A short sale can be a favorable option in the event that you’ve fallen behind on mortgage payments or face the possibility of foreclosure. But it’s certainly not a get out of jail free card issued by your friendly neighborhood bank. Short sales, like other types of distressed home sales, come with consequences to your credit and financial future.
The good news is America’s healthy real estate market has far fewer homeowners in the tough position of being upside-down on their mortgage: distressed sales made up just 12.4% of single-family home and condo sales in 2018, down from a peak of 38.6% in 2011 and 14.0% in 2017, according to the national property data warehouse ATTOM Data Solutions.
But short sales do still happen, even in the housing market’s glory days. Tamara Bourne, a top agent in Peachtree City, GA, who’s facilitated nearly 1,000 transactions to date, recalls a time when a school system lost Georgia accreditation and tanked property values, “so [residents’] houses were no longer worth what they were when they bought them,” she says.
Whatever the case, be sure you’re aware of all the strings attached for your particular lender agreement and check the fine print of your short sale arrangement before you sign anything—start with these six things to be wary of.
1. You may have better options at your disposal.
For a lender, a short sale is more appealing than a foreclosure, where the bank would assume the risk and legal costs of an REO property—in other words, a piece of real estate that the lender now owns. A short sale also allows a lender to minimize its losses.
That said, you may have other options for handling an upside-down or underwater mortgage. You can:
- Dip into savings or retirement funds to make up the difference;
- Pay what’s owed through a loan from the Federal Housing Administration;
- Rent out your home while you buy or lease another and use the lease income toward your mortgage;
- Use available funds for basic repairs (fresh paint, replacing flooring, hiring a professional stager) that can boost your home’s value and asking price;
- Ask your lender about any temporary mortgage relief options.
Also, if refinancing your home for more than its worth has landed you in this situation, you might not need a short sale if you can return any of the money you’ve borrowed.
“I would always tell [clients] you actually got the money on a refinancing situation. They’d already taken the money out of the house. Could they bring it back to the table at closing? Which I think is the best thing to do, the most honest thing,” Bourne said.
2. Be aware that your credit score is not safe.
A short sale doesn’t affect your credit score in the same way as a foreclosure, but it does stay on your financial record for a while. The Federal Trade Commission says that people who go through a foreclosure may have to wait seven years before they’re eligible for a new mortgage, while those who go through a short sale may qualify in two years.
A short sale also can lower your credit score by 85 to 160 points. The good news is, you can repair your credit within a few years if you continue to pay other bills on time.
“Most people go rent a house for three or four years” after a short sale, Bourne said. “Then we sell them a home when their credit is returned.”
3. Your lender won’t necessarily cancel the remaining debt.
For a short sale, you’ll work with your agent to provide your bank or lender with a market analysis about your neighborhood and documents supporting your financial hardship. The lender then decides whether to approve your short sale, Bourne said.
But even after your property sells, you still may owe money if the lender or lenders doesn’t cancel or “forgive” the remaining debt.
“It’s not across the board one way,” Bourne said. “Sometimes the whole thing is forgiven. Sometimes they’ll make augmented payments paid back. Sometimes it’s taxable. Sometimes it’s not.”
4. Any forgiven debt may be considered taxable income.
The amount of debt that you couldn’t pay back on the mortgage can be considered a windfall, so to speak, as far as the IRS is concerned. If the bank “forgives” or cancels any outstanding debt that’s subject to taxation, you’ll receive a 1099-C form, or Cancellation of Debt form, which must be filed with your federal tax return and added to your gross income.
Sometimes the canceled debt isn’t recorded as income but a “sale” for tax purposes and subject to capital gains or losses, according to Turbo Tax.
Talk to your agent and a tax professional about your particular situation to gauge whether you’d be financially responsible for the outcome of a short sale.
5. Short sales are anything but “short” in length.
The name aside, short sales can be lengthy, lasting months or years because of the legal guidelines involved. For example, once the house is listed for sale, the bank or lender fields and reviews any offers. “They [the potential buyers] send the offer in, and then the bank now negotiates that offer, if they’ll take it or not,” Bourne said. “The bank’s involved a lot more.”
Responding to concerns from the National Association of Realtors, the US Treasury Department has developed the Home Affordable Foreclosure Avoidance (HAFA) Program to establish uniform procedures, forms, and deadlines for short sales and transactions that return the property to the lender (known as a Deed-in-Lieu of foreclosure, or DIL).
The HAFA Program provides several benefits, such as $3,000 to borrowers for relocation assistance. To qualify, borrowers must have a documented financial hardship and:
- Must have obtained the mortgage before Jan. 1, 2009;
- Must have a first mortgage less than $729,750;
- Must not have purchased a new house within the past twelve months;
- Must not have a mortgage owned or guaranteed by mortgage companies Freddie Mac or Freddie Mae;
- Must not have been convicted within the past ten years of a financial crime such as felony larceny, forgery, fraud, money laundering, or tax evasion.
“Even if successful, the process usually takes many months and countless hours and often requires re-marketing because buyers lose patience and terminate the contract,” NAR notes.
6. Whether your home qualifies for a short sale is up to the bank.
Of course, all of the above considerations are contingent upon whether your bank or lender determines that you qualify for a short sale.
To start the process, after your agent’s market analysis, you’ll have to write a hardship letter with your agent’s guidance that explains your current financial instability and essentially apologizes to the lender for being unable to repay the mortgage. Common reasons for such hardship are a job transfer, loss of income, divorce, or death in the family.
You’ll also undergo a personal finance audit, providing proof of income, any assets (money market accounts or other property), and bank statements to prove your current financial situation, submitting up-to-date records and thorough documentation.
As short sale expert Brad Wallace of Philadelphia notes, “You’ve got to be able to qualify for a short sale. It’s all numbers. You’d better show that your bills outweigh your assets, or they will turn you down.”
A real estate agent who is experienced with short sales is vital to navigating this complicated transaction.
Discuss the agent’s prior experience, any short sales they’ve completed with your specific lender, and any additional training or certification they have.
For instance, NAR offers a Short Sales and Foreclosures Resource Certification program. An agent also may be a Certified Distressed Property Expert who has extensive knowledge of foreclosure avoidance options such as short sales.
Take your time before deciding whether to pursue a short sale, and do more research relevant to your particular circumstances. The Consumer Financial Protection Bureau provides housing counselors nationwide who are approved by the U.S. Department of Housing and Urban Development to offer independent advice about mortgage terms, defaults, foreclosures, short sales, and other credit issues.
Your best option may be to wait until the market in your area shifts in your favor, with local housing inventory selling within four months. “When it becomes a seller’s market,” Bourne said, “rarely do you have a short sale.”
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