Anytime a home owner can no longer afford to make their house payments and the home’s value is less than what is owed, a short sale should be considered. You do not have to be behind on your payments to request a lender to approve a short sale. For a home owner to qualify for a short sale there are three basic burdens of proof the lender will require.
1.) The owner must have a negative debt to income balance. Simply stated, the home owner’s income is not enough to pay their monthly bills. There are many reasons why monthly incomes change. Job loss, reduction in hours/salary, disability, and death.
2.) The owner must be insolvent. Meaning the home owner does not have any assets that can be sold to supplement their income or pay off the debt. This does not include retirement funds but there have been cases where the lender asked for the owner to pay some money at closing and this is the only place an owner can withdraw funds.
3.) There must be a documented hardship. The owner must be able to demonstrate that something has changed preventing them from being able to afford the home. There are many reasons for hardship. Common reasons are job loss, health issues, and divorce. Adjusting interest rates which increase the mortgage payment suddenly can also be a reason for a short sale hardship.
Assuming the above qualifications are met, the home owner should consider the following potential ramifications for selling the home for less than what is owed. In the state of California, there are recourse loans and non-recourse loans. Loans that were given for the initial purchase of a primary residence are considered non-recourse loans. This simply means any default amount or balance not paid, is forgiven without recourse. With a non-recourse loan the lender can not come after the mortgage holder for any unpaid balance once the debt has been settled.
Refinancing creates a recourse loan. If the borrower took on an additional loan, many times a home equity line of credit (HELOC), they have a recourse loan. With a recourse loan any debt not settled can be pursued by a lender. It is important to recognize that a loan modification can also change the note from a non-recourse loan to a recourse loan. If a new note is prepared for the loan (mortgage), the debt now becomes a recourse loan.
Prior to the housing crash, even though the settled debt may have been non-recourse, there were tax ramifications to short selling the home. Any forgiven debt was considered income and could be taxed accordingly. Every short sale will trigger the generation of a 1099 by the lender to the borrower. This will be the amount forgiven. It will be up to the borrower and their tax professional to determine whether or not this forgiven debt is taxable income.
Since the housing crash, the federal government and recently the state of California created legislation that provided mortgage debt tax relief. The federal legislation H.R. 1424, a part of the Bailout Legislation, extended relief through December 31, 2010. California SB 401, provides tax relief for forgiven debt between the years of 2009 and 2012 for a principle residence. It is very important to consult with a tax professional to understand how these tax laws are applied to your specific situation.
A short sale can reduce the amount of negative credit reporting on a borrower. If the borrower is not behind on payments and the short sale approval wording states the debt is settled completely, it is possible no credit hit will be recognized by the borrower. The credit hit comes from missing or late payments and settlement of debt with a statement of “less than balance owed” reported. Generally speaking, the credit hit from a short sale is less than a credit hit from a foreclosure or bankruptcy. A foreclosure and/or bankruptcy can affect a borrower’s credit for up to 7 years. However, even with a short sale, if a borrower has missed payments for a long time, the credit hit keeps adding up and eventually may be as bad as a foreclosure. This is the reason why it is so important to address the problem as soon as possible.
Ultimately, if you are wondering whether or not a short sale is the right decision for your situation it comes down to these considerations:
1.) Do you have a legitimate hardship that will make you unable to make your monthly mortgage payment? If you borrowed truthfully, owe more than your house is worth and circumstances outside your control have created an inability to pay back the debt by the agreed upon terms, you should investigate whether or not you qualify for a short sale.
2.) Do you want to save your credit as much as possible so that you may purchase a home again in the near future? If you have any intention of being a home owner in the future, saving your credit is critical. Anything you can do to reduce negative reporting will have an impact on your ability to borrow in the future.
3.) Are the legal and tax implications acceptable on a short sale for your specific situation? There are legal and tax implications to forgiving debt whether it is a short sale, foreclosure, and or bankruptcy. The only way to know how they will impact your specific situation is to consult with an attorney and tax professional.
Once you have answered these questions and a short sale proves to be the best option, consult with a trained short sale specialist. Short sales require a unique set of skills for a real estate agent and the short sale approval can very much depend on how your agent negotiates with the lender and buyer. As a Certified Distressed Property Expert, I have the training, resources, and experience necessary to serve as your short sale agent. If you would like to discuss your options with no obligation, contact me. Consulting with professionals will help you determine quickly whether or not a short sale is the right answer for you.