Short Sale FAQ
Frequently Asked Questions On Short Sales
Q: What is a Short Sale?
Answer: In "short" a short sale is when the lender agrees to settle the debt owed on the property for less than the full amount of the debt. In most cases “Settled” means the lender writes off the debt. You usually will receive a 1099 after a short sale for the amount of debt forgiven. The bank is agreeing not to go after you for the money they lost by filing a deficiency judgment in the future.
Q: How do I know if I qualify for a short sale?
Answer: Call me and let me ask a few questions. I can usually tell you over the phone in a matter of minutes. The overwhelming majority of my clients are approved for a short sale because 1) I know how to submit the short sale package in such a way that the lenders will approve them and 2) we use private negotiators who have a tremendous amount of experience and great relationships with the lenders.
Q: Will a short sale affect my credit?
Answer: There is a lot of misinformation on the internet about this. A short sale is recorded on your credit report as “debt settled for less than the amount owed”. In plain English, this will result in a relatively minor hit to your credit compared to a foreclosure or late payments on your mortgage. A short sale will affect everyone’s credit differently. The more established your credit, the less of an impact it will have on your score.
If you hear and read that a short sale will drop your credit 100 points or more, many people, when they do a short sale, stop making their mortgage payments. If you stop making your mortgage payments for 4 months, regardless of whether you do a short sale or not, 4 months of missed mortgage payments will have a significant negative impact on your credit.
Iif you are already behind on your payments, you have already incurred the majority of the hit that a short sale will have on your credit. Moving forward with a successful short sale will insure that your debt is settled with your lender.
However, if you are current on your payments and can stay current throughout the short sale process, you will save your credit to a large extent.
Q: TAXES: Will I have to pay taxes on the $$ the lender loses in the short sale?
Answer: THIS IS THE MOST ASKED QUESTION: There are several scenarios with regard to whether or not you will owe federal income taxes on the loss the lender takes in a short sale.
When you do a short sale, your lender is agreeing to settle the debt on the property for less than the amount they are owed. As a result the IRS allows them to write off this loss, which is why your lender will send you a 1099-C after the short sale.
The IRS considers “debt relief” to be income for tax purposes. If your lender writes off $20,000 on your short sale, they will send you a 1099-C for that amount, and you would include that when you file your income taxes. The “C” stands for “Cancellation of Debt” and the law says cancelled debt is taxable as income.
There are however EXCEPTIONS that most people who do a short sale qualify for that exclude them from having to pay taxes on their short sale.
Thanks to the Mortgage Tax Debt Relief Act that George W. Bush signed into law in January of 2008, homeowners who do a short sale on their primary residence, and have a purchase money loan (in other words, they have not pulled cash out of their home with a cash-out refinance) pay no taxes on the loss that their lender incurs in a short sale.
How you pull cash out/Equity:
Homeowners who have pulled out cash from their home but have put that money back into their home to “substantially improve” their home, also are excluded from taxes on the short sale.
All other short sale scenarios – if you pulled cash out on your primary residence but spent it something other than upgrading your home or if you are doing a short sale on a second home or investment property – result in a taxable event unless you qualify for the “Insolvency” exclusion.
The IRS does not require you to pay taxes on the loss the lender takes in a short sale if, at the time of the short sale, you are insolvent. "Insolvency" means your debts (including your mortgage) exceed the value of all your assets. In other words, if, at the time of the short sale, you have more debt than you do money or assets, you are considered insolvent.
Many people who short sale are insolvent and excluded from paying taxes on a short sale. I recommend you check with your accountant or go to the IRS website and look up IRS Form 982, which is the IRS form for debt relief and short sales. The IRS gives an explanation of “Insolvency” on this form.
UPDATE: 2010-2012 The laws regardling how Short Sales and DIL may affect your tax liability are changing everyday. Please contact me for the most up-to-date info on this topic. Here are the recent laws pertaining to tax consequences for Short Sales and DIL. Remember there is both Federal and State tax laws.
Note: see IRS link Legislation enacted in October 2008 extended this relief through 2012. Thus this relief now applies to debt forgiven in calendar years 2007 through 2012.
California-Federal Differences Taxes: Currently Jan 1 2010 CA tax law does not follow Federal law.
The FTB notes that while the California legislation is similar to federal law, there are important differences. The California law covers qualified debt forgiven in 2007 and 2008. The federal law, which originally covered debt forgiven from 2007 through 2009, was extended by the Emergency Economic Stabilization Act of 2008 (H.R. 1424) to cover debt forgiven from 2007 through 2012.
The California law limits the amount of qualified principal residence indebtedness to $800,000 for taxpayers who file as married/registered domestic partners (RDP) filing jointly, single, head of household, or widow/widower, and to $400,000 for taxpayers who file as married/RDP filing separately. Also, the California law limits debt relief to $250,000 for taxpayers who file as married/RDP filing jointly, single, head of household, or widow/widower, and to $125,000 for taxpayers who file as married/RDP filing separately. The federal law, on the other hand, limits the amount of qualified principal residence indebtedness to $2 million for taxpayers who file as married filing jointly, single, head of household, or widow/widower, and to $1 million for taxpayers who file as married filing separately. Furthermore, the federal law does not limit the debt relief amount.
Q: Will I have to pay CA state taxes on the money my lender loses ?
Answer: California has passed its own version of the federal Mortgage Tax Debt Relief Act. It is Senate Bill 1055, which conforms to the federal law described in detail above, but applies to California state income taxes on a short sale.
There are differences between the state and federal law.
The term of the California law was only until the end of 2008. As of Jan 2009, this law is no longer in effect.
However, CA Revenue & Taxation Code Section 17131 provides that, unless there is some specific California statute to the contrary, California law tracks federal law on what income is excluded from taxation. Since there is currently no specific California law on this issue, short sales do not produce taxable income under California law as long as the Federal Mortgage Tax Debt Forgiveness Act is in effect (until the end of 2012).
I recommend you speak with your accountant and have them answer any tax questions that you have. I am not a tax advisor and do not give tax advice.
Q: Can my lender go after me for the deficiency in the short sale?
Answer: The whole point of a short sale is to get out from under the debt of the mortgage. Your lender cannot write off their loss on their corporate taxes, send you a 1099-C so you have to pay taxes on the loss, report the short sale as a “settled debt” on your credit and then turn around and go after you for the money. This is why your lender will send you a 1099-C after the short sale. The “C” in “1099-C” stands for “Cancellation of Debt.”
hiring an inexperienced short sale agent or negotiator who does not negotiate a FULL release from your lender, could result in you being liable for the money the lender loses in a short sale or end up being forced to sign a promissory note to close the deal.
Q: What if I have a first and a second loan on my property with 2 different lenders (or the same lender)?
Answer: In most cases people that I do short sales for have a first and a second loan, more often with 2 different lenders. For the short sale to close escrow, both lenders have to agree to the short sale and agree to settle the debt. Thankfully both lenders have a vested interest in doing this. The lender with the first loan does not want to foreclose, and therefore is willing to give a little money to the second in order to get them to agree to the short sale.
The second lender will get nothing if the first forecloses, so with the attitude that something is better than nothing.
Q: What is the difference between a recourse and a non recourse loan?
Answer: A purchase money loan is considered to be a “non recourse” loan, while a “cash out” loan is considered to be a “recourse” loan.
The difference between these two loans is that in a “recourse loan” the lender has recourse to go after the borrower for the money they lose in a foreclosure. “Technically” because, for this to take place, the lender has to file a judicial foreclosure, which is rarely done in CA.
The majority of foreclosures in CA are “non-judicial” foreclosures, where the property is sold at a trustee sale.
Q: How will I know that I am being released from the debt?
Answer: You will know that you have been released from the debt right on the front in plain English. “releasing the lien”, “accepting a short payoff to satisfy the lien”, “reporting the sale as a settled debt to the reporting agencies”, “issuing a full satisfaction of the mortgage”, “not pursuing a deficiency judgment”, or some other variation that states they are settling the debt for less than what they were owed.
More importantly, your bank will issue a 1099-C to you, the borrower, after the short sale, confirming that the debt has been written off and is settled. Your lender cannot write off the debt, issue you a 1099-C & then go after you for the deficiency.
Q: What are the advantages of a short sale vs. letting my home go to foreclosure?
Answer: Many people ask this question: The primary advantage is that in a short sale, the debt is settled and you no longer owe the bank any money. If you foreclosure, you may still be liable for the deficiency in the event that the bank files a judicial foreclosure.
Secondly, is that in a short sale, your credit takes much less of a hit compared to a foreclosure.
Finally, Fannie Mae & Freddie Mac revised their guidelines in August of 2008 with regard to how they view borrowers who have filed bankruptcy, gone through foreclosure or done a short sale. Through these new guidelines, they are in effect severely penalizing those who go the route of foreclosure or bankruptcy, and rewarding or encouraging those who do short sales, which they view as the borrower doing the responsible thing in light of the circumstances.
Recent Fannie Mae / Freddie Mac guidelines, borrowers filing bankruptcy or foreclosure may have to wait up to 7 years to buy another home.
In contrast, the new guidelines stipulate only a 24 month period after a short sale.
Q: Are there any advantages to letting my home go to foreclosure vs. doing a short sale?
Answer: I have yet to hear a good premise for letting your home go to foreclosure vs. short sale. Depending on whether you have recourse or non-recourse loan, when you let your home go to foreclosure you either run the risk of being liable for the deficiency amount or liable for the income taxes on that loss.
Secondly, your credit will drop up to 400-500 points and you will not be able to buy a home or get any decent credit for up to 7 years.
Comparison: With a short sale, the lender agrees to SETTLE the debt for less than the amount owed. If you have recourse loan, you may be liable for income taxes on the lender’s loss (just as in a foreclosure) but you will not be liable for the deficiency (and if you qualify for the “Insolvency” exclusion, you will avoid the income taxes as well).
Further, the loss that the lender takes in a short sale will be MUCH LESS than the loss the lender takes at the end of the foreclosure process. The foreclosure process takes months & months, at the end of which the lender has to process the property through its overwhelmed system (another 3 -5 months) and then put the property back on the market, all while the market continues to drop.
Most importantly, the impact on your credit from a short sale will be significantly less than with a foreclosure and you will be able to buy again within 2 years, compared to up to a 7 year waiting period to buy a home after a foreclosure.
Q: How much will a short sale cost?
Answer: Nothing –lender pays all closing costs, escrow fees, commissions etc. The lender may also pay any outstanding property taxes.
Q: How long will a short sale take?
Answer: The short sale process typically takes about 4-6 months, start to finish. It can take longer depending on how backlogged the lender is. You can live in the property for the entire duration of the short sale or you can move out whenever you wish.
Q: Do I need to be behind on my payments to do a short sale?
Answer: No, although the lenders are more motivated to do the short sale if you are not making payments.
Q: Do I need to hire an attorney to do a short sale?
Answer: It is the belief of my office of professionals you will be best represented in a short sale by an experienced real estate agent who has great relationships with a private negotiator who works every day in the real estate business, will market your property aggressively in order to attract buyers, and who is experienced at doing short sales.
With this said a word of caution. Many attorneys seem to be preying on the fear and desperation of people facing foreclosure. Their websites use scare tactics to make people think that they would be crazy to do a short sale without first hiring an attorney that attorneys are the only ones qualified to interpret a short sale approval, and that hiring an attorney is a normal and accepted part of doing a short sale, like hiring an attorney for divorce proceedings.
The overwhelming majority of short sales are conducted by real estate brokers who are experienced at negotiating with the lenders and charge NO UPFRONT FEES for their services.
Q: I found an attorney's short sale website that talks about a new law in California that, as of July 1 2009, supposedly limits negotiating short sales to attorneys ONLY. It says that from July 1 on, all short sales have to be negotiated by attorneys and not realtors. Is this true?
Answer: No. Misinformation put out of late regarding this law by attorneys looking to get into the short sale business. I recommend you be very wary an attorney trying to interpret the law for his or her advantage.
The California Foreclosure Consultant Act (July 1 2009) applies to foreclosure consultants - those who collect an advance fee for modifying loans or helping borrowers avoid foreclosure in situations where a Notice of Default has been filed on the property. This Act has exclusion in it for licensed real estate agents.
Per CA Civic Code and the CA Assoc of Realtors, The California Foreclosure Consultant Act does not apply to real estate agents facilitating a short sale except in the extremely unusual event that an agent is 1) Making a direct loan for a residence in foreclosure, 2) Acquiring an interest in a residence in foreclosure, 3) Receiving an advance fee before performing services for a residence in foreclosure, or 4) Assisting an owner in obtaining the remaining proceeds if any from a foreclosure sale of an owner's residence.
Q: Who will be negotiating my short sale with the bank? Do you do this in your office or do you sub it out to an outside company?
Answer: My short sale team consists of my in-house negotiator, Transaction coordinator and attorney. I welcome you to come in and meet with us in my office, meet my team and get a first hand look at how I run things.
Q: Should I file bankruptcy? Will it allow me to keep my home? I’ve heard the lender cannot foreclose if I file bankruptcy.
Answer: In bankruptcy there are two types commonly used– Chapter 7 a.k.a “Fresh Start” & Chapter 13 “Wage Earner.” Chapter 7 can give individual filers ability to wipe away debts such as credit card and medical issues and continue to make their mortgage payments.
Chapter 13 encompasses setting up a 3-5 year repayment plan to repay debts. It requires you have a steady income, as you will be repaying all of your debt. Both have a very negative impact on your credit and remain on your credit report for 10 years.
Due to the new 2005 bankruptcy law, which raised the bar for people to qualify for Chapter 7 "fresh start" bankruptcy proceedings, fewer and fewer people pass the “means” test to qualify for Chapter 7 and for this reason can only qualify for Chapter 13 bankruptcy (a 3-5 year repayment plan).
Unfortunately both Chapter 7 and Chapter 13 temporarily delay foreclosure proceedings, neither allows you to keep your home unless you can bring your mortgage current.
Q: Can any agent do a short sale?
Answer: Technically yes... but can any agent actually succeed? Fortunately for me… No. Many agents have no interest in doing short sales because they require a tremendous amount of time and expertise. If you don’t know what you are doing, they often go to foreclosure.
You get one shot at doing a short sale – if your agent does not know what they are doing and has not learned the many tricks to the trade, you will likely find yourself being asked to sign a promissory note or worse, be denied by your lender or lenders and go to foreclosure.