Short Sale Facts
I have completed short sales for both buyers and sellers. There are 3 main questions I receive regarding short sales:
1. As a buyer, how long will the process take to successfully purchase a home
2. As a seller, what pitfalls exist if I choose to short sell my home
3. As a seller, what are the qualifications needed for a short sale
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BUYER – HOW LONG?
If you have read any news reports or real estate blogs you no doubt read tales of people waiting 6 – 9 – 12 months for a short sale to complete. Is this true? Yes and no. In the past it seemed most short sales drug on and on. It was a nightmare. Now, I would say the answer is no typically.
Banks finally realized dragging out the process was to no ones benefit. Congress also helped apply some pressure. So, now the typical process is faster but in no way would I call it short. A typical timeline might read:
1. Offer made and accepted by seller; off it goes to the bank
2. Some banks are swift and you will get a response within 30 days
3. Typical banks are still taking 30-60 days to make a decision
4. After approval you will typically run into a 45 day close for escrow
So you can see even in the swiftest situation you are looking at 2+ months. If you have the time to spare then you can get some great deals on homes. (Note I said deals, not steals.)
What errors can slow down the process?
1. Unrealistic offers. If your offer is greater then 15% less then the Fair Market Value you will most likely wait a long time and get a no
2. Slow paperwork on the part of the selling agent. The short sale process is a very detailed transaction. The bank wants what it wants when it wants it. Incomplete or missing paperwork is a major cause of delays.
SELLER – PITFALLS?
Selling any home can have drastic economic affects on your finances. Always precede any transaction with the aid of an accountant. This is doubly true for short sale homes. There are so many permutations on situations I could not possibly cover every situation so let me hit the top 3 considerations. When your home sells via a short sale there are 3 distinct financial pitfalls
1. Deficiency Judgments
2. Capital Gains
3. Forgiveness of Debt Income (Cancellation of Debt Income, Phantom Income)
For all examples I will use the following fictitious data:
Loan #1 Balance: $300,000
Loan #2 Balance: $50,000
Adjusted Basis of the Home: $325,000
Fair Market Value (Sales Price): $200,000
Deficiency is simply the Loan Balances minus the Sales Price. In my example it would be $300,000+$50,000 minus $200,000 equaling $150,000. This $150,000 is the deficiency is an amount that the bank could pursue you to pay. They may try to force you to sign a personal promissory note.
If you live in California you have the benefit of Senate Bill SB 931 (passed Oct 2010) and Senate Bill SB 458 (Passed July 2011). In short, SB 931 prevents the primary (first) loan from seeking a deficiency if they agree to a short sale. The problem with SB 931 was that it only stopped the first loan from seeking a deficiency. If you have 2 or more loans the rest were able to seek judgments. On July 15, 2011 SB 458 was chartered and the net result was that the junior loans were now cut off from seeking deficiencies.
There are exceptions but for most Californians you will be protected by both bills. If you live in another state check with your accountant or real estate professional to see if your state has any such protections.
Capital Gain is the profit you make when selling your home. And yes, you could have a profit when short selling your home. It all depends on your Adjusted Basis. True, most people in a short sale situation are looking at a capital loss but I just wanted to emphasize that just because you short sale does not mean automatically you have a capital loss.
In my example the Sales Price is $200,000 minus the Adjusted Basis of $325,000 resulting in a capital loss of $125,000. So, you do not pay capital gain taxes but neither do you get to use that loss as a tax deduction is most cases.
If you do have a capital gain you can still use the Capital Gain Exclusions ($500,000 married, $250,000 single) to mitigate or wipe out the taxable gain. Just because you short sale your home does not mean you lose this exemption
Phantom Income (aka Forgiveness of Debt Income and Cancellation of Debt Income) is so called because for the IRS you have income while you physically do not receive money. This income is calculated the same as the deficiency. Again my example would have a Forgiveness of Debt Income of $150,000.
What would happen to your personal taxes if you suddenly had an additional income of $150,000? For most it would be devastating. In a 40% tax bracket you would owe $60,000 come April 15th. Ouch!
Again, there is some good news. It comes in the form of the Mortgage Forgiveness Debt Relief Act of 2007 (with extensions to Dec 31, 2012). If you qualify for the MFDRA you can file form 982 and wipe out all that income. Yes, all, if you qualify. You can learn more about the MFDRA by visiting http://www.irs.gov/individuals/article/0,,id=179414,00.html
IMPORTANT: The MFDRA is set to expire 12/31/12; this year. To get this protection your short sale must close and recorded before January 1, 2013.
SELLER – QUALIFICATIONS
Do you qualify for a short sale? Just because you want to short sell you home does not mean you get to; you must qualify. There are 3 main requirements:
1. In default (missed at least 1 payment past the grace period.) Recently this definition has been expanded to include ‘near default’ meaning that default is reasonably foreseeable.
2. Little (less than 8%) to no equity. This is also typically called ‘being under water’
3. A legitimate financial hardship.
Financial Hardships could include:
1. Loss of job or reduction in pay (pay cut, loss of overtime, decreased business)
2. Divorce
3. Illness, medical hardship, or death
4. Increase of property taxes
5. Increase of monthly payment due to an ARM (adjustable rate mortgage) resetting
There is also a 4th common question. Do banks want short sales or foreclosures? It seems like a short sale is too good to be true. Wouldn’t the banks want to foreclose? The answer is a surprising no; a short sale is better for the bank. It is also better for America.
1. You are relieved from a debt that is harming you financially, mentally, and physically
2. The lender is saved from a costly foreclosure and resale process that will only hurt the economy and the recovery
3. The buyer gets a new home at a very favorable price
There is so much more I could say about short sales. Thanks for hanging with me this long. If you have any questions please do not hesitate to ask. You can e-mail me at david@davicares.com, give me a call at 619-937-5871, or use the form at the top left of this page to submit your info/question online. I serve in San Diego as a real estate professional but I have literally helped people from San Diego to San Francisco.
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