A short sale is when a bank or mortgage lender agrees to discount a loan balance due to an economic or financial hardship on the part of the mortgagor. The process is handled through the loss mitigation department. In a short sale, the home owner sells the mortgaged property for less than the outstanding balance of the loan, and turns over the proceeds of the sale to the lender in full satisfaction of the debt. In all short sales, the lender has the right to approve or disapprove of a proposed sale.
Not all banks will discount a loan balance. The circumstances are usually related to the current real estate market climate and the individual borrower's financial situation.
A short sale is most often executed to prevent a home foreclosure. Bank often choose to allow a short sale when they believe it will result in a smaller financial loss than foreclosing. For the home owner, the advantages include avoidance of having a foreclosure on their credit history and the partial control of the monetary deficiency. Short sales are typically faster and less expensive than foreclosures.
Short sales are often wrongly portrayed as difficult to complete or morally questionable. This is simply untrue if the value of the underlying asset, a home, has fallen dramatically and the debtor has limited assets. Short sales are common in standard business transactions. When it makes no business sense or is economically not feasible to retain an asset businesses default on their loans. It is not uncommon for business bonds to trade on the after-market for a small fraction of their face value in realization of the likelihood of these future defaults. Short sales in real estate are simply the application of the same principles in another discipline.
Loss Mitigation
Most lenders have a loss mitigation department that processes potential short sale transactions. Typically, lenders do not accept short sale offers or requests for short sales until a Notice of Default has been issued or recorded with the locality where the property is located.
Lenders have a varying tolerance for short sales and mitigated losses. The majority of lenders have a pre-determined criteria for such transactions. Other distressed lenders may allow any reasonable offer subject to a loss mitigator's approval. Junior liens - such as second mortgages, HELOC lenders, and HOA (special assessment liens) - may need to approve the short sale. Frequent objectors to short sales include tax lieners (income, estate or corporate franchise tax - as opposed to real property taxes, which have priority even when unrecorded) and mechanic's lien holders. It is possible for junior lien holders to prevent the short sale.
Recent Changes to Federal Laws
The amount forgiven by a lender is considered income for the borrower and is liable to be taxed. However, The Mortgage Forgiveness Debt Relief Act of 2007, removes such tax liability and allows the borrower and lender to work freely together to find a common solution that is beneficial to both parties. This protection is limited to primary residences –excluding rental properties -- so consultation with a tax advisor is necessary to ensure that a borrower qualifies. More recent legislation provides for a specialized type of refinancing option, available for mortgages made after in 2006 or later, for owner-occupied homes. Under this program a debtor provides information similar to that necessary for a short-sale but rather than selling the house to a third-party an FHA guaranteed loan at a fixed-rate is available if the original lender is willing to write-off all but 85-percent of outstanding of the debtor's obligations (including principal, interest, late-fees, prepayment penalties, and all other fees).
Credit
A short sale does affect a person's credit report, though the negative impact is typically less than a foreclosure. Short sales are a type of settlement and remain on a credit report for seven years. Depending upon other credit information it is typically possible to obtain another mortgage 1-3 years after a short sale.
Items needed to start the short sale process
Preliminary Net Sheet
This is an estimated closing statement that shows the sales price you expect to receive and all the costs of sale, unpaid loan balances, outstanding payments due and late fees, including real estate commissions, if any. Your closing agent or lawyer should be able to prepare this for you, if you do not know how to calculate any of these fees. If the bottom line shows cash to the seller, you will probably not need a short sale.
Hardship Letter
The sadder, the better. This statement of facts describes how you got into this financial bind and makes a plea to the lender to accept less than full payment. Lenders are not inhumane and can understand if you lost your job, were hospitalized or a truck ran over your entire family, but lenders are not particularly empathetic to situations involving dishonesty or criminal behavior.
Proof of Income and Assets
It is best to be truthful and honest about your financial situation and disclose assets. Lenders will want to know if you have savings accounts, money market accounts, stocks or bonds, negotiable instruments, cash or other real estate or anything of tangible value. Lenders are not in the charity business and often require assurance that the debtor cannot pay back any of the debt that it is forgiving.
Copies of Bank Statements
If your bank statements reflect unaccountable deposits, large cash withdrawals or an unusual number of checks, it's probably a good idea to explain each of those line items to the lender. In addition, the lender might want you to account for each and every deposit so it can determine whether deposits will continue.
Comparative Market Analysis
Sometimes markets decline and property values fall. If this is part of the reason that you cannot sell your home for enough to pay off the lender, this fact should be substantiated for the lender through a comparative market analysis (CMA). Your real estate agent can prepare a CMA for you, which will show prices of similar homes:
· Active on the market
· Pending sales
· Solds from the past six months.
Listing Agreement and Purchase Agreement
When you reach an agreement to sell with a prospective purchaser, the lender will want a copy of the offer, along with a copy of your listing agreement. Be prepared for the lender to renegotiate commissions and to refuse to pay for certain items such as home protection plans
or termite inspections.