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 subprime mortgage crisis 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 mortgage payments that are adjusting, increasing their monthly mortgage payments by hundreds of dollars.
Tightening credit, declining home values and an overall economic slowdown have resulted in an inability for these homeowners to refinance or sell their properties for an amount sufficient to pay off their existing mortgages. Borrowers behind on their mortgage payments due to a temporary financial setback can work with their lender to modify the terms of their loan or negotiate a forbearance agreement to get back on track. But for those homeowners dealing with an ongoing financial hardship and slipping into default, a short sale may be the answer.
A short sale is a process by which the homeowner sells the home, but the sale price does not yield enough to cover the balance of the mortgage. The lender then agrees to accept a payoff amount less than what is owed 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 disclosures.
At a minimum, the homeowner must provide a financial statement, financial documents, a comparative market analysis of their home and a hardship letter, specifically detailing the circumstances which have led to the default. Additionally, an estimate regarding the costs of sale, and the net amount to be recovered by the bank needs to be prepared. If the numbers work, it can be a win-win, allowing the homeowner to move on and sparing the bank from the expensive burden of foreclosing and adding another property to its inventory.
Despite the benefits, the process can be long and tedious. Many banks are presently overwhelmed with foreclosures and short sales. Loss mitigation departments often do not evaluate short sale proposals until there is a signed purchase and sale agreement in hand. Sellers need to proceed with caution, and have a clear understanding of their legal rights and obligations, as well as their contractual duties, prior to signing a purchase and sale agreement. A prudent seller should engage legal counsel and the assistance of a Realtor. The Realtor’s commission, costs and even a portion of the legal fees may be disbursed from closing, essentially being paid by the bank, if the deal is structured correctly.
Although a short sale will affect the credit score of a seller, the alternatives of a foreclosure or bankruptcy will likely have much greater and long-lasting impacts. Mortgage broker Jonathan Estrella, of Star Financial Inc. in Newport, states “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. However, 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 Forgiveness Debt Relief Act of 2007 also provides greater tax incentives than ever before for homeowners who participate in a short sale involving their principal residence. Previously, forgiven debt was treated by the IRS as income, but many can now avoid that tax consequence. Homeowners should seek the advice of a tax professional to fully appreciate the benefits and 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 that your rights and interests are protected and provide you with the greatest opportunity for success. •
J. Russell Jackson is the founding
member of Jackson Law in Providence.
