Recent estimates indicate that possibly more than twenty-five percent of all homeowners are upside-down on their home mortgages, meaning that they owe more on their home loan or loans than the fair market value of the residence. This makes it virtually impossible to sell at a private sale. When a couple goes through a divorce or dissolution and needs to divide the assets including such a home, what are they to do? One answer is to walk away from the house, which will lead to foreclosure litigation and a crippled credit rating. Another possible answer is to complete a short sale.
A short sale is when a lender agrees to the sale of a property by the owner for less than the amount owed to the lender. It means that the lender is willing to accept less than the amount owed. Except for those lenders who are participants in the Home Affordable Foreclosure Alternatives Program (HAFA), the lender may or may not pursue the difference against the borrower. If the lender does forgive the difference, it likely will not be considered as income by the IRS as long as it complies under the Mortgage Forgiveness Debt Relief Act of 2007(which most primary residences will qualify).
Lenders approve short sales when the seller owes more than the house is worth and the lender agrees that the owner has a hardship (e.g. unemployment, divorce, medical emergency, bankruptcy, death). The lender usually requires the owner provide a financial statement, hardship letter, tax returns, W-2s, pay stubs, bank statements, and a market analysis or list of comparable sales for the property.
For a short sale to work, you must have a cooperative lender and a patient buyer. The process usually takes several months. The time frame is typically as follows: Bank acknowledgment-10 to 30 days; assignment of a negotiator-30 to 60 days; appraisal ordered-a few weeks; review of the file-14 to 30 days. If all goes well, the bank will issue a short sale approval letter. If the buyer is still interested, the property can close.
But understand that the deficiency balance can be handled three (3) different ways by the lender:
- The lender may agree to cancel the entire deficiency balance;
- The lender can attempt to collect the deficiency balance from the seller after the property has closed; or
- The lender may require the seller to sign an unsecured promissory note for the deficiency balance as a condition of agreeing to the short sale. If the new note amount is for less than the balance of the original debt, the difference would be considered a canceled debt.
It is important to realize that you must negotiate for the release of both the property lien and the underlying personal debt secured by the note. If you fail to do this, the lender may not forgive the personal debt, and it will survive the short sale and become a collection matter.
Effective April 5, 2010, those lenders who participate in the Home Affordable Foreclosure Alternatives Program (HAFA) must fully release borrower from future liability for the first mortgage debt and, if the subordinate lien holder receives an incentive under HAFA, that debt as well. HAFA is part of President Obamas Making Homes Affordable Program. It provides incentives to lenders who help borrowers modify their loan or help them avoid foreclosure through short sales. However, HAFA is not available for FHA or VA loans, and, with respect to other liens, applies only if the lender has chosen to participate in the program.
Obviously, not all sellers nor all properties qualify for a short sale. However, in todays economy, lenders have been far more willing to consider short sales than in the past; particularly, if it makes more financial sense than to foreclose. For those suffering financial hardship and have no equity in their home and needing to sell their residence quickly, this certainly is an option worth discussing with ones realtor, lender and attorney.
In a future article, I will be discussing the implications that The Mortgage Forgiveness Debt Relief Act of 2007 has on the taxability of the cancelled debt amount. If you complete a short sale, the last thing you would want to receive in the mail is a 1099-C indicating that you owe taxes on the cancelled debt amount!
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Joseph E. Balmer
Joseph Balmer manages the Probate, Trust and Estate Administration department at Dayton, Ohio, law firm, Holzfaster, Cecil, McKnight & Mues, and has been certified by the Ohio State Bar Association as a specialist in Estate Planning, Trust and Probate Law since 2006.