While the real estate market in Colorado purportedly is showing signs of life, there still are thousands of homes in foreclosures and/or on the market for short sales. Although a short sale is surrounded by complexities and mystifies homeowners who are not familiar with the process, there is no question that short sales, although not for everyone, have some substantial advantages over allowing a home to go though the foreclosure process.
Simply defined, a short sale is one in which the lender, usually a bank, is willing to extinguish a deed of trust or mortgage for an amount less than the balance due on the loan. For example, if the balance on the loan is $200,000, and the lender is willing to cancel the note for $150,000 more or less, provided the seller finds a buyer willing to pay the reduced amount. A lender will do this because accepting a lesser amount often is more economical than shouldering the expense of a foreclosure and then pursuing a deficiency which it almost never gets. In addition, the amount that the lender gets from the short sale is often more than it would receive from a foreclosure, once all of the foreclosure costs, sales commissions and other expenses are subtracted from the often laborious process of selling the property.
For the struggling homeowner, a short sale has less of an impact on the homeowner’s credit score than the devastating effect of a foreclosure. In addition, depending on the nature of the short sale and the deficiency accrued by the homeowner, the homeowner may be eligible to purchase another home in anywhere from two to four years; where it would take some seven years if the bank takes the home back through foreclosure.
The homeowner would be wise to consider a short sale before falling too far behind on his mortgage payments, since the consequence of default on the mortgage payment will sometimes outweigh the benefits of a short sale.
Unfortunately, a short sale is not necessarily an easy road to redemption, especially for the buyer. A buyer looking to purchase a property at a bargain price may have to be somewhat flexible in order to learn if a significant price reduction will be accepted by the bank, since no short sale can occur without the lender’s approval. This can take anywhere from a few months up to a year,. A person who needs a home within a certain time period would be better off going in another direction.
Additionally, the Colorado Real Estate Commission requires that all short sale contracts contain a short sale addendum which allows either party to cancel the contract at any time for any reason. This takes away the certainty that the contract will indeed close, and essentially nullifies the inspection clause of the contract since short sale lenders generally require that the property be sold “as is.” On the other hand, a property in foreclosure is often in far worse condition than a property subject to a short sale, since the owners attempting the short sale are generally still living in the home.
One major advantage of a short sale and even a foreclosure is the recent extension of the Mortgage Forgiveness Debt Relief Act of 2007. Before the act was passed, an individual completing a short sale may get forgiveness of the difference between the amount owed on the loan and the amount the bank is willing to take for the property. However, the bank was required to give the homeowner an IRS Form 1099, in which the Internal Revenue Service saddles the homeowner with ordinary income for the difference. In other words, if the amount of the loan is $150,000.00, and the amount the bank accepts is $100,000.00, the homeowner would end up paying income tax on $50,000. Under the Mortgage Forgiveness Debt Relief Act, that debt forgiveness becomes tax free, provided the home is the seller’s primary residence. While the act was scheduled to expire on December 31, 2012, the “fiscal cliff” compromise reached by Congress extended through January 1, 2014, the tax free aspect of the debt forgiveness. The Act also covers deficiencies created by foreclosure.
Because there are so many twists to a short sale, it is strongly recommended that a homeowner considering a short sale, either as buyer or seller, utilize the services of a competent real estate broker or attorney knowledgeable in the short sale market.