In a short sale, the mortgage lender agrees to discount the loan balance in order to assist the property owner in selling his or her property. A short sale may result in the lender being paid the discounted amount, or it may result in the lender allowing the buyer to assume the discounted loan.
In some cases, lenders agree to provide the seller with a full satisfaction of the debt, or release of liability of the shortfall, and in other cases, the lender will not agree to release the seller of liability. If a property owner does not receive a full release of liability, and the loan is a recourse loan, the lender can file suit against the former property owner (borrower) to collect any deficiency or shortage.
Lenders agree to short sales when it is in their best interest to do so. Short sales are sometimes in the best interest of the seller, but often a short sale works to the great disadvantage of the property owner.
Before a property owner agrees to offer his or her property for sale, in anticipation of a short sale, the property owner should consult with a CPA or Enrolled Agent to obtain important and necessary tax advice, and an experienced attorney to determine possible legal liability. Owners should not rely exclusively upon the advice of a real estate agent.
First, it is important to understand that any release of liability document offered by a mortgage lender should be reviewed and approved by the property owner's attorney before acceptance. Not all releases of liability are the same. The document offered by the lender may not be a full release of liability.
Secondly, a lender's release of liability offers no protection to a property owner for any tax consequences. Often, when a mortgage lender agrees to discount the loan, the discount is considered income for federal and state tax purposes. Thus, a $100,000 discount could result in a combined federal and state income tax approximating $30,000. Obviously, a surprise tax resulting from a discounted loan can be disastrous. Even a foreclosure (no short sale) can result in such a taxable event. Thus, it is critically important to determine, long before a short sale or foreclosure, whether you are at risk of paying a tax.
If there is a risk of paying significant federal and / or state income tax, the property owner should consult with a bankruptcy attorney. If a bankruptcy is filed before a short sale or foreclosure, it is highly likely that any tax can be avoided. If a bankruptcy is filed after a short sale or foreclosure, such a tax will not be dischargeable for three years and only if certain conditions are met.
It is clear that there is no substitute for obtaining qualified tax and legal advice before a short sale or foreclosure.
Even when taxes are not a factor, it is often more valuable to allow a lender to foreclose than going through the process of a short sale. Consider the following:
|| Short Sale
| Time owners can spend in the property without paying the mortgage lender.
|| Owners must vacate after the foreclosure and before an unlawful detainer lawsuit is finalized. A foreclosure generally takes four months to complete. Responding to an unlawful detainer action will generally give the owners an additional four to five weeks. A bankruptcy filing will often give the owners an additional four weeks.
|| Owners must vacate immediately or before the close of escrow.
|| Owners do not have to show the property to prospective buyers.
|| Owners will be required to give the real estate broker access to the property seven days a week, days and evenings.
| Credit Consideration
|| A foreclosure will clearly reflect negatively on the owner's credit report for seven years. After two years the effect will be reduced by 90%.
|| A short sale is a charge - off and will clearly reflect negatively on the owner's credit report. Most creditors do not distinguish between foreclosures and large charge - offs. After two years the effect will be reduced by 90%.
In negotiating a short sale with a mortgage lender, it is important to keep in mind that any subordinate (junior) lenders(s), and any homeowner association, will most likely have to agree to a reduced payoff. It is unlikely that a mortgage lender will accept a discount unless the subordinate lender(s) agree to a major discount as well. Many mortgage lenders will not insist that a homeowners association take a discount because the amount owed is usually relatively small compared to the debt.
Is there a time when a short sale makes sense? There are some circumstances where it will make sense to attempt a short sale. If you are considering a short sale, please contact Michael T. Chulak & Associates for a free consultation before you make a mistake.