Do short sales help you avoid the stigma that comes with a bankruptcy?

By Sheryl Landrum
Home Worth Columnist

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A number of homeowners looking to avoid foreclosure are opting for a short sale instead. A short sale occurs when the lender approves the sale of a home for less than what is owed and agrees to accept the proceeds as payment-in-full. However, home sellers beware; short sales may not be what they are cracked up to be.

What Do Home Sellers Need to Know About Short Sales

• While a short sale means the lender agrees to accept less than what is owed from the buyer, it doesn't mean that you are off the hook. A short sale involves not only negotiating with a buyer; you negotiate with the lender as well. What you want from the lender is a promise to accept the proceeds as "payment in full without pursuit of deficiency judgment." This promise is also known as a "deed in lieu of foreclosure."
• In most cases mortgage debt forgiven by your lender will not be federally taxed as income to you, thanks to the passage of the Mortgage Forgiveness Debt Relief Act late in 2007. However, if the property is not your primary residence, if the loan being forgiven is a cash-out refinance, or if the loan exceeded $2 million (for a married couple, $1 million if filing separately), you could end up with a taxable gain at the end of the year. In addition, not all states aligned their tax codes with the IRS as of this writing. So there could be state taxes involved even if there are no federally-taxed gains. Check with a tax pro first.
• According to Fair Isaac's, myfico.com, short sales, deeds in lieu of foreclosure or a foreclosure itself are all weighed the same when it comes to calculating credit scores. However, it makes a big difference to those investing in mortgages--Fannie Mae now requires that borrowers with a home foreclosure on their credit report must wait for five years before being eligible for a FNMA-insured loan, but those who manage a pre-foreclosure (short sale) only have to wait 2 years.

How Do You Qualify for a Short Sale?

If you are considering selling your house through a short-sale, talk to a trusted attorney or tax consultant. Also, you will need to talk to your lender as well to understand the short sale process. Your lender will probably need:

• A letter of authorization to release your information to outside parties.
• A "hardship" letter explaining how you have come into the financial situation leaving you unable to pay your mortgage (loss of job, illness, etc.) and asking the lender to accept less than full payment of what is due.
• A statement of income and assets with documentation of everything you have, everything you earn, and everything you owe.
• A net sheet that shows your expected sales price less the costs and expenses of selling the home and retiring the mortgage.

Before you begin the process of a short sale, talk to your lender, find an expert real estate agent (some specialize in short sales), and see an attorney or CPA before going ahead. While a short sale may help you get out from under mortgage debt, make sure you know all your options and consider the consequences before you begin the process of selling your home.

About the Author
Sheryl Landrum is a Senior Loan Officer with First Capital Mortgage of San Diego at the Prudential Realty Office in Bonsall, California.