1.
What is a short sale and why would a lender accept one?
2.
Foreclosure vs. Short Sale
3.
What are your options?
4.
Where to obtain legal and tax advice
5.
Beware of scams!
6.
What are the steps in a short sale?
7.
What’s in a typical short sale package?
8.
The Short Sale Finish Line
What is a short sale and why would a lender accept one?
What Is the Definition of a Short Sale in Arizona?
A short sale is a real estate transaction in which the sales price offered by a potential Buyer is insufficient to pay the loan(s) owed on a property in addition to the costs of sale and the seller is unable to pay the difference. Simply put, a Seller owes more on the home than the house is worth at the present market value
So basically, a potential Buyer can submit an offer to a Seller on the home for thousands less than what is currently owed, and through the process of a Real Estate transaction, the bank reviews the offer and makes a determination if it will accept the offer and absorb the loss of the difference owed.
For example, if your home is worth $200,000 in the current market but you have a loan or loans of $250,000 then a short sale is a consideration.
Why Would A Lender Accept A Short Sale?
On the surface it seems odd that a lender would agree to take such a loss. But as we examine the situation a bit more closely, it becomes the best option for bank under certain circumstances.
Generally, a bank will begin to look at the
Short Sale in Arizona option only if the homeowner is behind on payments and the foreclosure process is imminent. The process to end up at the
Short Sale option typically works like this:
- The homeowner(s) begin to miss payments for various reasons (sickness, loss of income etc…)
- The lender(s) try to arrange a repayment plan
- The repayment plan or modification fails or is never attempted
- The bank has no other alternative than to begin the foreclosure process
If you must sell your Arizona home you basically have three options.
- Bring cash to the table and make up the difference of the deficit plus costs and expenses
- Let the home go into foreclosure
- Pursue a short sale
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Foreclosure vs. Short Sale
Banks have begun to realize that a foreclosure or the process of taking ownership of your home and having you leave is not the best option for them.
A Lender has to incur expenses to complete an Arizona foreclosure and take the property back. These expenses include
- Attorney, Court and Legal Fees
- Remodeling, and Maintenance
- Costs incurred to re-sell the property
- Continued loss of income
- Possible vandalism of vacant home.
Worse still is the bank has a “non-performing asset” on their books which lowers their rating and prevents them from lending out more money that will produce a return. A Bank is in the business of loaning money, NOT HOLDING NON PERFORMING ASSETS!
Studies have shown that a bank loses anywhere from 20-30% more if they take a back home through the foreclosure process than through a short sale so basically in most instances, a short sale is less expensive than the Arizona Foreclosure Process so lenders choose to cut their losses early. This is why a Short Sale in Arizona is often times accepted by a bank
Credit Consequences of a Short Sale vs. Foreclosure
The credit consequences of a short sale and the credit consequences of a foreclosure vary slightly. The general consensus is that a short sale will show up on your credit report as a “settlement”, “settlement for less than owed” or a “pre-foreclosure in redemption”.
Also, since most lenders will not consider allowing a short sale until a few payments have actually been missed you may also have a few “lates” on your credit report. Neither of these marks is a good thing to have but it’s possible to get them off of your credit report within a few years or less.
Now I have asked many credit experts and in general, a short sale can drop your credit score by 100-200 points. Most experts vary on the amount it will affect your credit, but it really does not matter. Expect that your credit will be severely affected during this process and immediately after the short sale is accepted; enroll yourself into a good credit repair program begin credit repair immediately after the Arizona short sale is completed! There is also the possibility that through negotiation with the lender you can avoid having the short sale reported to a credit agency.
A foreclosure on your credit report can take 7-10 years to remove and can cost your credit rating (FICO) up to 200-280 points which is a very big hit. So, if you have no better alternatives pursue a short sale aggressively and avoid foreclosure.
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What are your options?
So we’ve determined what a short sale is and why it makes sense for a Lender to consider one. What about YOUR options and should you consider a short sale?
Work with your bank and discuss other options
Before taking any action call your Bank and discuss your situation. Options for them to work with you include:
- Reinstatement: Paying the total amount owed by a specific date in exchange for the lender agreeing not to foreclose.
- Forbearance: An agreement to reduce or suspend payments for a short period of time.
- Repayment Plan: An agreement to resume making monthly payments with a portion of the past due payments each month until they are caught up.
- Claim Advance/Partial Claim: If the loan is insured, a homeowner may qualify for an interest-free loan from the mortgage guarantor to bring the account current.
If working with your Bank has not produced desired results utilize free services available to Arizona residents .The state of Arizona has many resources to help you.
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Where to obtain legal and tax advice
Obtain Legal Advice
An attorney can advise you about your options and legal liabilityand you should seek the advice of one to examine your total situation. If you don’t have an attorney, consider seeking free or low cost legal assistance or contact a legal aid organization in your county listed at:
Attorneys who are State Bar Real Estate Law Certified Specialists can be located at: www.azbar.org/LegalResources/findspecialist.cfm.
Obtain Tax Advice
Always talk to your accountant! The tax ramifications regarding a short sale can be significant. Many homeowners are unaware that when completing a short sale, possible short sale tax issues can arise. As such, an owner considering an Arizona short sale should discuss these possible issues with an attorney, accountant, or other appropriate professional.
Attorneys who are State Bar Tax Law Certified Specialists can be located at: www.azbar.org/LegalResources/findspecialist.cfm
From my understanding, the debt forgiven by a lender is generally taxable to the borrower as “debt discharge income.” When a taxpayer receives proceeds from a new loan, those proceeds are not taxable income because there is an offsetting obligation to repay. However, if the debt is cancelled, there may be debt discharge income.
This basically means that if you owe $250,000 and short sale the home for $200,000, on your next tax return it could look like you have $50,000 worth of earned income from the sale of your residence and would be treated as taxable income. If your lender chooses to, they could send you an IRS Form 1099-C: Cancellation of Debt at the end of the year. What are the odds that you have extra tax money lying around after you just went through an Arizona short sale on your home?
GOOD NEWS! H.R. 1876
: The Mortgage Forgiveness Debt Relief Act of 2007 would eliminate the tax owed on any forgiven mortgage debt. This bill has been passed and signed into law by the president and was extended into 2012.
The bill permanently eliminates tax on up to $2 million of debt for a principal residence. This bill protects primary residence homeowners only (not investors), and the best part about this bill is that it is retroactive to January 1st, 2007. This means that any Arizona short sale conducted after that date automatically is protected from any tax implications! It is set to end December 31, 2012. For more info, please visit
http://www.whitehouse.gov/news/releases/2007/12/20071220-6.html
IRS FORM 982
If you are not protected under the new Mortgage Forgiveness Debt Relief Act of 2007, you still have a way around the tax consequences of a short sale. If you receive a 1099-C from a creditor, you must report the amount of the canceled debt as income to the IRS even though you did not actually receive any money (phantom income). (The amount shown in Box 2 of the 1099-C form is the amount that must be reported!) However, the IRS recognizes “Insolvency” as a situation where cancelled debt might not have to be reported as income. Insolvency is basically your total debts exceed your total assets at the time your debt was settled or deemed non-collectable.
If you are “insolvent”, you need to explain this to the IRS in one of two ways.
1) By filling out IRS Form 982: Reduction of Tax Attributes Due to Discharge of Indebtedness (
http://www.irs.gov/pub/irs-pdf/f982.pdf) or
2) Attaching a detailed letter to your tax return explaining the calculation of your total debts and assets.
You accountant can help qualify your insolvency and help you fill out any IRS Forms! Here are some helpful questions that you will need to ask you tax professional:
- Can I avoid paying taxes on the forgiven debt if I was insolvent at the time of the short sale?
- Do I have to file bankruptcy to be considered insolvent?
- If you already went through a short sale and paid taxes can you file an amended return and get a refund?
- Does a IRS Form 982 have to be filed in order to be eligible for tax relief?
- Am I protected under the Mortgage Forgiveness Debt Relief Act Of 2007?
For Mortgage Forgiveness Debt Relief Act and Debt Cancellation tax information, go to: www.irs.gov/individuals/article/0,,id=179414,00.html
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Beware of scams!
Homeowners worried about foreclosure may be susceptible to predatory “rescue” scams which may cost you money with no results, result in the loss of your home entirely, or involve you in a fraudulent scheme. The process of pre foreclosure is a matter of public record, therefore, you may be solicited by companies or individuals who may be looking to “help”you.
Here are “red flags” you should look out for. Fraudulent schemes include:
• Guarantees to stop the foreclosure
• Large upfront fees
• Instructions not to contact the lender
• Transfer of title or lease of the property
• The proposed buyer is an LLC
• Requests that the homeowner execute a power of attorney
• The proposed buyer, at the buyer’s sole expense, retains a third party to negotiate the short sale for the seller’s benefit.
If you suspect a scam, report the incident to:
The Department of Financial Institutions at
fraudline@azdfi.gov
The Attorney General’s Office at www.azag.gov/consumer/foreclosure/index.html#Complaint
NeighborWorks© at www.loanscamalert.org/default.aspx
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What are the steps in a short sale?
What Are The Steps In A Short Sale?
First, you must choose a Realtor to market and find a Buyer for your home. The Realtor will be the one who makes contact and communicates on your behalf with the loss Mitigation department at the Bank with permission in the form of a letter signed by you.
For example, when I handle a short sale on behalf of a client not only am I responsible for finding a Buyer as in any normal transaction and commence to marketing and preparation, two other critical tasks are my responsibility.
First and foremost, is to help my client prepare a
superior Short Sale Package in order to determine if you qualify for a Short Sale.
In theory, a Short Sale is not necessarily complicated. Putting together the necessary paperwork and sending it off to the bank is the first step. It’s time consuming and you need to be as detailed as possible. It’s said it’s easier to get a loan then to get out of one but don’t be discouraged. Stay focused and commit to putting a package together that is complete and one that is easy for a Bank’s loss mitigator to work with so you don’t go to the bottom of the heap!
If there is one thing I’ve learned through my personal experience and that of my peers who are skilled at working with short sales is that putting a good package together is 80% of the battle!
The second crucial element in the process is to choose a list price that makes sense and submit a market analysis to justify the asking and acceptance price! The bank will review any contract it receives and will contract what’s called a BPO (Broker Price Opinion) from an outside independent Real Estate Agent once they receive an offer to see if the price on the contract is in line with what the value they receive back from the BPO.
Most agents make a mistake on these two critical items and doom the sale from the start. If these two crucial components of the process are done correctly, the success rate is extremely high!
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What’s in a typical short sale package?
What Is In A Typical Short Sale Package?
Remember the reason a lender will approve
short sale is because it will benefit them, not you! The lenders need to know that if they don’t approve the short sale, they will have to foreclose on the property and that the short sale is more cost effective than foreclosing.
Every real estate short sale begins the same way with the building of a short sale Packet. The lender(s) need certain documentation and a proof of hardship in order to complete a short sale request. Below is a list of items commonly found in a short sale package:
- Hardship Letter. A handwritten letter explaining the borrower’s situation and requesting a short sale. It should describe why the borrower cannot make their mortgage payments and their fear of possible foreclosure. It should be a plea for the lender to consider a short sale!
- Two Years Tax Returns and W-2’s.
- Letter Of Authorization (LOA). This gives your Realtor authority to talk with your lender(s) on your behalf.
- Two Most Recent Bank And Retirement Account Statements.
- Two Most Recent Pay Check Stubs.
- Current Financial Statement.
- Any Documents Supporting The Hardship.
- Current Market Analysis (CMA). Typically from a Realtor or appraiser.
- Estimated Net Sheet Or HUD-1 (Your Realtor will provide this document.
- A Copy Of The Executed Sales Contract With Buyers Proof Of Funds Or LSR.
- FHA And VA Might Have Their Own Forms
Short Sale Hardship Letter
You lose your job, get sick, or are in the middle of a nasty divorce! There are many reasons why a homeowner would fall behind on their mortgage payments and in order for your lender(s) to begin looking at the short sale option, you need to prove a financial hardship. Obviously every homeowner has a unique explanation of “why” they are in there current situation.
Some of the most common financial hardships include:
- Too Much Debt
- Unemployment
- Reduced Income
- Divorce
- Death of my Spouse
- Separation
- Medical Bills
- Death of a family member
- Payment Increase
- Business Failure
- Job Relocation
- Illness
- Damage to Property
- Military Service
- Incarceration
- Other (Please Specify)
Included in a typical short sale packet is a hardship letter. Basically you want to explain the “hardship” that caused your delinquency. Remember, anything you say in the short sale hardship letter about what caused you delinquency needs to be verified! Get any and all documents together to do so and attach them with your letter.
Here are some basic tips to remember when writing your short sale hardship letter:
- Start off with all the names on the loan(s) and the loan numbers
- Explain your financial situation as well as your hardship
- Explain what expenses you have decreased in order to try and make your mortgage payments. Ex. Cut back on cable TV and eating out.
- Explain to them that you understand that will not be receiving any proceeds from the sale of the home.
- Handwritten is probably better (as long as it is legible).
It is our suggestion that you type out your short sale hardship up first until it sounds the way you want it to, then hand write it out. This is an important part of the short sale package that must “tug” on the heart strings of your assigned Loss Mitigation Specialists.
You accountant can help qualify your insolvency and help you fill out any IRS Forms! Here are some helpful questions that you will need to ask you tax professional:
- Can I avoid paying taxes on the forgiven debt if I was insolvent at the time of the short sale?
- Do I have to file bankruptcy to be considered insolvent?
- If you already went through a short sale and paid taxes can you file an amended return and get a refund?
- Does a IRS Form 982 have to be filed in order to be eligible for tax relief?
- Am I protected under the Mortgage Forgiveness Debt Relief Act Of 2007?
Once I receive these items, I package them up with an offer, and send the short sale packet off to your lender(s). Expect at least 1-2 weeks before it gets into the lender(s) system and assigned a Loss Mitigation Specialist. Once in the system, the lender(s) typically order a Brokers Price Opinion (BPO) to establish value.
Brokers Price Opinion – Another Important Element That Effects A Successful Short Sale
The first thing your lender(s) need to do in the short sale process is establish the current market value of your home. They do this in the form of a Brokers Price Opinion (BPO). A BPO is typically conducted by a real estate agent or a licensed appraiser (normally a real estate agent) that is hired by your lender(s).
The BPO will contain comparable sales of similar houses in the neighborhood, with adjustments made for condition and attributes, to determine what the market value of the subject property is. Expect the Brokers Price Opinion process to take 1-2 weeks from the time the BPO is ordered to the time it is completed and inputted back into the lender(s) systems. Also, expect each lien holder to complete their own BPO…for example if you have a first and second mortgage, each lender will order their own Brokers Price Opinion.
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The Short Sale Finish Line
The Short Sale Finish Line
After all the items necessary to make a decision on the acceptance of your Short Sale have been compiled, then it’s time for the moment of truth. And if we did everything we needed to do,in the correct manner, there is an excellent chance it will be approved.
The climate is very good for banks to accept short sales rather than foreclosure on a home because it has been a hard lesson for them to learn that foreclosures cost them more and it’s better to work with you now rather than take the home back.
Once approved, the bank will issue a Letter of Approval, that’s what we’ve been working for. All the hard work has paid off but don’t celebrate just yet. It’s a good idea for your Attorney and your Accountant to review the documents to make sure the terms are acceptable. It was hard won but don’t make a mistake at the very end and accept something that might not be good for you. After all, you have gone through this whole process to turn things around and to start planning for a better future and and it’s better future I wish for you.
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Disclaimer to this information: Phoenix Real Estate Corner is not acting as a Real Estate attorney or CPA / tax expert by providing this information. If you are facing default and foreclosure proceedings have started, you should consult with an experienced real estate attorney and CPA, specific to the state in which your property is located. They can review your specific situation and advise you of your liability and protection under the anti-deficiency and tax liability laws of your specific state.
