As someone who exclusively handles Massachusetts short sales, I am repeatedly asked the same questions from both homeowners and Realtors when considering a short sale. As more homeowners default on their mortgages, I believe it is important to dispel some of the short sale myths that give these often misunderstood transactions a negative connotation. Short sales currently account for a large portion of home sales and there is no indication that these transactions are going to disappear anytime soon. Whether you are a seasoned Realtor, or a homeowner considering a short sale, it is important to know exactly what to expect from a short sale.
What Is A Short Sale?
A short sale occurs when the lender agrees to accept less money than the total amount due on your mortgage. The transaction is referred to as a short sale because the total proceeds of the ‘sale’ constitute a ‘short’ payoff of the lien. Upon receipt of this lesser amount, a successful short sale will result in the lender agreeing to completely release the homeowner from the loan obligation. The entire process can be extremely time consuming and typically requires a lengthy negotiation with the lender. Banks and loan servicers are increasingly starting to recognize short sales as their preferred method to dispose of distressed properties. It is important to note, however, that short sales are generally reserved for homeowners who do not qualify for a loan modification or simply prefer to sell their home instead of going through the foreclosure process.
How Do I Know If I Qualify For A Short Sale?
All homeowners qualify for a short sale as long as you recently experienced a financial hardship. A financial hardship is any event that negatively affects your finances such that the loan is no longer affordable. Most, if not all homeowners will qualify for a short sale if they can prove that they have an involuntary hardship. Acceptable hardships typically include:
- Loss of a employment;
- Curtailment of income;
- Increased mortgage payment or liabilities;
- Loss of tenant(s);
- Divorce or Separation;
- Catastrophic medical event;
- Job relocation
- Military service; or
- Death in the family
As a part of the short sale application process, you will be asked to write a hardship letter informing the lender why you are no longer able to make mortgage payments on your home. If you recently experienced a financial hardship, you will first need to list the property for sale with an experienced real estate agent. Once you receive an offer, you will next provide a short sale package to your current lender. The short sale package typically includes tax returns, personal bank statements and proof of income along with your a hardship letter. The lender will review these items, order an appraisal of the property, and either accept or present the homeowner with a counter-offer. In all of my short sales, I am yet to have the lender flat-out reject an offer.
How Long Does A Short Sale Take?
Unfortunately, there is no definitive answer to this question. The amount of time it takes to complete a short sale depends on various factors such as how many liens are on the property, which lenders service the loan, whether third- party investor or mortgage insurer approval is required and, most important, the experience level of your short sale negotiator. On average, the negotiation should take an experienced short sale professional about 60 days from the time all documents are submitted to the lender.
The process may take longer if the property has multiple liens because each lien holder must agree to the short sale. In some cases, the mortgage will be part of a bundle of loans that were packaged and sold to individual investors. These ‘securitized’ mortgages require third-party approval in order to be ‘sold short’. Likewise, some lenders actually took out insurance policies against default and, therefore, require third-party approval from the mortgage insurance provider before they can agree to a short sale.
As someone who exclusively handles short sales, the foregoing are the most common factors contributing to the amount of time needed to complete a short sale. Without question, the most common reason for a lengthy short sale is an inexperienced short sale negotiator. If the person collecting the documents and communicating with the lender lacks short sale experience, the transaction is doomed from the outset. If your negotiator fails to meet a deadline or doesn’t correctly perform one of the requested tasks, your short sale can easily get lost amongst the lender’s thousands of short sale requests. As a short sale negotiator with an extremely high success rate, I would encourage all homeowners and Realtors to do their homework before entrusting your short sale transaction with someone who claims to be a short sale expert.
What Are The Tax Implications Of A Short Sale?
DISCLAIMER: The authors of this website are not tax professionals and therefore do not give any tax advice. All readers are encouraged to seek the advice of an independent tax advisor when considering a short sale. That said, the tax implications of a short sale will primarily depend on whether the property being sold is your primary residence and, if so, whether you qualify for a tax exemption. In general, if you owe a debt to a third party and they cancel or forgive that debt, the IRS considers the canceled debt as taxable income. In the case of a mortgage loan, you are not required to include the loan proceeds as income when you initially borrow the money because you have an obligation to repay the lender. When that obligation is subsequently forgiven, the amount you received as loan proceeds is reportable as income because you no longer have the obligation to repay the lender. Following the short sale, your lender is obligated to report the forgiven debt to the IRS on a Cancellation of Debt form 1099-C . Individuals are similarly required to report the forgiven debt to the IRS on Form 1040. Cancellation of debt is not always treated as taxable income. The most common situations when cancellation of debt income is not taxable involve:
- Qualified principal residence indebtedness: This is the exception created by the Mortgage Debt Relief Act of 2007 and applies to most homeowners;
- Bankruptcy: Debts discharged through bankruptcy are not considered taxable income;
- Insolvency: If you are insolvent when the debt is cancelled, some or all of the cancelled debt may not be taxable to you. You are insolvent when your total debts are more than the fair market value of your total assets;
- Certain farm debts: If you incurred the debt directly in operation of a farm, more than half your income from the prior three years was from farming, and the loan was owed to a person or agency regularly engaged in lending, your cancelled debt is generally not considered taxable income; and
- Non-recourse loans: A non-recourse loan is a loan for which the lender’s only remedy in case of default is to repossess the property being financed or used as collateral. That is, the lender cannot pursue you personally in case of default. Forgiveness of a non-recourse loan resulting from a foreclosure does not result in cancellation of debt income. However, it may result in other tax consequences.
The Mortgage Forgiveness Debt Relief Act of 2007 is the most common exception to the rule that cancelled debt is taxable income. According to the Debt Relief Act, taxpayers may exclude debt forgiven on their ‘qualified principal residence’ if the balance of their loan is $2 million or less. Qualified principal residence indebtedness is limited to forgiven or cancelled debt used to buy, build or substantially improve your principal residence, or to refinance debt incurred for those purposes. Thus, even debt incurred as a result of a refinance loan will qualify for this exclusion, but only to the extent that the principal balance of the old mortgage would have qualified. In other words, if the debt forgiven was a result of a short sale of your qualified principle residence, and you never refinanced, you will qualify for the tax relief. If, however, you took out a refinance loan, you will qualify for tax relief only up to the principal amount of the original mortgage. Debt forgiven on second homes, rental property, business property, credit cards or car loans does not qualify for the new tax-relief provision. A homeowner may qualify for tax relief following a short sale if they are deemed insolvent, files bankruptcy or lives in a jurisdiction that treats the debt as ‘non-recourse’. Keep in mind, however, that not all states recognize the mortgage debt relief act and you should always consult with a tax professional prior to agreeing to a short sale.
If the debt is non-recourse, the debt is only secured by the property, and the debtor is not personally liable for the balance. Forgiveness of a non-recourse loan resulting from a short sale does not result in cancellation of debt income but it may result in other tax consequences. These exceptions are discussed in detail in Publication 4681. Conversely, if the debt is recourse, the debtor is personally liable for the unpaid debt the lender may pursue a money judgment for the amount owed.
Thus, if the property is your qualified primary residence, you live in a non-recourse jurisdiction or you are declared insolvent, it is possible that a short sale will result in little or no tax consequences. You should never, under any circumstances, take a negotiator’s word that the debt will be forgiven and always demand that the lender provide any such agreement in writing. Regardless, you should always consult with a local attorney or tax professional regarding your jurisdiction’s tax laws to determine whether a short sale of your property will result in tax consequences.
What Are The Legal Implications Of A Short Sale?
DISCLAIMER: The authors of this website are not licensed attorneys and do not give legal advice. All readers are encouraged to seek the advice of an independent attorney when considering a short sale. As mentioned in the previous section, if the lender forgives the debt, then the amount forgiven may be considered taxable income. If, however, the lender refuses to forgive the difference, then it becomes a personal debt obligation. A personal debt obligation means that a lender (or a third party who buys the debt obligation from the lender) has the right to legally pursue you by getting a court ordered money judgment. In Massachusetts, the judgment is good for 20 years. If you are working with an experienced short sale negotiator, this individual should always request that the lender’s final approval letter contain ‘deficiency language’which releases the homeowner from all obligations under the note. The deficiency language provides the homeowner with a written agreement stating “in consideration of the short payoff the lender agrees to completely release the homeowner from all loan obligations and the lender hereby relinquishes the right to pursue any deficiency judgment against said individuals”. In addition, each state has specific laws which may dictate the legal implications of a short sale. Regardless, you should always consult with an attorney before agreeing to a short sale as well as work with an experienced short sale negotiatorto ensure that all deficiency rights are properly released following a short sale.
What Are The Benefits Of A Short Sale?
A homeowner can benefit from a short sale because it allows you to get out of a difficult financial situation without having to go through the foreclosure process. A foreclosure will seriously damage your credit and negatively affect your ability to borrow money for a prolonged period of time. In general, if your home is foreclosed upon, you may not be able to get a conventional loan for at least a period of five to seven years. Conversely, following a short sale, you can qualify to purchase a home in as little as two years. With regard to your credit score, the credit bureaus have yet to define a uniform standard for reporting short sales. As long as you remain relatively current on your payments, and at least avoid being seriously delinquent, you may be able to avoid a huge hit to your credit by choosing a short sale instead of a foreclosure. In either event , your credit score is going to be negatively impacted.
With regard to the deficiency judgment, a short sale is clearly a better option than a foreclosure. If the lender forecloses on your home, they will pursue a deficiency judgment against the homeowner. In contrast, the deficiency is always negotiable in all short sales and any experienced negotiator should be able to get the lender to agree to waive their deficiency rights against the homeowner. As a result, a short sale is clearly the a better option than a foreclosure for a homeowner who cannot afford to pay back the lender.
Why Would A Lender Agree To A Short Sale?
Banks spend an average of $40,000-$50,000 to foreclose on a property. Not to mention, the foreclosure process can take a very long time. Banks are not in the business of owning the actual real estate and would much rather avoid the carrying costs of maintaining a vacant property. In addition, the bank’s foreclosure practices have recently been called into question and, as a result, they may lack the legal authority to foreclose. A national study recently stated that a homeowner is delinquent on their payments on average 492 days before foreclosure. Consequently, a short sale may provide both the lender and the homeowner with a less costly alternative to foreclosure.
Must I Be Delinquent On My Mortgage In Order To Qualify For A Short Sale?
No. You do not need to be behind with your mortgage payments in order to qualify for a short sale. In the past, many lenders required the homeowner to be in default prior to applying for a short sale. This is no longer the case. Whether your property is in foreclosure, or you are current with your payments, you may qualify for a short sale as long as you have an acceptable financial hardship. In fact, a majority of lenders are now encouraging homeowners to pursue a short sale, and, in some cases, even provide distressed homeowners financial incentives upon learning that they can no longer make the mortgage payments.
Update to original post: Many underlying investors, such as Fannie Mae or Freddie Mac, require the homeonwer to be in imminent threat of default in order to approve a short sale. Thus, they may require the homeowner to be at least 31 days, or in some cases 61 days delinquent, in order to approve a short sale.
Do I Qualify For A Short Sale If I Have Two Mortgages On The Property?
Yes. Both lien holders will have to agree to the short sale but these types of transactions are very common. In addition, a majority of second lien holders will accept a fraction of the total amount owed on the note because they are in second lien position. Regardless, you want to ensure that both lenders provide you with a written release stating that you have no future debt obligations as a result of the short sale.
What Is A Short Sale Negotiator And Why Are They Necessary?
A short sale negotiator can be either a Realtor, attorney or an independent third party. Regardless of who handles the short sale negotiation, the lender generally pays the entire negotiation fee at closing. Unlike a Realtor, however, an independent third party negotiator does not work on commission and is not bound by a fiduciary duty to their client. The primary objective of a third party negotiator is to get the property sold and relieve the homeowner from their debt obligation. A homeowner can benefit from the use of a short sale negotiator because they are familiar with the lender-specific short sale procedures and have likely developed relationships with the major lenders. A successful negotiator has the ability to leverage these relationships in order to efficiently and effectively handle each short sale transaction. As a homeowner, it is important to do your homework when choosing to work with a negotiator and make sure that they are not only experienced, but that they are in compliance with state and federal laws. Never pay a third-party any up-front fees and be aware of mortgage scams.
About the Author: Andrew Coppo of Greater Boston Short Sales, LLC (GBSS) is Massachusetts’ leading short sale negotiator. GBSS assists buyers, sellers, real estate agents and attorneys with getting their short sales closed. Contact us today if you are a homeowner facing foreclosure or a Realtor seeking assistance with a short sale transaction. GBSS is a MARS provider. Please read our disclaimer HERE.
If you are considering a Massachusetts short sale, and would like a free short sale consultation, please call Andrew Coppo to schedule a meeting or a telephone consultation at (617)264-0376.