With real estate values falling 20 to 50 percent many homeowners have no equity in their home and, often are upside down. If you are in this situation you need a plan to either protect your home or, if that is not possible, a plan to get rid of your debt and started on a road to recovery that will result in you being able to get into a new home.
If you sell your home when you owe more than you can sell the property for you need to obtain the approval of each creditor on the property that you cannot fully payoff. This is called a "Short Sale". Many people assume that because the creditor approved the short sale that they also agreed to forgive the debt that could not be paid off upon the sale of the home. This assumption is not correct. A short sale approval should be in writing and should address whether the unpaid debt is forgiven or not and you should try to get the creditor to agree to how they will report the short sale to the credit bureau.
If there is more than one creditor on your property obtaining a short sale approval is much more difficult to obtain. It is more difficult to obtain the short sale approval from the creditors who are behind the first creditor because they generally are taking a much greater loss than the first creditor and their legal position is different than the first creditor. When negotiating with the subsequent creditors you must realize that they will be much more interested in your complete financial picture than will the first creditor. In order to effectively negotiate with these creditors you must be familiar with creditor/debtor law and bankruptcy. In other words, if they sue you what can you protect from collection and if you file bankruptcy what assets can you keep through the bankruptcy process.
Many people and companies will offer to negotiate your short sale but many are not knowledgeable about the numerous legal issues that arise in a short sale situation. Numerous short sales have occurred where no written agreement was obtained as to whether the creditor forgave the unpaid debt. Imagine the shock to those borrowers if they are sued for the unpaid debt some time in the future! Many people negotiating short sales do not have a firm grasp of the legal issues that may arise or that need to be addressed. If they cannot properly advise you as to what your options are if the creditor sues you how can you determine whether the short sale approval that they will agree to is in your best interests? Only a lawyer is qualified to address the numerous legal issues that need to be addressed. Of course, a lawyer is not qualified to address many of the financial, real estate and tax issues that also may arise so in the end you are best served by having a "team" of professionals that can help guide you through the process.
In a normal short sale process you may have to work with a financial planner, a real estate agent, a real estate attorney and, possibly, a bankruptcy attorney. The No Home Equity Flow Chart diagrams out the various professionals that can be utilized to deal with the various issues that can arise and the manydifferent paths you may travel.
Is a Short Sale Better Than a Foreclosure or Bankruptcy on Your Credit Scores?
Many people assert that a short sale has less of an impact on the home owners credit score than does a foreclosure or bankruptcy. Rarely, does anyone ask for proof.
A recent Fair Isaac Corporation (FICO) study found little to no difference in credit score recovery between a short sale, foreclosure or bankruptcy. The results are as follows:
The higher your credit score starts out, generally the greater the drop and the longer it takes to fully recover to your starting FICO score.
There are also many other factors that lenders consider that can help or hurt the borrower. The type of lender and the type of loan can also change the impact of a foreclosure, short sale or bankruptcy. Generally, the borrower will have to wait the longest following a foreclosure to buy a house. Freddie Mac and Fannie Mae require a two year wait after a short sale, deed-in-lieu or bankruptcy and three years after a foreclosure if there was extenuating circumstances such as job loss, illness or divorce. Without such extenuating circumstances, the wait can extend to 4 years after bankruptcy and 7 years after foreclosure.
F.H.A. require a 3 year wait after a short sale (assuming no extenuating circumstances) or a foreclosure and 2 years after a bankrupcty. However, if the short sale was to "take advantage of a decling market conditions" this may negatively impact the borrowers ability to obtain a home loan.
There are many factors to consider whether a short sale is advantageous to the homeowner or not. When considering the impact of a short sale, foreclosure or bankruptcy on your credit score or the time needed to recover, make sure you consult with an experienced loan officer that you trust and don't rely on statements that are made to encourage you to take one course or another without statistics to back up the claim.
Debt Forgiveness as Taxable Income
When debt is foregiven, the general rule is that the foregiven amount will be considered income for tax purposes. The principal behind this policy is that a forgivenss of debt is no different than if someone had given the borrower the money needed to pay the debt off.
A short sale (or deed-in-lue) often involves a foregivenss of debt. The short sale agreement should include an agreement as to whether the unpaid debt is foregiven or not. If the debt is foregiven, their may be tax consequences for the borrower.
There are exceptions to the general rule that the forgiveness of the loan is income; however, you should consult with a tax professional to determine whether one of the exceptions apply to your specific situation. The three general execptions are as follows:
1. Mortgage Forgiveness Debt Relief Act. In response to the real estate implosion and the resulting significant decline in real estate values, Congress passed the Mortgage Forgiveness Debt Relief Act of 2007 (see 26 U.S.C. 108). This is a temporary law (through December 31, 2012) which exempts some debt relief from taxation. This applies to loans on principal residential property that was used to build, buy or improve the property.
2. Insolvency exception. You may not have to include the forgiven amount to the extent you can prove that you were insolvent at the time of the transaction.
3. Bankruptcy exception. If you discharge the deficiency in bankruptcy then the amount of the discharged debt will not be considered income.
Whether an exclusion applies to your situation is specific to you situation. You should not rely on general statements and should consult with an expereinced tax accountant.
Click the following link for information on debt foregiveness: IRS Questions and Answers About Debt Foregiveness
Homes Affordable Foreclosure Alternative (HAFA) Short Sales
The HAFA short sale and deed-in-lieu program was established by the US Treasury and commenced in April of 2010. While it is a voluntary program, all major lenders have agreed to participate.
The goals of the HAFA program is to encourage servicers to more efficiently process short sales and deed-in-lieu, to create common forms and processes and to relieve borowers of the entire debt associated with their property. The program has financial incentives for servicers, lenders and borrowers.
To date, the program has failed to meet its goals. Most servicers struggle to understand their own HAFA program, fail to follow the program and have not reduced the time it takes to complete a short slae. In fact, a HAFA short sale may take longer than a standard short sale if the servicer does not know how to proceed. The financial incentives have not proven attractive enough to lenders for them to give up their right to sue borrowers for the remaining debt that was left unpaid after the short sale.
The following link shows the performance of the major servicers with respect to HAFA short sales since HAFA commenced.