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Selling At A Loss – Short Sales

When does foreclosure begin?
Lenders will initiate foreclosure proceedings when borrowers become delinquent in their mortgage obligations, usually after three payments are missed. The lender will then notify the borrower in writing that he or she is in default. The lender can request a trustee’s sale or a judicial foreclosure, in which the property is sold at public auction. A borrower can cure the default by paying the overdue amount and the pending payment after the notice of default is recorded, usually no later than a few days before the property’s sale. Some sales allow the successful bidder to take possession of the property immediately. If the former owner refuses to vacate the premises, the court can issue an unlawful detainer that allows the sheriff to come out and evict them. Borrowers should do everything they can to avoid foreclosure, which is one of the most damaging events that can occur in an individual’s credit history.

How long do bankruptcies and foreclosures stay on a credit report?
Bankruptcies and foreclosures can remain on a credit report for seven to ten years. Some lenders will consider a borrower earlier if they have re-established good credit.  The circumstances surrounding the bankruptcy can also influence a lender’s decision. For example, if you went through a bankruptcy because your employer had financial difficulties, a lender may be more sympathetic. If, however, you went through a bankruptcy because you overextended personal credit lines and lived beyond your means, the lender probably will be less inclined to be flexible.  If you short sale your home, lenders usually require a two year period before you can apply for a new loan.

Can a home sell for less than its mortgage?
A short sale is when a home is sold for less than the amount owed on the mortgage and the bank accepts less than the full amount owed on the balance.  A seller may not have to be behind on their loan payments to seek a short sale.  If sellers wish to pursue a short sale: they must owe more than what the home is worth, demonstrate the house cannot be sold for the amount owed and suffer from a financial hardship that makes their mortgage payments unaffordable.  The first step in the short sale process is to assemble a short sale package.  This includes financial statements documenting income, monthly expenses, bank statements, two years tax returns and a financial hardship letter from the seller explaining their circumstances.  If the house is sold as a short sale, there will be a difference between the mortgage balance and what the bank collects.  Sometimes this shortage is negotiable.  If the bank forgives the shortage, the bank can write off the amount with the IRS, which means the seller may have to pay taxes on the amount forgiven.  However, the 2007 Mortgage Debt Relief Act generally allows taxpayers the potential for relief from tax on mortgage debt forgiveness.  A short sale will affect the seller’s credit score, but is usually a better alternative to foreclosure.  A seller should consult their tax accountant and attorney for legal advise in considering all options available and the ramifications of such.

How does a home go into foreclosure?
Foreclosure proceedings usually begin after a borrower has skipped three mortgage payments. The lender will record a notice of default against the property. Unless the debt is satisfied, the lender will foreclose on the mortgage and proceed to set up a trustee sale.

How does someone sell a slow mover?
Even in a down market, real estate experts say that price and condition are the two most important factors in selling a home.  If you are selling in a slow market, your first step would be to lower your price.  Also, go through the house and see if there are cosmetic defects that you missed and can be repaired.  Secondly, you need to make sure that the home is getting the exposure it deserves through open houses, broker open houses, advertising, good signage, and listings on the local multiple listing service (MLS) and on the Internet.  Another option is to pull your house off the market and wait for the market to improve.  Finally, if you who have no equity in the house, and are forced to sell because of a divorce or financial considerations, you could discuss a short sale or a deed-in-lieu-of-foreclosure with your lender.  A short sale is when the seller finds a buyer for a price that is below the mortgage amount and negotiates the difference with the lender.  In a deed-in-lieu-of-foreclosure situation, the lender agrees to take the house back without instituting foreclosure proceedings.  The latter are radical options.  Your simplest, and in many cases most effective, option is to lower the price.

12/4/13 UPDATE:

The CALIFORNIA ASSOCIATION OF REALTORS®’ (C.A.R.) announced today it received a letter from the California Franchise Tax Board (FTB), obtained by Board of Equalization (BOE) member George Runner, clarifying that California families who have lost their home in a short sale are not subject to state income tax liability on debt forgiveness “phantom income” they never received in a short sale.

Last month, in a letter to California Sen. Barbara Boxer, the Internal Revenue Service (IRS) recognized that the debt written off in a short sale does not constitute recourse debt under California law, and thus does not create so-called “cancellation of debt” income to the underwater home seller for federal income tax purposes.  Following the IRS’s clarification, C.A.R. sought a similar ruling by the California FTB.  Now with the FTB’s clarification, underwater home sellers also are assured that they are not subject to state income tax liability, rescuing tens of thousands of distressed home sellers from California tax liability for debt written off by lenders in short sales.