Q&A:  What exactly is a short sale?

A short sale occurs when a bank agrees to accept less than the total amount owed on a mortgage to avoid having to foreclose on the property.  This is not a new practice; banks have been doing short sales for years.  Only during the past four to five years has this process become a part of the public consciousness.

IF YOU ARE THE HOMEOWNER:  YOUR FIRST ORDER OF BUSINESS IS TO SPEAK WITH AN ATTORNEY. 

Here's a bit more info that might help:

To be eligible for a short sale you first have to qualify!

To qualify for a short sale:

• Your house must be worth less than you owe on it.
• You must be able to prove that you are the victim of a true financial hardship, such as a decrease in wages, job loss, or medical condition that has altered your ability to make the same income as when the loan was originated.  Divorce, estate situations, etc… also qualify.  There are some exceptions to hardship now, but for the most part the bank or investor will need to verify some type of hardship.

Now that you have a basic understanding of what a short sale is,  LET’S BUST SOME MYTHS!!

Myth #1  If you let your home go to foreclosure you are done with the situation and you can walk away with a clean slate.

The reality is that this couldn’t be any farther from the truth in most situations.  You could end up with an IRS tax liability and still owing the bank money.  Please keep in mind that if your property does go into foreclosure you may be liable for the difference of what is owed on the property versus what is sells for at auction, in the form of a deficiency balance!  Please note this is state specific and in most states you will be liable for the shortfall, but in some states the bank may not always be able to pursue the debt.   Check your state law as it varies widely from state to state.

Here is an example of how a deficiency balance works:

If you owe $200,000 on the property and it sells at auction for $150,000, you could be liable for the $50,000 difference if your state law allows it.

Not only could you be liable for the difference to the bank, but in some situations you could also be liable to the IRS!   Although there are exemptions (mostly for principal residences) under the Mortgage Debt Forgiveness Act, there are times when you could be taxed on both a short sale and a foreclosure, even in a principal residence situation.  I advise talking to a CPA if you are in this situation and as you are weighing your options.

 A short sale can alleviate your liability to the bank, in most situations.  There are also exceptions to this, but in most cases banks are releasing homeowners from the deficiency balance on a short sale.

Myth #2  There are no options to avoid foreclosure.

Now more than ever, there are options to avoid foreclosure.  Besides a short sale, loan modifications along with "deed in lieu" are also examples of the many options.  In most cases (but not all) a short sale is the best option.  Either way, there are more options today than there have ever been to avoid foreclosure.

Myth #3  Banks do not want to participate in a short sale, or, it is too hard to qualify for a short sale.

Banks would rather perform a short sale than a foreclosure any day.  A foreclosure takes a long time and creates a huge expense for the banks; a short sale saves them both time and money.  In speaking with some of the biggest lenders and servicers in the country, they have said they average a net of 17-25% more on a short sale than on a foreclosure.  A testament to this are the financial incentives now being offered by banks, and how much the entire process has recently changed to try and streamline it for all parties.   Qualifying for a short sale is easier than you think – you just need to have a true financial hardship, or a change in your finances and your house has to be worth less than what you owe on it. Also, banks now have government incentives to participate in short sales.

Myth #4   Short sales are not that common.

At this time, short sales range from 10-50 % of sales in various markets and it is predicted that in 2013 we will have more short sales than any other year, to date.  One of the biggest reasons is that MHA (Making Home Affordable) expires December 2013. Many of the Government incentives like HAFA, will expire the end of this year.   Short sales are in every market, and are not just limited to any particular income class. This has affected people from all facets of life. A short sale should be looked at as a helpful tool, not a negative stigma.That is why the government is offering programs that actually pay consumers to participate in short sales. It is not just affecting one community; it is affecting communities and consumers across the nation.

Myth #5  The short sale process is too difficult and they often get denied.

Though the short sale process is time consuming,  it is not as difficult as the media would have you believe.  The problem is that most short sales are denied because of a misunderstanding of the process.  It is true that if the short sale process is not followed correctly there is a good chance of getting denied.  An experienced agent knows how to avoid this.  Short sales require a lot of experience, and a special skill set.  If you are looking to go the option of a short sale make sure your agent is skilled and experienced in this area.

Myth #6   Short sales will cost me money out of pocket.

A short sale should not cost you any out-of-pocket money.  In fact, you could get between $3000-up to $30,000 to participate in a short sale.  In many ways, a short sale may put you in a better financial position than prior to your short sale.  Almost every short sale program now has some type of financial incentive for the home owner, as long as it is a principal residence, and we are even seeing relocation money being paid on some investment/second homes.  As a seller of a property you should never have to pay for a short sale cost up front to any professional service . Realtors charge a commission that will be paid for by the bank.  In most communities there are also non-profits and HUD counselors who can help you with foreclosure prevention options for free.  The only potential cost you could incur is if the bank would not release you from a deficiency balance in the short sale, which is happening less and less.

Myth #7  If I am behind on my payments, I can perform a short sale any time.

The farther you get behind on your payments, the harder it is to get a short sale approved.  The closer a property gets to a foreclosure the harder it is to convince the bank to perform a short sale.  As they get closer to a foreclosure sale, more money is spent, thus deterring them from doing a short sale.  If you think you need to perform a short sale, time is of the essence –  the sooner you start the process, the better.  Waiting too long can trigger the ramifications of a foreclosure, losing the ability to do a short sale as a viable option.

Myth #8   I have already been sent a foreclosure notice so I can’t perform a short sale.  

For the most part, just because you received a foreclosure notice or notice of default it does not mean that you do not have time to perform a short sale.  The timeline and specifics do vary from state to state, but I've heard of banks postponing a foreclosure to work a short sale option as close as 30 days prior to the scheduled foreclosure auction.  Still, the longer you wait the less chance you have.  If you have received a legal foreclosure notice, please reach out to a professional right away.  The longer you wait, and the closer you get to foreclosure, the fewer options you have.  If you have received a notice to foreclose, this means the bank is filing paperwork and starting the process to take legal action to repossess the house.  You may still have time, at this point to prevent foreclosure, but do not hesitate!  The closer you get to the foreclosure date, the harder it becomes to negotiate with the bank for whichever option you choose.

Myth #9   I was denied for a loan modification, so I know I will get denied for a short sale.

Short sales and loan modifications are handled by two separate departments at the bank.  These processes are totally different in approval and denial.  If you got denied for a modification you can still apply for a short sale.  In some cases, you can get a short sale approved faster than a loan modification, as some loan modifications are denied because they cannot reduce the loan low enough based on the consumers income.

Myth #10   If I go through a short sale I cannot buy another house for a long time.

The time to buy another house depends on your entire credit picture and can vary from 2-3 years. Fannie and Freddie Mac just said on November first that a homeowner may be eligible two years after a short sale to repurchase.  There are even a few FHA programs that allow for a purchase sooner than that, but the guidelines are fairly strict.  Some regional and local banks will finance 16-18 months after a short sale, but the interest rate will more than likely be higher than one of the national chains, and this is based on their specific underwriting guidelines.

These are just a few of the common myths surrounding short sales and foreclosure. With the options available today, no homeowner should ever have to go through foreclosure, and hopefully this information can help a few more homeowners think twice before walking away from their home not realizing the possible long term ramifications a foreclosure can have.

Next time I'll address "Deed in Lieu of Foreclosure"

info via KCM Blog