Short sales, tall benefits

REThink Real Estate

By Inman News Feed
Add Comment Add Comment | Comments: 0 | Posted Dec. 16, 2010

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REThink Real Estate

Tara-Nicholle Nelson
Inman News™

Q: Would you let me know what the benefit of doing a short sale is? --Linda

A: Whether there are benefits to doing a short sale, and what they are, depends on a number of factors, including whether you are buying or selling, where you are located, and the specifics of your personal finances and situation.

For clarity's sake, let's start with a definition: A short sale is a home that is being sold for less than the payoff amounts owed at the time of sale to all outstanding mortgage holders and lien holders. More simply, to "short sale" a property is to sell a home for less than is owed on it, with the permission of all entities and persons who hold loans or liens that are secured by the property.

The way your question is phrased leads me to suspect that you are a seller, but I'm not 100 percent sure, so let's talk quickly about benefits of buying a short sale as a buyer. There are really very few.

For a buyer, the primary motivation for buying a property that is a short sale is that the particular home desired has more loans and liens on it than will be paid off by the purchase price (and the sellers cannot or will not make up the difference).

It is not necessarily, or even usually, the case that short sales reflect a discount from the fair market value of the home to the buyer; the discount that gives rise to the "short" moniker is actually a discount to the seller from the amount they owe.

For buyers who are concerned that they may not receive absolutely clear title when they purchase a foreclosed home, due to bank problems with processing foreclosure documents, the short sale does offer the advantage of all parties -- bank, buyer and seller -- agreeing to the transfer of title, rather than the title being forcibly taken by the bank via foreclosure.

This is a small or illusory advantage, though; given the fact that short-sale approvals by banks can take anywhere from six weeks to eight months, with no certainty that they will actually close, the advantage to a buyer of doing a short sale arises almost entirely from the ability to secure a particular home the buyer wants very badly.

Also, in some markets, many of the homes on the market are short sales, so there's not much of a choice on the buyer's part.

For sellers, though, there are many more factors at play. To begin with, usually a short sale is being considered only by a seller who owes more on the home than it is worth, who has come to the conclusion that he can no longer afford to keep the home for whatever reason, and is resigned to selecting between letting the home go back to the bank via foreclosure or selling the home via a short sale. So, let's look at the pros and cons of short sales in the context of comparing them with foreclosures.

At the dawn of the housing crisis about four years ago, the conventional wisdom was that short sales were less injurious to the sellers' credit scores than a foreclosure, and that's why many sellers decided to go the short-sale route.

Since then, though, the FICO score algorithm has been revised and we've seen the credit effects of many more short sales AND foreclosures than we had before; the consensus among industry insiders is now that short sales and foreclosures cause roughly equivalent credit score damage -- especially since banks have a tendency to mostly approve short sales on accounts that are in default, or behind on their mortgage payment.

As a result, most successful short sales incur credit damage not just from the short sale, but also from multiple late mortgage payments, similar to a foreclosure.

For purposes of income taxation, both foreclosures and short sales involve cancellation of debt income, which is normally taxable by the federal and most state governments. Currently, though, the Mortgage Debt Forgiveness Relief Act of 2007 exempts homeowners from incurring federal income tax when they divest of their homes through either foreclosure or short sales through 2012; most states have a similar rule, so there's no advantage (or disadvantage) to a short sale there.

There are really two significant, possible advantages to selling your home via short sale vs. letting it go to foreclosure, as I see it. The first is that with some loan products, the post-short-sale waiting period before you can qualify to buy another home may be shorter than the post-foreclosure waiting period.

There are lots of caveats and exceptions, but on an FHA loan, some short-sale sellers -- namely those who are not behind on their loans at the time of sale, a small population indeed -- may be eligible for a new loan immediately after their short sale closes.

For conventional (i.e., non-FHA) loans, one most common guideline requires a two-year waiting period following a short sale or deed-in-lieu of foreclosure (more on the deed-in-lieu in a moment), compared with a seven-year post-foreclosure waiting period for conventional loans.

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