The Real Estate Short Sale: Answers to Essential Questions

One of the most problematic factors in today's economic crisis lies within the housing market. CoreLogic, the nation's leading provider of information on property ownership, recently reported that a whopping 10.8 million residential properties are currently in a situation of negative equity. That is, the mortgages held on these properties are higher in value than the properties themselves. That figure represents a staggering 22.5% of all residential properties in the country.

Consequentially, homeowners everywhere affected by this condition are finding themselves in dire straits. Many can no longer afford to stay in their homes, and are forced into foreclosure, an often devastating blow to credit ratings and lives. One alternative that has arisen out of this condition is fast becoming one of the real estate market's most common trends: the short sale.

Though not as severe a solution as a foreclosure, the short sale comes with its own consequences and not everyone qualifies to proceed with such an option. Generally, a homeowner must already be in some sort of financial distress before a lender would even consider allowing a short sale of a home. Of course, this latest trend is still relatively new and there are many variables to consider in contemplating a short sale of a home.

The following are answers to some common questions regarding the short sale of a home and are the first steps in gaining knowledge on the topic before making the decision to delve into such an agreement.

What is a short sale?

A short sale is in essence, an agreement between the seller of a home and the mortgage holder, usually when foreclosure is a looming possibility and the owner of the home cannot get a selling price comparable to what is owed the lender on the mortgage. The financial institution agrees to allow the home to be sold for less than the outstanding balance of the debt and the homeowner agrees to relinquish any rights in the bargaining process with potential buyers.

Why would a bank allow a short sale?

Foreclosures are very costly to financial institutions. From foreclosure proceedings to taking physical ownership of the home and then selling it off, the entire process can add up to much more than the mortgage holder would lose in a short sale agreement.

Do all financial institutions allow short sales on mortgaged properties?

No, financial institutions are not obligated to allow short sales on properties in which they hold an interest, though more and more banks and mortgage companies are engaging in the practice. It's always best to check with the financial institution directly before making such a decision. (Please check below for links to specific major financial institutions that engage in short sale agreements. Otherwise contact your mortgage lender.)

What costs are involved for the homeowner in a short sale transaction?

In most cases, a short sale costs the seller nothing. Closing costs are usually paid by the mortgage holder.

Can the seller make a profit from a short sale?

By the very nature of this type of transaction, the seller walks away with nothing because the selling price is lower than what they've owed on the home.

What happens with the remaining debt that was owed on the property before the sale?

It all depends on the financial institution. In some cases, the lender may make arrangements for the homeowner to make restitution on a portion of the loss difference, or in some cases, the debt may be forgiven altogether.

Will the seller's credit rating be affected if they allow a short sale on their property to occur?

While credit reporting is at the discretion of the mortgage holder, standard practice has been for the financial institution to report the debt as "paid", but with an added clause that says, "settled for less" or something of that nature. Though this scenario is a relatively new concept in credit reporting, it is generally accepted that approximately 80 points will be deducted from the seller's credit score and the negative effects will last about two years.

Are there any tax implications to the seller in a short sale transaction?

Though both the IRS and a tax specialist should be consulted regarding any and all tax implications relating to the short sale of a home, the United States government passed two laws that affect these types of agreements. The Mortgage Forgiveness Debt Relief Act of 2007 and the Economic Stabilization Act of 2008 were signed into law as a means to curb the economic recession and looming housing crisis. The laws provide safeguards against tax implications that would beforehand have affected sellers restructuring their mortgages or being foreclosed upon.

Before the laws were passed, if a lending institution settled a debt with a borrower for an amount less than the original agreement, they would notify the IRS and a 1099-C form would be generated, thereby including the deficit as income for the borrower. The 2008 law provides that debt on a borrower's principal residence that is forgiven or cancelled by a lender may be excluded as income. Debt reduced through a mortgage restructuring or forgiven through foreclosure proceedings qualifies for the relief provided for in the law. Since short sales are in lieu of foreclosures, the law generally is extended to these agreements, as well.

The original Mortgage Forgiveness Debt Relief Act of 2008 was to be in effect for 3 years, but the subsequent Economic Stabilization Act of 2008 extended the provisions until the year 2012.

Clearly, there are many variables to consider when looking at the option of a short sale of a home. It is always a good idea to consult experts, such as realtors, real estate and tax attorneys, and of course, your financial institution before proceeding with such an agreement.

Sources:

Personal experience

http://articles.moneycentral.msn.com/Banking/HomebuyingGuide/UseAShortSaleToEscapeForeclosure.aspx

http://www.buzzle.com/articles/short-sale-tax-implications.html

http://www.fairfaxtimes.com/cms/story.php?id=2681

http://www.irs.gov/individuals/article/0,,id=179414,00.html

http://www.louisvilleshortsaleexpert.com/how-much-does-a-short-sale-cost-the-seller/

http://problembanklist.com/banks-may-be-facing-a-tidal-wave-of-mortgage-defaults-0257/

http://www.shortsalehelp.com/

http://www.shortsales101.com/basics.htm

http://www.smartmoney.com/personal-finance/real-estate/the-shortcomings-of-short-sales/

Major Banks that work with short sales:

Bank of America

http://homeloanhelp.bankofamerica.com/en/short-sale.html

Chase

https://www.chase.com/chf/mortgage/hrm_shortsaleinfo

Citibank's Office of Homeownership Preservation

http://www.citigroup.com/citi/citizen/community/homeownershippreservation/

HSBC

http://www.us.hsbc.com/1/2/3/personal/home-loans/mortgage/existing/when-payment-difficulties-arise

Wells Fargo

https://151.151.13.133/homeassist/