Breakdown of the Short Sale Process
Many homeowners are now faced with the reality that they owe more on their homes than they’re worth. Maybe they bought the home for $150,000 and then in 2005-2006 when values were on the rise they refinanced because their value went up to $220,000. And now for one reason or another they can no longer afford their mortgage payments and their home value is back down around $150,000.
Many people feel trapped, as if there is no way out. There is: which is why short sales are on the rise. A short sale, simply put, is when your lien holder (the bank) agrees to accept less for your home than you currently owe them.
Although it seems pretty simple, there is definitely a science that goes into it, and should only be tackled by an experienced short sale agent that knows how to handle them and knows how to get them done. Below you will find exactly what it takes to get a short sale accomplished.Do You Qualify?
Listing the Home for Sale
The home will be listed just like listing any home for sale. An experienced realtor will do extensive research and conduct a comparative market analysis to determine what your home is worth.
Once you and your agent have determined a fair market value for your home, a list price is set and your home will go on the open market just like any other home for sale. Pictures will be taken of the inside, any known defects will be disclosed upfront, and your home will be put up for sale. It is not yet mandatory in Massachusettts or New Hampshire, but all good agents know to disclose upfront that it is in fact a short sale transaction. The reason this should be disclosed is so potential buyers may not have the time to be able to wait for the bank’s approval. On average it can take 1- 3 months to obtain.
The goal of the listing agent is to sell the home for top dollar just like any other home they list. A buyer who is willing to wait for approval makes an offer. If it is a good offer the seller accepts it “subject to lien holder approval.”
Dealing with the Banks
Once an offer is accepted, the second step in handling a short sale is dealing with the banks. The best way to approach this is to have as much of your short sale package together ahead of time. The main things a bank will be asking for are:
- Letter of Hardship
- Past two Pay Stubs
- Past two months Bank Statements
- Past Two Years Tax Returns
To touch upon each of these briefly:
The hardship letter is a letter from you, the seller (the borrower, in the bank’s eyes) which states your financial and/or personal hardship, what caused you to be in this situation (i.e., divorce, a loss of a job, relocation, illness, etc.) that will help the bank understand why it’s imperative that you do a short sale.
The next couple of documents on the list are your pay stubs, bank statements and tax returns. These are pretty straight forward. The goal with these documents is to show verification to the bank that you cannot afford your home any longer. Just as the preapproval process is to prove you are qualified to purchase a home, this is to prove you are no longer qualified.
As stated above, a real estate professional that knows how to handle short sales will be able to help you gather all of this information.
After the bank has agreed to do the short sale and provided a short sale approval in writing, a closing is scheduled. The closing is usually within 30 days of the approval letter being issued. All loan servicers will provide in writing specific language about the remaining balance being waived. Balances are waived completely over 90% of the time.
Two Common Questions/Concerns We Hear About Short Sales:
1. Tax Liability: One question that always seems to come up from distressed homeowners considering doing a short sale is, “Will I owe taxes on the balance that is waived?”
In 2007 The Mortgage Forgiveness Debt Relief Act was passed. In short, this generally allows taxpayers to exclude from their income the forgiven amount on their primary residence. This act applies to tax years 2007-2013 up to $2 million dollars. The original Act was set to expire in 2012 but was extended to 2013.
Below are a few frequently asked questions and answers concerning the Mortgage Forgiveness Debt Relief Act, extracted from the IRS website (www.irs.gov)
- What does exclusion of income mean?
Normally, debt that is forgiven or cancelled by a lender must be included as income on your tax return and is taxable. But the Mortgage Forgiveness Debt Relief Act allows you to exclude certain cancelled debt on your principal residence from income.
- Does the Mortgage Forgiveness Debt Relief Act apply to all forgiven or cancelled debts?
No. The Act applies only to forgiven or cancelled debt used to buy, build or substantially improve your principal residence, or to refinance debt incurred for those purposes. In addition, the debt must be secured by the home. This is known as qualified principal residence indebtedness. The maximum amount you can treat as qualified principal residence indebtedness is $2 million or $1 million if married filing separately.
- Does the Mortgage Forgiveness Debt Relief Act apply to debt incurred to refinance a home?
Debt used to refinance your home qualifies for this exclusion, but only to the extent that the principal balance of the old mortgage, immediately before the refinancing, would have qualified. For more information, including an example, see Publication 4681.
- How long is this special relief in effect?
It applies to qualified principal residence indebtedness forgiven in calendar years 2007 through 2013.
- Is there a limit on the amount of forgiven qualified principal residence indebtedness that can be excluded from income?
The maximum amount you can treat as qualified principal residence indebtedness is $2 million ($1 million if married filing separately for the tax year), at the time the loan was forgiven.
(For more information on this Act you can visit IRS.gov.)
2. Deficiency Balance: Another question that always comes up is whether or not the bank will really forgive the remaining balance (deficiency balance) on their loan. The deficiency balance is the difference between what you owe and what your home sells for minus the fees involved in the sale. Again, over 90% of the time this balance is waived through a short sale and yes this would be in writing in the actual approval.
Let’s say your home sells for $400,000 but you owe $550,000 which makes for a $150,000 difference. But you cannot forget about all the fees, missed mortgage payments, and closing costs that get added on top of that. That could be up to $200,000 in debt that the bank forgives. Most loans are owned by Government Sponsored Enterprises (GSEs) Fannie Mae, Freddie Mac, or the FHA. It is estimated the three of them own around 80% of all outstanding mortgage debt across the country. All three of them do forgive the balances after a short sale as long as no fraud was involved.
So whether your loan is serviced by Bank of America, Chase, GMAC, Citi, HSBC, Wells Fargo, American Home Mortgage, or Ocwen, or any other servicer, chances are it is owned by one of the three GSEs. Every one of those servicers does put a deficiency balance waiver into their Short sale approvals. If they tell you different they are wrong! To see approvals with balance waivers from all of these banks click here to view our sample short sale approvals.
Short Sale vs Foreclosure
The last thing distressed homeowners need to remember is that if you allow your home to be foreclosed on, the bank has every right to pursue you for the deficiency balance on both 1st and 2nd mortgages.
According to an article printed in the Boston Herald, the “state law allows second-lien holders to go after some post-foreclosure debts for as long as 20 years. Firms can also go to court and get ‘deficiency judgments’ good for a second 20 years.”
In most cases on GSE backed loans they do not pursue but they can and there is a lot of talk that they may down the line. A Housing Wire article states Fannie Mae will take legal action against borrowers who strategically default in order to recoup mortgage debt. And the Wall Street Journal reported that forty one states and the District of Columbia permit lenders to sue borrower for mortgage debt still left after a foreclosure sale.
The great thing about a short sale is that it creates closure. Once a short sale is complete and you have your short sale approvals in hand stating that the debts are forgiven you can be certain that you will not hear from the bank ever again.Do You Qualify?