A short sale is a sales transaction in which the seller's mortgage lender agrees to accept a payoff of less than the balance due on the loan. Whether you are able to do a short sale or end up in foreclosure, the delinquent mortgage will negatively affect your credit rating. So, what are the advantages of a short sale?
According to sources in the mortgage industry, people who agree to a short sale with the lender do far less damage to their credit rating than those who go through foreclosure. With foreclosure you end up with "debt discharged due to foreclosure" on your credit report which can reduce your credit score by over 250 points. You could also have to wait up to three years to qualify for a mortgage at a reasonable rate.
Short sales show up on a credit report as a "pre-foreclosure in redemption" status and can result in a credit score reduction of 100 points or less. After the sale, the mortgage may show up as "discharged." People who successfully complete a short sale may also qualify for a mortgage at a reasonable interest rate in as little as 18 months. So, if buying a home is a future goal, then a short sale can be the better option for many.
So, what are the disadvantages to a short sale? Homeowners cannot simply decide that they want to unload a home with a short sale; the lender must agree to it. The key to getting a lender to go along is to demonstrate two things: that you have no other financial resources to pay the mortgage, and that the sale price the buyer is willing to pay is the fair price the market will bear. If a lender believes it can get more for the house by taking possession of it and selling it themselves, then they will not go along with a short sale. Also, you must be careful and fully understand what the lender offers. Ideally, they would agree to cancel the entire deficiency balance, but, they can also try and collect the difference after you close. Make sure you are clear on their offer.
People who want to go this route should contact a local real estate firm and ask to work with a real estate agent who has actual experience with short sales. These specially trained agents will know the process and deliver the documentation that the lender requires to authorize the short sale. The agent can also find a buyer that is qualified to complete the transaction.
If all goes as planned, the lender will receive all of the proceeds, typically not enough to pay off the loan. The remaining balance of the loan is discharged. But a homeowner agreeing to a short sale should also get legal advice to protect his or herself from future claims of the lender. In some states, only purchase mortgages are fully discharged. For all other types of debt (equity loans, refinancing, etc), the homeowner can be held personally liable for repayment in the future. For this reason, a lawyer's advice will include getting the lender to agree to fully discharge all mortgage debt involved in the short sale.
Another disadvantage of a short sale is the possibility of added taxable income. The IRS considers any canceled mortgage debt ordinary income. This means that the amount forgiven is taxed at the same rate — somewhere between 15 percent and 30 percent — as the sellers’ salaries. In addition, because the IRS requires the lender to file a 1099-C form stating the amount of the canceled debt, the IRS will have a record of the exact amount of the debt that was cancelled. A seller will also receive a copy of the 1099-C to use in filing income taxes. The seller’s home state would also consider the cancelled debt as ordinary income.
So is it right for you? Before proceding, make sure to get all the facts. Seek professional advice from the lender, a real estate short-sale specialist, tax advisor, etc.. Only then can you decide what is the right decision for you.
