A number of factors have come together during the course of the last year which have resulted in a "perfect storm" in the real estate market. The sub-prime mortgage crises has produced a large population of homeowners who borrowed against their properties when the market was hot, values were high, credit was easy, and adjustable rate mortgages provided low initial payments. Many of these same folks are now facing the sobering reality of dealing with mortgage rates that are starting to go variable, resulting in substantially higher monthly payments. These difficulties are compounded by tightening credit, depreciated home values, and an overall economic slow down, resulting in an inability for these troubled homeowners to refinance or sell their properties for an amount sufficient to payoff the entire principal due and outstanding on their mortgages. The unfortunate results have been rising loan defaults and a record number of foreclosures nationwide. Although the outlook may look bleak, homeowners getting squeezed to the edge of foreclosure still may have a few options.
Borrowers behind on their mortgage payments can work with their lender to modify the terms of the loan or negotiate a forbearance agreement to get back on track with their lender and recover from a temporary financial setback. A forbearance agreement will allow a borrower to pay an accrued deficiency over an extended period of time, provided they can resume and continue to make regular mortgage payments, and demonstrate that the financial issues which led to the arrearage have been resolved. A loan modification is a renegotiation of the terms of the original note and mortgage, often resulting in a reduced monthly payment. For a homeowner looking to keep their property, pursuing either of these options may make sense, especially if the borrower's financial situation has stabilized. For those homeowners, however, who are in properties they can no longer afford, are dealing with an ongoing financial hardship, and are slipping into default on their loans, a short sale may be the answer.
A short sale is a process by which the lender agrees to accept a payoff amount less than what is due and owing on the loan. In exchange for the payment, the lender will release the mortgage on the property, and in many circumstances, agree to accept the lesser amount as payment in full, waiving any deficiency remaining on the note. In order to make this happen, the borrower must be prepared to run through a gauntlet of requirements and disclosures prior to getting any consideration from the bank. At a minimum, the homeowner must be prepared to provide a financial statement, proof of income and assets, copies of bank statements, a comparative market analysis indicating the market value of the property, and a detailed hardship letter which gives an explanation as to the circumstances which have led to the borrower's default. Additionally, an estimate regarding the costs of sale, and the net amount to be received by the bank will need to be prepared. If the numbers work, it can be a win-win for both lender and borrower, allowing the homeowner to move on and sparing a bank the time, trouble and expense of foreclosing and adding another property to their inventory.
Despite the benefits, the process can be long and tedious. Banks are so overwhelmed with modification requests, foreclosures, and short sales, that loss mitigation departments will often not evaluate the borrower's proposal until there is a signed purchase and sale agreement in hand. Sellers will need to proceed with caution, and should have a clear understanding of their legal rights and obligations, as well as their contractual duties, prior to signing a purchase and sale agreement. At the very least, sellers need to make sure they can back out of an agreement and void a contract and sale agreement if the bank rejects the short sale proposal. A prudent seller should engage legal counsel and the assistance of a realtor to work through this process. If all goes well, the realtor's commission, many costs and most of the legal fees will be disbursed from closing at the time of sale, and in essence be paid by the bank.
Ultimately for the homeowner in trouble, the goal of a short sale is to get the property sold, get out from under the mortgage, and move forward without having to pay any deficiency to the bank. Make no mistake, however, this process will affect a borrower's credit score, but the alternatives of a foreclosure or bankruptcy may have much greater and long lasting impacts. Local mortgage broker Jonathan Estrella of Star Financial, Inc. states that "A credit report containing the terms Foreclosure, Deed in Lieu of Foreclosure or Short Sale, may prohibit prospective borrowers from qualifying for a mortgage for a minimum of 2 years. As part of the short sale process, it is imperative that borrowers attempt to negotiate with lenders regarding the manner in which the transaction will be reported. The responsiveness of lenders on this issue will vary, but if a lender accepts the short sale as payment in full, and lists it as such on the borrower's credit report, it will enable a borrower to rehabilitate their credit score and gain underwriting approval for a future mortgage much sooner."
The good news is that there are greater tax incentives for most homeowners to complete a short sale. Up until recently, the amount of the deficiency forgiven by the lender was treated by the IRS as taxable income to the borrower; however the Mortgage Forgiveness Debt Relief Act of 2007 changes this practice. Under most circumstances, taxpayers may now exclude debt forgiven on their principal residences. Homeowners should seek the advice of a tax professional to fully appreciate the limitations and filing requirements of the new law, however for many, this represents a significant savings opportunity. "The new law contains important provisions for struggling homeowners," said Acting IRS Commissioner Linda Stiff. "We urge people with mortgage problems to take full advantage of the valuable tax relief available."
Engaging in a short sale can be a long and intense process for people already faced with difficult decisions. For the right cases, the benefits of completing a short sale will far outweigh the costs of taking no action, and leaving your future to be determined by others. Getting informed and drawing on the recourses of legal, tax and real estate professionals will ensure your rights and interests are protected and provide you with the greatest opportunity for success.
J.Russell Jackson may be reached at
counsel@jacksonlawltd.com or 401.848.7979
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