A "short sale" occurs when a lender "discounts" the balance due on a homeowner's mortgage if he is in financial trouble, if they so choose. The purpose, of course, is so the homeowner can find a buyer quickly, before foreclosure becomes necessary.
Foreclosure is an expensive and time-consuming process that some lenders may want to avoid. But in most instances, lenders would rather foreclose, and then sell at nearly market value. Why take a discount if they can get full value? So, in most cases, a short sale is simply not going to happen.
But even in those cases where a lender may consider a short sale, the process is complicated and time-consuming, with an inordinate amount of paperwork.
The paperwork involved is much more complex than in an ordinary transaction. The lender will want documentation that includes:
· a letter of authorization (lender's will not provide personal info about the seller or his mortgage without it);
· a preliminary net sheet (estimated closing statement that includes the proposed sale price, costs of the sale, unpaid loan balances, outstanding payments and late fees, and real estate commissions, if any);
· a hardship letter (statement of facts that show it is impossible for the homeowner to redeem himself and pay his debt, through no fault of his own);
· proof of income and assets (of both the homeowner and the investor/buyer);
· copies of bank statements (of both seller and buyer);
· a comparative market analysis showing the actual value of the property;
· the purchase agreement from the buyer.
You may want to note that any property that has a second mortgage will not qualify for a short sale. This is because it is virtually impossible to get a second lender to remove its lien, thereby taking the risk of losing its investment.
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How do a foreclosure and a short sale show up on the homeowner’s credit?
Foreclosures show up as FORECLOSURE, and stay on your record for seven years. Anytime the homeowner applies for a new loan or has their credit run, the foreclosure will show up. Many times employers ask if the homeowner has been foreclosed upon when interview for a job.
A short sale is listed as SETTLED DEBT, and is much less harmful to the homeowner’s credit. Please consult a credit company for more information.
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What liability does the homeowner have when doing a short sale? A foreclosure?
In a short sale, it is possible the bank could 1099 the homeowner for the difference in what you sell their property for and what was owed. This means the IRS could consider the difference as income, and the debtor could be taxed on that income. The bank might also ask the homeowner to pay a portion of the difference back in the form of an unsecured note, which is similar to an I.O.U. It is best to negotiate with the lender to have the bank consider the debt settled.
In a foreclosure, the house is sold at an auction, which typically causes the difference to be much greater. It is more likely the bank will seek a deficiency judgment against the homeowner.
JUST IN CASE YOU MISSED IT . . . .
On December 20th, 2007, President Bush signed the MORTGAGE FORGIVENESS DEBT RELIEF ACT which ensures that any debt forgiven on a mortgage secured for a principal residence will not be taxed. This means when a lender forgives some portion of a borrower's mortgage debt in a short sale, a foreclosure, a workout with the lender, etc.. the borrower will not be required to recognize income or pay tax on the forgiven amount. This relief applies to debts forgiven between January 1, 2007 and December 31, 2009.