Q: Would you let me know what the benefit of doing a short sale is? –Linda
A: Whether there are benefits to doing a short sale, and what they are, depends on a number of factors, including whether you are buying or selling, where you are located, and the specifics of your personal finances and situation.
For clarity’s sake, let’s start with a definition: A short sale is a home that is being sold for less than the payoff amounts owed at the time of sale to all outstanding mortgage holders and lien holders. More simply, to "short sale" a property is to sell a home for less than is owed on it, with the permission of all entities and persons who hold loans or liens that are secured by the property.
The way your question is phrased leads me to suspect that you are a seller, but I’m not 100 percent sure, so let’s talk quickly about benefits of buying a short sale as a buyer. There are really very few.
For a buyer, the primary motivation for buying a property that is a short sale is that the particular home desired has more loans and liens on it than will be paid off by the purchase price (and the sellers cannot or will not make up the difference).
It is not necessarily, or even usually, the case that short sales reflect a discount from the fair market value of the home to the buyer; the discount that gives rise to the "short" moniker is actually a discount to the seller from the amount they owe.
For buyers who are concerned that they may not receive absolutely clear title when they purchase a foreclosed home, due to bank problems with processing foreclosure documents, the short sale does offer the advantage of all parties — bank, buyer and seller — agreeing to the transfer of title, rather than the title being forcibly taken by the bank via foreclosure.
This is a small or illusory advantage, though; given the fact that short-sale approvals by banks can take anywhere from six weeks to eight months, with no certainty that they will actually close, the advantage to a buyer of doing a short sale arises almost entirely from the ability to secure a particular home the buyer wants very badly.
Also, in some markets, many of the homes on the market are short sales, so there’s not much of a choice on the buyer’s part.
For sellers, though, there are many more factors at play. To begin with, usually a short sale is being considered only by a seller who owes more on the home than it is worth, who has come to the conclusion that he can no longer afford to keep the home for whatever reason, and is resigned to selecting between letting the home go back to the bank via foreclosure or selling the home via a short sale. So, let’s look at the pros and cons of short sales in the context of comparing them with foreclosures.
At the dawn of the housing crisis about four years ago, the conventional wisdom was that short sales were less injurious to the sellers’ credit scores than a foreclosure, and that’s why many sellers decided to go the short-sale route.
Since then, though, the FICO score algorithm has been revised and we’ve seen the credit effects of many more short sales AND foreclosures than we had before; the consensus among industry insiders is now that short sales and foreclosures cause roughly equivalent credit score damage — especially since banks have a tendency to mostly approve short sales on accounts that are in default, or behind on their mortgage payment.
As a result, most successful short sales incur credit damage not just from the short sale, but also from multiple late mortgage payments, similar to a foreclosure.
For purposes of income taxation, both foreclosures and short sales involve cancellation of debt income, which is normally taxable by the federal and most state governments. Currently, though, the Mortgage Debt Forgiveness Relief Act of 2007 exempts homeowners from incurring federal income tax when they divest of their homes through either foreclosure or short sales through 2012; most states have a similar rule, so there’s no advantage (or disadvantage) to a short sale there.
There are really two significant, possible advantages to selling your home via short sale vs. letting it go to foreclosure, as I see it. The first is that with some loan products, the post-short-sale waiting period before you can qualify to buy another home may be shorter than the post-foreclosure waiting period.
There are lots of caveats and exceptions, but on an FHA loan, some short-sale sellers — namely those who are not behind on their loans at the time of sale, a small population indeed — may be eligible for a new loan immediately after their short sale closes.
For conventional (i.e., non-FHA) loans, one most common guideline requires a two-year waiting period following a short sale or deed-in-lieu of foreclosure (more on the deed-in-lieu in a moment), compared with a seven-year post-foreclosure waiting period for conventional loans.
To be clear, though, FHA loans only impose a three-year waiting period after a foreclosure, and FHA loans have a much lower minimum downpayment requirement and similar interest rates (on today’s market) to conventional loans. As a result, the short sale effectively allows you to buy within one to three years sooner than you would if your home was lost to foreclosure, assuming that’s something in which you’d be interested.
The other advantage of a short sale over foreclosure is that in a short sale, sellers can sometimes eliminate their exposure to a later deficiency judgment or lawsuit by their second mortgage or home equity line lender.
In some states, a lender who forecloses on a home can later sue the homeowner for the difference between what they owed and what the lender was able to sell the home for; in a short sale, smart sellers (and their agents and attorneys) can negotiate for the lender to agree not to later come after the seller for any deficiency.
Similarly, it may be possible to get to waive later liability on the seller’s part as part of their agreement to accept less than they are owed in the course of a short sale. This can be a very big deal; even in non-deficiency-judgment states — these subordinate loans and lines of credit expose the former homeowner to liability for years following a foreclosure.
I like to think of these alternatives — short sale, deed-in-lieu and foreclosure — as stages in a single process. While it’s true that the post-short-sale waiting period is only two years on a conventional loan if the mortgage was current before the short sale, the reality is that most short-sellers find it nonsensical to pay the mortgage on a home they know they will be losing, one way or the other. Additionally, many banks simply don’t approve short sales on accounts with current payments.
Also, I feel there’s no sense in agonizing over whether to sell your home via short sale when, ultimately, much of whether you’d be able to successfully do so is out of your control as a seller; without putting the place on the market, you don’t know whether you’ll get a buyer to bite or the bank(s) to sign off on a short sale.
As a result, for upside-down homeowners who are clear that they can’t keep their homes, one wise course of action is to stop making mortgage payments and immediately list their home for sale as a short sale. (The commissions and taxes on sale are paid out of the proceeds of the sale, if it goes through, FYI.)
If you get an offer and the bank approves the short sale, make sure to work with your broker and/or attorney to get all future liability for your loans and liens waived as part of the deal.
If you don’t get an offer, most banks will allow you to apply for a deed-in-lieu of foreclosure after you’ve had the property on the market for at least 90 days.
If the bank approves of that, you should still try to get all liability waived by the lender in first position and try to negotiate a cash-for-keys exchange to help defray your move-out expenses (note: you may still have to deal with subordinate lenders and HELOC holders in the future).
If the bank rejects your application for a deed-in-lieu, continued non-payment of the mortgage will eventually result in losing the home to foreclosure, in a time frame ranging anywhere from six to 20 months-plus following the first missed mortgage payment.
Whatever route you go, I would advise any seller considering a short sale to consult with local real estate broker, mortgage professional, attorney and certified public accountant (yep, all of them) to get a personalized analysis of your situation and recommendations that take your whole financial and life picture into account.