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FAQ: Short Sales May Offer Solution to Problem of High Balance Foreclosures - 2007-10-13 |
Last week we looked at a relatively new strategy that lenders are employing to reduce the flood of homes being repossessed and sitting unsold on the Atlanta real estate market.
It's called a short sale, and it happens when a lender agrees to accept a discounted payoff instead of pursing a foreclosure of a borrowers house. It is most often employed when a borrowers loan balance is higher than the current resale value of the house involved.
Here are some frequently asked questions about short sales:
Q: If I am behind on my home loan and about to face foreclosure, how can I know if my lender might accept a short sale offer?
A: Communicate with the lender and seek credit counseling. Know that the lender doesn't want to foreclose, and try to negotiate a monthly payment that you can afford.
If your real estate professional tells you that your loan balance exceeds the resale value of your home, and you have suffered some financial hardship, ask your lender if they have a "loss mitigation" department.
Q: What exactly qualifies as a "financial hardship?"
A: In general terms, it would likely be a life event over which you had little or no control that left you financially unable to meet your obligations. For example, a disabling injury as the result of an accident would likely qualify as a hardship, whereas a case of overspending might not. Each lender sets their own standards for reviewing short sales.
Q: What are the benefits to the borrower if the lender accepts a discounted payoff?
A: The primary benefit is that the borrower is no longer responsible for making a monthly payment they cannot afford. The house ends up being sold, and the lender usually cancels the debt which remains after the transaction. While individual cases vary, the lender typically does not seek to collect the deficit.
Q: Can the lender come back later and try to collect the debt?
A: It depends on the lender and the individual borrowers situation. In most cases, it is determined that the borrower is financially insolvent, and attempts at collection would not be successful. The borrower should always seek a "full and final" release from the lender as part of the agreement.
Q: What are the disadvantages to the borrower in a short sale?
A: First, the borrowers credit is severely damaged as the amount forgiven is recorded as a charge-off, although this is no worse than a foreclosure. Second, the borrower receives no compensation from the sale of his house, not even enough to help with a move. If the lender sees that the borrower is benefitting from the sale, it will require that any such funds be redirected toward the loan payoff. And finally, it is possible that the lender may issue the borrower a "Form 1099 Miscellaneous Income" for the amount of debt that is forgiven.
Q: Why would the lender issue a 1099 for the discharged debt?
A: The IRS considers final "debt forgiveness" to be the same as "regular income" to the borrower, and requires lenders to notify the agency of such transactions. While the borrower theoretically would have to account for such income in the year of the forgiveness, it usually comes during a period of extreme low income or insolvency, and often has little impact on a taxpayers liability. Even so, it would be a good idea to consult your CPA before entering into a short sale.
Q: If I have a loan that is preventing me from selling my house and I am facing foreclosure, can I sell my house to a family member at a short sale discount, then buy it back later?
A: The lender's "loss mitigation representative" will examine every detail of your proposed transaction with three goals in mind. First, does this transaction obtain every possible dollar for the lender? Second, is there any possibility that the lender would end up financially better off by foreclosing and reselling the house at a future date? And finally, is there any financial benefit being transferred to the borrower (or his agents) as a result of the transaction.
Most lenders will require that the borrower and proposed purchaser certify that they are independent parties and that the short sale is not between parties that are related in any way.
Q: What happens if the borrower declares bankruptcy before the short sale is consummated?
A: A short sale negotiation is considered to be a "collection activity" by the lender, and bankruptcy law forbids creditors from engaging in such activity unless specifically allowed to do so by the court.
Q: What other types of documentation does a lender require before approving a proposed short sale?
A: Almost all the same items that the borrower had to submit in order to get approved for the loan in the first place. Typically the lender wants to see a market analysis from the real estate agent estimating a likely selling price, an estimate of repairs needed, and complete financial data from the borrower including tax returns, pay stubs, W-2's, and at least two months checking and savings account statements.
Q: Why does the lender need to see all the borrowers financial records?
A: The lender is concerned that the borrower might have undisclosed assets which might be used to satisfy the home loan in question. So if the borrower has an art collection or a fat savings account somewhere, the lender wants to know about it. Only when the lender is satisfied that further collection efforts are useless will a discounted payoff be considered.
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