Short selling a home can be an option for homeowners trying to sell their homes whose values have dropped, or when struggling to make payments; however, not every homeowner in these situations qualify for a short sale. A short sale is when a home is sold for less than the amount that is owed on any liens against the property. This option is generally used in lieu of foreclosure.
A short sale has to be approved by any lenders who have a stake in the property being sold, and the seller and property have to meet certain requirements to qualify.
Short Sale Definition
A short sale happens when the lender is shorted on a mortgage, meaning the lender accepts less than the total amount that is due. If your mortgage is $100,000, but your home value dropped to $90,000, you are short $10,000 plus the costs to close the sale. It might be possible to sell your home short if your mortgage balance matches the sales price because there are still closing costs that will bring the home into the short sale category.
Many entities profit from short sales, but there is no profit for the seller in a short sale.
Qualifications for a Short Sale
Before you decide to pursue a short sale, consider the following to determine whether you may qualify for one. If you don't meet all four requirements, you may not qualify to sell your home in this manner.
- The home's market value has dropped: Hard comparable sales must substantiate that the home is valued at less than the unpaid balance due to the lender. This unpaid balance may include a prepayment penalty.
- The mortgage is in or near default status: In the past, lenders would not consider a short sale if the payments were up-to-date. Currently, lenders are eager to head off any future financing problems, no matter the payment status. A high risk of default will generally sway a lender toward accepting a short sale.
- The seller has fallen on hard times: The seller must submit a letter of hardship that explains why they can not pay the difference due upon sale, including why the seller has stopped or will stop making the monthly payments.
- The seller has no assets: The lender will probably want to see a copy of the seller's tax returns and/or a financial statement. If the lender discovers enough assets, they may not grant the short sale because the lender will feel that the seller can pay the shorted difference. Sellers with assets may still be granted a short sale but could be required to pay back the shortfall.
Some examples of hardships are unemployment, bankruptcy, divorce with the loss of income, or a medical emergency with the loss of income. Assets could be IRAs, savings accounts, or other real estate.
Steps in a Short Sale
Sometimes, to avoid going through the cost of foreclosure, a lender will sanction a short sale by letting a buyer purchase the home for less than the mortgage balance while the home is in the pre-foreclosure stage, one of the three stages of foreclosures. Some sample steps of a short sale are:
- The seller signs a listing agreement with a real estate agent subject to approval from the bank as a short sale.
- The agent finds a buyer who makes an offer based on market value, which is often less than the amount of the mortgage.
- The seller accepts the buyer's purchase offer.
- The seller's lender accepts the buyer's purchase offer.
- The transaction closes when the buyer delivers the funds, the lender releases the lien, and the seller delivers the deed.
Short Sale Consequences
A short sale is dependent on a buyer making an offer to purchase. If you do not receive an offer, you won't qualify for a short sale. So even if you meet all the other criteria, it is possible that no one will buy the short sale. It is also dependent on the lender accepting the buyer's offer. If the lender rejects the offer, a short sale will not take place.
If the lender agrees to the short sale, they may possess the right to issue a 1099-C to the buyer for the difference (where the difference is viewed as income for the seller), due to a provision in the IRS code dealing with debt forgiveness. Many situations are exempt from debt forgiveness, according to the Mortgage Forgiveness Debt Relief Act of 2007.
You should speak to a real estate lawyer and a tax accountant to determine the amount of short sale tax consequences, and whether you can afford to pay those taxes.
While a short sale will not show up on your credit report, the loan status will. For those in default, it's a pre-foreclosure that has been redeemed, which is often reported as Paid in Full for Less Than Agreed.
Short sales affect credit ratings. While the damage to your credit report may not seem as significantly bad as a foreclosure, creditors may not distinguish between the two.