No homeowner wants to go through foreclosure and its credit rating destruction. Fortunately, there is an alternative: a short sale.
What is a real estate short sale?
A short sale in real estate is a transaction in which a homeowner sells their property for less than the amount they owe on their mortgage. The proceeds from the sale are used to pay off the outstanding mortgage balance, and any remaining debt is typically forgiven by the lender. Short sales are often used as an alternative to foreclosure, as they allow the homeowner to avoid the negative credit consequences associated with a foreclosure.
The process of a short sale can be complex and time-consuming, as it requires the cooperation of both the homeowner and the lender. The homeowner must provide financial information to the lender, and the lender must agree to the terms of the short sale. Once the lender approves the short sale, the property is then put on the market and sold to a buyer, who typically pays less than the market value of the property.
What are the steps sellers need to take in order to sell their properties in short sales?
Contact a real estate agent with experience in short sales: A real estate agent with experience in short sales can help the homeowner understand the process, and can assist with marketing the property and finding a buyer.
Gather financial information: The homeowner will need to provide financial information to the lender, such as income and expenses, to demonstrate that they are unable to make the mortgage payments.
Contact the lender: The homeowner will need to contact their lender and inform them of their intent to sell the property in a short sale. The lender will typically request additional information and may assign a loss mitigation representative to handle the short sale.
Negotiate with the lender: The homeowner, the real estate agent and the lender will need to negotiate the terms of the short sale, including the sales price and any other terms such as the deficiency and the closing cost.
Find a buyer: Once the lender approves the short sale, the property will be put on the market and a buyer will be found. The buyer will need to conduct their due diligence, and may request repairs or other changes to the property before closing.
Close the sale: Once the buyer and the lender have agreed on the terms of the sale, the closing process can take place. The proceeds from the sale will be used to pay off the outstanding mortgage balance, and any remaining debt will be forgiven by the lender.
It’s important to note that the short sale process can be time-consuming, and it may take several months or more to complete.
What is the impact of short sale on credit score?
A short sale can have a negative impact on a person’s credit score. The exact impact will depend on a number of factors, such as the individual’s credit history and the specific details of the short sale.
Generally, a short sale will show up on a credit report as a “settled” or “paid as negotiated” account, which can be less damaging than a foreclosure or a bankruptcy, but still negatively impact the credit score. A short sale also stays on credit report for 7 years, just like a foreclosure or a bankruptcy. Additionally, a short sale may be considered a “derogatory” mark on a credit report, which can further lower a person’s credit score.
A person’s credit score can drop as a result of a short sale, but the specific impact will depend on the individual’s credit history and the credit scoring model used to calculate the score. However, it’s important to note that a short sale can be a better option than a foreclosure, which can have a more severe impact on a person’s credit score.
Short sale vs foreclosure
A short sale and a foreclosure are both options for homeowners who are unable to make their mortgage payments, but they are different in a number of ways.
- A short sale is a process in which a homeowner sells their property for less than the amount they owe on their mortgage.
- The proceeds from the sale are used to pay off the outstanding mortgage balance, and any remaining debt is typically forgiven by the lender.
- Short sales are often used as an alternative to foreclosure, as they allow the homeowner to avoid the negative credit consequences associated with a foreclosure.
- A short sale can have a negative impact on a person’s credit score, but the specific impact will depend on the individual’s credit history and the credit scoring model used to calculate the score.
- A foreclosure is a legal process in which a lender forces the sale of a property to recover the outstanding mortgage debt.
- Foreclosures typically happen when a homeowner has failed to make mortgage payments for an extended period of time.
- Foreclosures can have a more severe impact on a person’s credit score than a short sale.
- Foreclosures also have an impact on the neighborhood and the property values.
In a short sale, the homeowner is able to sell the property and potentially avoid a foreclosure, while in a foreclosure, the property is taken over by the lender and sold.
Tax Implications of Short Sales
Typically, a short sale involves forgiveness of part of the mortgage debt owed by the homeowner. Debt forgiveness can constitute taxable income to the borrower. Whether the debt forgiven in a short sale is taxable income depends on several factors, including whether the mortgage is a recourse or a non-recourse loan, the forgiven debt qualifies for the qualified principal residence indebtedness exclusion, or the homeowner was insolvent at the time of the debt cancellation.
Forgiveness of a non-recourse loan (a loan for which the borrower is not personally liable) does not result in taxable income to the borrower. Twelve states allow only non-recourse home loans. But recourse loans are standard practice in the other 38 states.
Fortunately, for underwater homeowners who have recourse loans, Congress passed the Mortgage Forgiveness Debt Relief Act in 2007. Thanks to this law, up to $750,000 of “qualified principal residence indebtedness” forgiven by a lender is excluded from tax. This exclusion remains in effect through 2025 and applies only to debt to acquire or build the taxpayer’s principal residence.
Homeowners who don’t qualify for the qualified principal residence indebtedness exclusion can still avoid paying tax on their canceled indebtedness if they were insolvent when the debt was canceled. Taxpayers are insolvent if their total liabilities exceed the fair market value of all their assets immediately before the debt cancellation. It’s likely that most homeowners who can get their lenders to agree to a short sale qualify as insolvent.
It’s important to consult with a real estate agent, tax professional, and credit counselor to evaluate the potential impact of a short sale or a foreclosure on your credit score and to know the best course of action that suits your case.