A short sale happens when you sell your home for less than what you currently owe on the mortgage. While a short sale isn’t an ideal situation, it can be better for you, your finances, and your credit rating than a foreclosure. However, you need to consider the consequences a short sale will have on your financial situation.
Basics of a short sale
Before you decide that a short sale is the right move for you, here are a few things you should understand.
It’s not guaranteed
Because the home is used as collateral on your mortgage loan, your lender may be hesitant to approve a short sale. Lenders will typically only do so if it’s their best interest, or if it’s the only option for recouping as much money as possible from the mortgage loan.
It requires documentation
Before your lender will allow a short sale, it will need to know that you’ve done your due diligence. Here are a handful of things you may need to provide before the lender will even consider your offer:
- A hardship letter in which you explain why you can no longer make your monthly payments
- A market analysis that shows the prices of comparable properties in your area that have recently sold or have been on the market for a long time
- A statement of your income and assets
- Bank statements from the last few months
- Any other liens on your property
- A buyer with an offer
- Purchase agreement and listing agreement
It may take a long time to close
Unlike traditional real estate transactions, short sales take extra effort. This is primarily because not only do the buyer and seller need to agree to a selling price, but the lender also has to approve it.
It also requires a good real estate agent who has experience working with short sales and can give you the right advice when you need it. Otherwise, it could take even longer to close and you could have a harder time getting the right deal.
It requires good legal and tax advice
Selling your home for less than what you owe can have both legal and tax ramifications. As such, it’s essential that you get legal and tax advice before you complete a short sale. You may even want to consider doing so before you even reach out to your lender to talk about it.
Your goal for proceeding with a short sale is to close the deal with your lender agreeing to take less or even no money at all. You’ll also want the lender to agree to report to the credit bureaus that your account is paid in full.
It will still hurt your credit
You can request that the lender report your account as paid in full — something you won’t get with a foreclosure. But even so, a short sale is still one of the worst things that can happen to your credit score. That’s because the lender will typically note that it was paid for less than originally agreed, a charged-off account, a settlement, or a deed-in-lieu of foreclosure.
Depending on how the lender reports a short sale, it could be better or worse for your score. No matter what, though, a short sale can stay on your credit report for as long as seven years. So, it’s crucial that you have a plan for rebounding by developing and practicing good credit habits.
Make sure your future debt payments are always on time and keep your credit card balances low, if applicable. These positive items can help offset the negative impact of the short sale.
Getting real estate, legal, and tax advice
A short sale can be a balancing act, so getting professional assistance is usually a good idea. However, understand what skills an agent, attorney, and accountant each bring to the table.
Real estate agent
The right agent is typically one who has previous experience working with short sales. They can assist you in negotiating and submitting your deal to your lender, identifying a price, and marketing the home.
They can also help you choose the right type of short sale for your situation. There are generally four types of short sales: traditional, Home Affordable Foreclosure Alternative (HAFA), Fannie Mae HAFA, and Freddie Mac HAFA.
Real estate attorney
Real estate agents and accountants can’t offer legal advice if they aren’t licensed to practice law. If the following two situations apply to you, it’s typically a good idea to hire a real estate attorney to help you navigate the legal complexities of the process:
- A release of personal liability: Once you complete the short sale, you should request a release of liability. This protects you from future requests to repay the difference between your outstanding mortgage and the actual sale price on your short sale home.
- Asset protection: No lender likes to lose money on a loan. They will likely look at your assets and income to determine if they can recoup any or all of their loss.
One of the biggest benefits of having a tax accountant to understand how a short sale can affect you from a tax liability standpoint. The IRS offers information on the Mortgage Forgiveness Debt Relief Act. But if you need additional financial and tax assistance, you would be wise to speak with a tax accountant.
Additional Information on Short Sales
A few final words of advice before you decide a short sale is right for you. Keep in mind that a short sale does not automatically discharge your debt. You may still owe your lender the difference between the sale price and the balance due.
It may also result in a higher tax liability. When a debt is forgiven, it is considered a relief of debt and may be treated as income for tax purposes. Finally, a short sale will have an impact on your credit score. The exact impact will depend on many factors, be sure to investigate the situation fully ahead of time.