Short Sale and Foreclosures
A short sale is a situation in which the seller
(1) owes more money on the loan (and any other liens on the property) than the sale of the property will likely produce on the market and
(2) is unable or unwilling to bring money to closing. In a short sale, the lender has not yet foreclosed on the property, which provides a window of opportunity for the owner to sell the property in order to at least partially satisfy the amount owed to the lender.
Your lender must agree to forgive all or a portion of the amounts you are short.
It is important to seek the advice of professionals prior to performing a short sale. There are many legal implications that need understanding and resolution prior accepting a banks letter of short sale approval.
Short sales are considered preferable to foreclosures because short sales
(1) Lessen the impact a foreclosure can have on the surrounding community
(2) Wont damage the distressed owner’s credit as much as a foreclosure
For example, if the borrower is still current with other payments, a short sale may lower the borrower’s credit score by as little as 50 points.
A deed in lieu of foreclosure occurs when the borrower agrees to trade the property to the lender in exchange for the cancellation of the note. This foreclosure alternative is more likely to work in states where there is a long foreclosure timeline. The lender will be able to get the property much sooner than going through the foreclosure process, which lessens the probability of the property being in disrepair as well as eliminates the lenders costs to foreclose.
Market conditions as well as state-specific laws will influence whether and how a lender accepts a deed in lieu of foreclosure. Typically, lenders are less willing to consider a deed in lieu of foreclosure in declining markets. However, in appreciating markets, lenders may accept properties in lieu of foreclosure.
If homeowners are simply unhappy that the value of the property is less than what they paid or owe, they need to contact an attorney for advice. Walking away from the loan or asking the lender to proceed with a short sale simply because the value went down may not be a viable option and if it is, there will often be additional financial consequences.
Foreclosure to Homeowners Credit
- How short sale is reported will effect credit score
- After short sale, lender can report as:
1. Paid in full – paid as agreed
2. Paid – settled
3. Paid – unrated
- If the owner is current with other payments, a short sale may only lower score by 50 points.
Can lower credit score by 200 points or more
Foreclosure remains a public record and on credit history for 7 years.
The short sale approval process varies in different circumstances. The loss mitigation departments of different banks will have a slightly different way of managing the process. The usual steps after listing the property for sale are
Proving Financial Hardship: You must prove to your lender(s) that you are experiencing financial hardship and will be required to provide the following information.
A seller’s hardship letter and financial information as outlined below.
The goal of the hardship letter is to have the seller explain their situation to the bank. The hardship letter should communicate three key points:
- “I’m sorry”
- “Here are my circumstances (such as job loss, medical issues, divorce, health issues, damage to the property not covered by insurance, etc.”
- “I have exhausted all of my options and the only next step is letting the property go to foreclosure.”
To whom it may concern:
This is a very difficult letter to write. I have always been able to pay my debts in the past and am truly sorry that I cannot do so now.
I lost my job as a construction manager and have been unemployed for six months. I have been receiving unemployment benefits which only accounts for approximately one quarter of my previous income. My wife is not employed and is responsible for looking after our five children. We have both been seeking employment and have exhausted our savings. Our credit cards are maxed out and we are in the process of filing for divorce.
We can no longer afford to make the $2000 monthly mortgage payment on our home and we are currently six months in arrears and see no way to bring current the $12,000 in arrears. Our real estate taxes are also due and we have no way of paying these either, along with our HOA’s.
We have listed our property with a realtor for $395,000 and have only received this one offer. We wish to avoid a foreclosure sale that will further damage our credit and we respectfully request that you consider this offer and work with our agent to negotiate a short-sale transaction.
We have exhausted all of our options and the only next step is letting the property go into foreclosure.
Mr. & Mrs. Seller
An owners’ financial statement should be a simple list of assets and liabilities.
- Real Estate
- Stocks, bonds, mutual funds
- Bank Accounts
- Personal Property
- Retirement Accounts
- Real estate loans(s)
- Personal loans
- Credit card debt
- IRS liens
Lenders will require the sums of all monthly expenses in addition to the list of assets and liabilities. These should include
- Credit card bills
- Utility bills
- Auto payments
- Insurance costs
- Food and clothing
- Medical bills
- Child support
- Tuition expenses
These items are typically the same required by a borrower when applying for a loan. The lender will let you know how far back (2 months, 3 months, 12 months etc.) the seller needs to go in supplying this information.
- Pay stubs. Pay stubs allow the lender to see if the monthly take-home pay would cover the loan payments plus all the other monthly expenses. If the owner is unemployed, there will be no pay stubs to include.
- W-2s and/or tax returns. The lender is trying to get a complete picture of the owner’s financial situation. Is the income going up or down? Will the borrower be able to make payments if the lender agrees to a repayment program.
- Bank statements and credit reports. Again, the lender wants to be sure the borrower is truly unable to make the payments and these support that. The bank will order a credit report on the borrower but if they have one available attaching it is a benefit.
An authorization letter to Release Financial Information must be completed.
Lien Holder _______________________
Property Address ______________________________
Seller consents that Lien Holder and its representatives may supply and communicate any loan, financial or other information of Seller, confidential or otherwise, with any of the following involved in the transaction and their representatives
- Sellers Attorney or Representative (names) ___________________
- Sellers’ Broker and Agent (names) ______________________________
__Seller______________________ ______________________________ _______________
In order to provide the lender with a complete picture of the seller’s hardship, it can help to provide additional documents:
- HOA liens
- Medical bills
- Disability statements
- Unemployment benefits or status
- Divorce decree
Medical hardships and unemployment, to a certain extent, are easy for a lender to understand and they will agree to a short sale in just about every medical hardship situation. The seller should not try to “fake” medical hardship. The lender will verify this information.
Once you have proven financial hardship the next step is to determine property value. You must be able to demonstrate that the property is worth less than the total amount owed to your lender and any other lien holders. Your lender will order a BPO (Brokers Price Opinon) or an Appraisal of the property from a licensed appraiser of their choosing.
Your agent must find a qualified buyer and submit for approval to your lender(s) an offer to purchase the property. Each lender holding a mortgage or lien against the property must approve the potential purchase to the extent that their loans will be be paid in full at close of escrow. Most lenders will not review any documentation until a bona fide offer to purchase is received which must be accompanied by either proof of funds in the case of a cash offer, or a preapproval letter from a lender.
Once the lender(s) have acknowledged that your cannot meet your obligations and the property is worth less than they are owed it is up to you or your authorized agent to convince the appropriate parties with each lender, which is usually the negotiator, that they should approve the short sale. Often the negotiator has to get the final approval from the investor. Most lenders handle this process via their Loss Mitigation, Pre-foreclosure, or Loan Workout departments.
Prior to the Mortgage Debt Relief and Emergency Economic Stabilization Act of 2008 being put into effect, money forgiven by a lender in a short sale was considered taxable income. In many circumstances, the new law no longer requires taxpayers to pay federal income tax on the forgiven debt, provided the property is their principal residence only.
Taxpayers may exclude debt forgiven on their principal residence of the loan balance was less than $2 million. The limit is $1 million for a married person filing a separate return.
The law applies to debt forgiven in 2007, 2008, and 2009, and the Economic Stabilization Act of 2008 has extended this forgiveness through 2012. It includes debt reduced through mortgage restructuring, refinancing, home equity lines of credit, short sales as well as mortgage debt forgiven in connection with foreclosures, As a reminder, this is debt that was used to buy, build, or improve a principal residence ONLY.