowers favorable terms on these loans, because the government protects them against default.
If a borrower provides a written statement of why the short sale occurred, the lender may approve the loan within 2-4 years after the short sale. Typically, the bank wants to see that the short sale occurred due to short-term hick-ups, rather than longer-term financial hardships.
An FHA mortgage is backed by the Federal Housing Administration and designed for borrowers with low to moderate income.
Unless you were up-to-date with your monthly mortgage payments at the time of the short sale (this is unlikely), you may have to wait up to 3 years to secure an FHA loan.
Similar to the government-backed loans, if you are able to show the short sale occurred due to a short-term hardship or event, an FHA mortgage may be an option sooner.
Thoroughly Check and Keep Your Documentation
On another note, when the short sale is completed and the transaction is closed, it is very important that the seller keeps and stores all of their short sale approval documentation, as well as the settlement paperwork.
As the seller of a short sale, keep all documentation in a place where it will be easily accessible, if needed.
Think about it: the people that work at the bank and are responsible for filing and recording your short sale are only human. Humans make mistakes!
It is very possible that the lender rep accidentally reports your home as a foreclosure instead of a short sale.
Don’t panic! As long as you have all of your short sale and settlement documentation handy, you’re fine! I highly recommend keeping copies of all paperwork. At a minimum, here is what you’ll need:
- Executed purchase contract
- Executed settlement sheet (HUD1, closing disclosure, etc.)
- Copy of deed
Short sale paperwork:
- Copy of short sale approval letter
- Copy of any executed lender short sale affidavits.
Can a Bank Foreclose During the Short Sale?
This answer varies and is solely dependent on your given servicer, investor on the loan, and how far into the short sale process you are.
In other words, this will be a case by case basis.
If your house is listed for sale as a short sale and there is an upcoming foreclosure auction scheduled, the lender may not postpone the auction date, if no offer is received prior to the date. In this case, the bank would still foreclose, even as the home is listed for sale.
However, if an offer is received prior to the foreclosure auction date, your lender may postpone the auction, in order to review the offer that has been submitted. In this instance, the bank would not be foreclosing on their scheduled date.
It is important to note that when a lender “postpones” or “puts the foreclosure on hold” to review an offer for short sale, this does not mean you are off the hook! It simply delays the foreclosure process.
The only way to avoid and stop the foreclosure is by completing the short sale.
Short Sale vs Foreclosure
So, which is the best option for you? Here are a few differences between the two:
Short sale has a negative impact on credit, but is not recorded as a foreclosure by the lender. Short sale prevents a much larger negative impact a foreclosure would have on the homeowner’s credit.
According to FICO, a foreclosure can drop your credit score from an average 85-160 points and stay on your credit an average of 7 years.
In some circumstances, if the home is listed as your primary residence, you may be eligible for relocation assistance. In these cases, the bank will write you a check to help with moving expenses. The amount varies, but averages between $1,000-$3,000.
The lender simply takes the home back, without offering any financial assistance to the homeowner.
Save Yourself Money
When homeowners work with a
According to the U.S. Congress Joint Economic Committee, the average legal cost to a homeowner going through foreclosure is around $7,500.
Short Sale vs Deed in Lieu of Foreclosure
Availability as an Option
As long as the homeowner’s situation meets the criteria, they should be eligible for a short sale.
Deed in Lieu
This option will be offered on a case by case basis, depending on the lender’s comfort level in the given situation.
As noted earlier, short sales have a negative impact on credit, but typically lessening than foreclosures.
Deed in Lieu
Negative impacts on credit are widely known to be similar to that of foreclosures.
Pros and Cons of a Short Sale
As a seller, short sales have many positives, along with some negatives. It is important to be aware and knowledgeable of both.
Below is a summary of the pros and cons of a short sale for the seller.
Benefits of a Short Sale
When a short sale is completed, a foreclosure does not go on the seller’s financial record or credit report. As stated previously, a short sale puts the seller in the position to work hard and obtain financing in the near future.
Take Back Your Freedom and Peace of Mind
Freeing yourself of your problem home will alleviate your mind from the worries/stress of the looming foreclosure, constant barrage of bills, creditor phone calls, etc.
Relocation assistance is a compensation the lender offers a homeowner when they do a short sale and move out of the home. In order to be eligible, the subject property must be listed as your primary residence. It is important to note that relocation assistance is offered on a case by case basis. The compensation from the lender is between $1,000-$3,000, on average.
No Deficiency Judgement
A deficiency judgement is the balance the lender is losing in the sale. A seller and their representatives should always ensure the verbiage on the short sale approval letter indicates that the lender is waiving their right to pursue the deficiency judgement from the borrower.
Bank Pays Realtor Commission and Closing Costs
Unlike in a traditional transaction, the lender is responsible for the seller-side charges on the settlement sheet.
No Legal Fees to Foreclosure Attorney
Hiring an attorney for a foreclosure can be financially burdensome to a seller who is already in a tough spot financially. In some states, the attorney will have to charge you for showing up to court on numerous occasions, in addition to the hourly expenses for paperwork.
Lenders Like Short Sales
Believe it or not, a short sale is actually beneficial to the lender. As long as you qualify, you’ll typically get their cooperation. Foreclosures are expensive and time consuming for the lender. On top of that, banks do not want to take back your property. They aren’t in the land lord business for a reason!
Short Sales Are Straight Forward
Unlike the complexities of foreclosures, short sales are to the point. Once the seller completes and submits the requested paperwork and an offer is submitted, the bank orders an appraisal. Based off of the appraisal results, the lender either counters or accepts the offer.
Negative Consequences of a Short Sale
Negative Impact on Credit
A short sale is better for your credit than a foreclosure. However, the fact of the matter is that it still has a negative impact.
Bank Has Final Say
A seller of a short sale home has much more control and involvement in the process than they do during a foreclosure. For example, the homeowner chooses the offer, executes it, then submits to the bank. However, the final review and decision is in the lenders hands.
The Deficiency Balance Is Taxable
The seller and their representatives should always ensure the short sale approval letter waives the lender's right to come after the deficiency balance (balance owed). However, the borrower will have to fill out a 1099-C, which is the IRS tax form on the amount owed to the bank. So, if the mortgage balance is $100,000 and the home sold for $70,000, then $30,000 is taxable.
When and Why Should I Do a Short Sale on My Home?
After weighing the various advantages and disadvantages of short selling, you’re left with two questions:
Why and When?
Here is your “why”:
If you are a homeowner who resonated with at least one of the 8 benefits listed above, then short selling your home is worth it!
Most importantly, you will be alleviated of the stress that comes along with the home and the debt associated with it.
When you decide that a short sale is the right choice for you, the answer to “when” becomes very easy: ASAP!
The biggest mistake we see people make is wait too long, after determining a short sale is their best option.
The longer a homeowner waits, the more interest accrues and the closer the foreclosure auction date becomes. As the foreclosure auction date gets closer, performing a short sale becomes more difficult.
The information provided on this webpage may not be applied to a particular reader's situation and should not be taken as a legal or financial advice. For a legal of financial advice contact a licensed professional in your location.
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