For Sellers

Forclosure or Short Sale

Homeowners facing foreclosure often wonder whether a “short sale” is a better alternative. The answer depends on who’s asking. Foreclosures and short sales affect different people differently, depending on their financial situations, priorities, goals, adversity towards risks, property conditions, market conditions, and many other considerations. To help you answer that question for yourself, here are some of the major factors to consider when choosing between foreclosure and short sale.

FACTORS FORECLOSURE SHORT SALE
DEFINITION If you default on your loan, foreclosure is the legal process that your lender may use to sell your property to satisfy the debt you owe. A short sale is a sales transaction where the seller’s lender voluntarily agrees to receive a loan payoff for less than what’s owed.
CREDIT Foreclosure and short sale have the same negative impact on your FICO score, according to www.myfico.com. The derogatory item stays on your credit for 7 years, but your FICO score may begin to improve after 2 years if you keep your other credit obligations in good standing. Aside from your FICO score, whether foreclosure or short sale is better for your overall credit-worthiness depends on the purpose for which you’re using your credit, such as mortgage loan, auto loan, credit card, apartment rental, or job application (see right column). A short sale may be reflected in your credit as an account that is “not paid as agreed” or settled for less, and has the same negative impact as a foreclosure on your FICO score according to www.myfico.com. However, a short sale may be better than foreclosure for obtaining a new mortgage loan under current Fannie Mae guidelines. According to Fannie Mae, only 2 years must lapse after a short sale for a borrower to show reestablished credit, whereas 5 years must lapse after foreclosure (or 3 years after foreclosure if the borrower has a hardship or other extenuating circumstance).
TAX 1. Cancellation of Debt: Foreclosure may give rise to taxable income to you for cancellation of
debt, which is roughly calculated as your loan balance minus your property’s fair market value at foreclosure. Certain exceptions apply, such as bankruptcy, insolvency, forgiveness of a non-recourse loan (IRS), and a loan for purchasing or substantially improving your qualified principal residence.
2. Capital Gains: Foreclosure may also give rise to taxable income for capital gains, which is roughly calculated as your loan balance (or the property’s fair market value) minus your original purchase price and major improvement costs. However, you generally do not have to pay taxes on capital gains up to $250,000 (or $500,000 for married couples filing joint returns) if you owned and used the property as your principal residence for at least 2 of the last 5 years.
1. Cancellation of Debt: As with foreclosure, a short sale may give rise to taxable income for
cancellation of debt, but the calculation is different. For a short sale, the cancellation of debt income is roughly your loan balance minus the sales price. Certain exceptions apply, such as bankruptcy, insolvency, and a loan for purchasing or substantially improving your qualified principal residence.
2. Capital Gains: As with foreclosure, a short sale may give rise to taxable income for capital gains, but the calculation is different. For a short sale, the capital gains calculation is roughly your selling price minus your original purchase price and major improvement costs. As with a foreclosure, you generally do not have to pay taxes on capital gains up to $250,000 (or $500,000 for married couples filing joint returns) if you owned and used the property as your principal residence for at least 2 of the last 5 years.
PERSONAL LIABILITY If your loan balance is more than the foreclosure sales price, you generally will not be personally
liable for the difference under certain circumstances, such as if the lender forecloses non-judicially through a trustee’s sale or if you have a purchase-money, owner-occupied loan for one-to-four residential units. Certain exceptions apply, such as loan fraud, intentional property damage, certain wiped-out junior liens, and FHA and VA loans.
If your loan balance is more than the sales price of your property, whether you’ll be personally
liable for the difference may depend on what you negotiate with your mortgage lender. Your lender may agree to forgive you for the shortfall, refuse to forgive you for the shortfall, require you to repay the shortfall, or say nothing about the shortfall. If the lender agrees to forgive you for the shortfall, make sure to get that agreement in writing and signed by the lender.
POSSESSION You generally have the right to stay in your home during the foreclosure process which takes a
minimum of about 4 or 5 months. If you do not leave after a trustee’s sale of the property, the new owner may negotiate a cash-for-keys agreement with you, commence the eviction proceedings by serving you a 3-day notice to vacate, or take some other action.
You generally have the right to stay in your home until you close escrow on a short sale transaction. You may, however, be able to negotiate with your buyer for a longer or shorter stay.
DEFINITION If you default on your loan, foreclosure is the legal process that your lender may use to sell your property to satisfy the debt you owe. A short sale is a sales transaction where the seller’s lender voluntarily agrees to receive a loan payoff for less than what’s owed.
PERSONAL CONCERNS The foreclosure process does not take much effort on your part, but the wait can be agonizing
and stressful for certain people. Although non-judicial foreclosure takes a minimum of about 4 or 5 months, you generally cannot dictate how quickly the lender proceeds with each step of the foreclosure process. You may also feel uncomfortable with what you may perceive as the shame or stigma associated with foreclosure, such as when a notice of trustee’s sale is posted on your property or the sheriff comes to escort you and your family out of the property.
Doing a short sale may involve a lot of time, effort, and paperwork on your part to list and market
your home, to get your lender’s approval, and to consummate the sale with your buyer. Yet, during this process, you generally do not know whether you will succeed in closing your short sale transaction. Despite the hard work and uncertainty, you may prefer a short sale because it allows you to take a proactive approach to finalizing this chapter of your life so you can move on to the next one as quickly as possible.
ASSISTANCE To assist you, a foreclosure consultant as defined under Cal. Civ. Code § 2945.45 must be
registered with the California Department of Justice and bonded for $100,000. Real estate licensees are generally exempt from this requirement. To check whether someone is properly registered as a foreclosure consultant, call the California Attorney General’s Office.
One big advantage of a short sale is you can hire a professional real estate agent to help you
through what can otherwise be a complicated and difficult process. You may check whether someone is a real estate licensee at http://www2.dre.ca.gov/PublicASP/pplinfo.asp.

Tips for a Short Sale Seller

As a seller attempting a short sale, you want to be at the top of your game. To succeed, you not only have to find a buyer for your home, but also convince your mortgage lender to accept a loan payoff of less than what you owe. A short sale can be a long and arduous process, and yet, you have no guarantee of success. To help ensure success, here are some good tips for selling in a short sale situation:

  • Hire a REALTOR®: One of the best things you can do in a short sale is to hire a qualified REALTOR® to guide you through the process. A REALTOR® can represent you in finding a buyer and negotiating with your lender. Not all real estate agents are REALTORS®. The word REALTOR® is a trademark designation to distinguish that a real estate agent has, among other things, voluntarily pledged to abide by the strict code of professional ethics of the NATIONAL ASSOCIATION OF REALTORS® to protect and promote their clients’ interests.
  • Take a proactive approach: When you’re an “upside down” seller owing more on your mortgage than your property is worth, the prospect of selling short is likely to be upsetting. You may have never expected that owning a piece of the American dream could turn into a nightmare. Despite the grim realities, selling in a short sale may get you out of a bad situation. But it may take a commitment of time and effort on your part. Taking a proactive approach to your short sale may help you get out of that nightmare as quickly and painlessly as you can.
  • Knowledge is your friend: A short sale is a new experience for most homeowners, but knowledge is a key to success. You should know the pros and cons of a short sale, including the credit, tax, liability, and other potential consequences. You should also understand the overall short sale process — what you need to do, how long the process may take, and what the common pitfalls may be. Your REALTOR® may be a great resource for information. Short sale information is also available online, such as news articles, governmental websites, lenders’ websites, and short sale blogs. Be careful, however, as a lot of misinformation on short sales also floats in our midst.
  • Do your homework: As early in the game as possible, determine your lender’s short sale requirements and whether you satisfy those requirements. If you have multiple loans or other interests secured by your property, you may have to get a short sale approval from all of those creditors. Every lender is different. Not only that, but a lender’s requirements may change over time. To approve a short sale, your lender may require that you demonstrate and document a true financial hardship, such as job loss, illness, disability, or death of a co-owner. A decline in property value, absent more, may not be enough to demonstrate a financial hardship. Your lender may have other eligibility requirements, such as a current delinquency in mortgage payments, income verification, or property valuation. You should also determine how your lender intends to treat the shortfall (or the difference between your loan balance andthe payoff amount). Your lender may forgive the debt, refuse to forgive the debt, require you to repay it, or say nothing at all about it.
  • Get a good price for your home: Getting a good sales price not only improves your chances of getting your short sale approved, but may also have other advantages. A better sales price reduces your shortfall which is the difference between your loan balance and payoff amount. Minimizing your shortfall may be advantageous for possible repayment, tax, liability, or other reasons. So do the best you can to improve your home’s marketability. Even if you don’t want to spend a lot of money for a short sale, you can still make your home ready and available for showings by cleaning the house, getting rid of clutter, putting away personal items, making minor repairs, and doing yard work. Ask your REALTOR® for other suggestions to improve the marketability of your home.
  • Get a good buyer: Your ideal buyer may be someone who will wait patiently until your lender approves your short sale and, as soon as that occurs, the buyer will quickly perform to close the deal. These qualities are admittedly difficult to prescreen for, but do the best you can. Before entering into a sales contract with a prospective buyer, you may ask to verify his or her ability to buy, such as a loan prequalification or approval letter, credit report, and source of down payment and closing costs. You’re better off asking upfront than to be surprised later in the process by your buyer’s inability to obtain a loan or otherwise perform. You may also try to negotiate favorable contractual terms for yourself, such as a meaningful good faith deposit from the buyer, a substantial down payment, and reasonable time frames for your buyer to inspect the property, obtain financing, and close the transaction.
  • Submit a complete short sale package: A short sale request typically involves a lot of paperwork. You may greatly expedite the approval process by providing your lender with a complete short sale package containing all the required information and documentation in an organized manner. Getting paperwork to the lender piecemeal is likely to cause delays.
  • Be patient but persistent: Once you’ve submitted your short sale request to your lender, waiting for a response may be one of the most frustrating aspects of a short sale. The short sale process can take a few weeks to a few months. Patience and persistence may help you get through that waiting process.
  • Avoid scam artists: Be wary of scam artists who prey on distressed homeowners hoping to dupe you out of your money and property. As one homeowner who fell victim to a foreclosure-rescue scam said, “When you’re down and out you’ll believe anything.” Watch out for the common signs of a scam, such as someone who asks for money upfront, asks for you to do something immediately without delay, or gives you an unqualified promise to stop foreclosure or other assurances. Also watch out for new types of scams that crop up every day.

Short Sale Process

As if selling a home is not hard enough, many California homeowners face the added challenge of selling short. To do a short sale, you have to find a buyer and convince your mortgage lender to accept a loan payoff of less than what you owe. A short sale can get thorny and complicated, but understanding the process will help you manage your expectations and improve your chances of success. To get you started, here’s a brief overview of the typical, traditional short sale process:

STEPS DESCRIPTION
Hire a REALTOR® The first step in the short sale process is to hire a REALTOR® to represent you in selling your property and negotiating with your mortgage lender. Your REALTOR® may meet with you to preview your property, discuss your particular circumstances, and offer different strategies as how to best proceed.
Contact Your Lender You may authorize your listing agent to contact your mortgage lender on your behalf to determine the lender’s short sale requirements. Many lenders require that you enter into a contract to sell your property before submitting your short sale request, but there may be a growing trend for lenders to pre-approve short sales.
List Your Property For Sale You may maximize your marketing efforts by listing your home for sale with your REALTOR®. Getting a good price and a good buyer for your property helps to ensure your lender will approve your short sale request. Your REALTOR® may help you to, among other things, get your property ready for showings, advertise and market your property for sale, conduct open houses, and interface with prospective buyers and their real estate agents.
Enter into Sales Contract If a buyer is interested in purchasing your home, the buyer will write an offer to purchase which you may accept contingent upon, among other things, your mortgage lender’s approval of a short sale.
Submit Request to Lender You may prepare a short sale package for submission to your lender. A short sale package generally includes information about you, your financial situation, your property, and your sales transaction. Your lender may require you to submit a hardship letter explaining the reasons you are unable or unwilling to repay your mortgage loan. You may have to obtain a short sale approval from any creditor with a security interest in the property you are selling (such as first trust deed, second trust deed, judgment lien, or federal tax lien).
Obtain Short Sale Approval After you’ve submitted your short sale request, the lender’s response generally takes many weeks to many months. If your lender approves your short sale request, carefully review the terms and conditions of that approval. The short sale approval may have an expiration date. Also, some lenders may agree to release the real property as security for their loans, but not to release the seller from personal liability for the underlying unpaid debt.
Perform on Sales Contract Depending on your agreement with your buyer, you may arrange to notify the buyer of the short sale lender’s approval before the buyer starts to perform on the sales contract by, among other things, submitting the good faith deposit into escrow, getting the property inspected and appraised, obtaining financing, and proceeding to close escrow.
Close Escrow Towards the end of your transaction, you will generally go into the escrow office to transfer title of the property to the buyer. In the meantime, the buyer goes into escrow to deliver the funds for the down payment and closing costs and sign loan documents for the funding of the buyer’s loan if any. The sale is consummated and the escrow officer disburses all funds accordingly.

Copyright© 2010 CALIFORNIA ASSOCIATION OF REALTORS® (C.A.R.). The information contained herein is believed to be accurate as of May 24, 2010. It is intended to provide general answers to general questions and is not intended as a substitute for individual legal advice. Advice in specific situations may differ depending upon a wide variety of factors. Therefore, readers with specific legal questions should seek the advice of an attorney. Permission is granted to C.A.R. members only to reproduce this material for non-commercial purposes (personal use and to distribute to clients). C.A.R. members must reprint the material in its entirety, but may add their own names and contact information where specified.

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