Masterpiece Realty’s Short Sale Guide
Will the Mortgage Forgiveness Debt Relief Act of 2007 be Extended?
As of this writing there is no definitive answer to this question. The Act is due to expire on December 31, 2012. President Obama’s FY2013 budget proposal includes an extension of the Act, however in the current political environment there is no guarantee that this budget or any other form of extension will be adopted. This means that for those eligible under the Act for relief from the income tax consequences of the cancellation of debt resulting from an approved short sale the time is very short to get a property listed and sold with short sale approvel. For a further explanation of the Act see the separate discussion below.
Short Sale Overview
Short sales will continue to be a significant market segment for the foreseeable future. A property owner who is “upside down” or is having difficulty making their mortgage payments has a number of options including the following:
- Loan modification
- Participation in government sponsored programs such as HAMP
- Hang on and wait out market
- Deed in Lieu of Foreclosure
- Short Sale
Among the factors to be considered are the following:
- The current value of the property
- Current loan balances
- Are the loans recourse or non recourse?
- California anti deficiency laws
- Nature of the homeowner’s hardship
- Is the property the owner’s Primary Residence as defined by law?
- Tax consequences (Form 1099C cancellation of debt issue)
- Short and long term impact on credit
- Short and long term impact on ability to purchase a home in the future
- Eligibility for participation in HAFA program
Although lenders vary somewhat most of them require the following documents to be included in their Short Sale Package:
- Hardship Letter
- 2 years of Tax Returns
- 2 months of Bank Statements
- 2 most recent Pay Stubs (If self employed a Profit & Loss Statement for the most recent year)
- Fully signed Purchase Agreement
- Estimated Closing Statement (HUD-1) showing net amount to be received by Lender or Lenders
The short sale approval process is comprised of at least the following 3 stages:
- Information gathering consisting of obtaining the documentation listed above and also obtaining either an appraisal or a Broker Price Opinion (BPO) indicating the fair market value of the property
- Assignment to a negotiator or underwriter who performs the following tasks: sometimes asks for more information or documents; makes counter offers if the price in the Purchase Agreement is less than the appraisal or BPO; and makes final recommendation to the underlying investor (i.e the owner of the loan)
- Final approval or decline of the short sale by the investor.
A common perception in the current real estate environment is that buyers can get a bargain by purchasing a short sale property. Although this is quite often the case there is a mitigating factor based on the fact that the loan servicing provider who handles the short sale must answer to the underlying investor and show that the short sale was approved at or close to the property’s fair market value. This is done by obtaining either an appraisal or a broker price opinion (BPO).
For sellers, buyers and real estate agents valuation disputes can arise based on the following type of scenario: A short sale is submitted for approval at a price of $500,000. The short sale lender’s appraisal or BPO (commissioned by the loan service provider) comes in at $575,000. Either the current buyer has to come up to the $575,000 price or the seller and their agent have to find another buyer willing to do so. Where this cannot be done because the $575,000 value just isn’t there a valuation dispute arises which the seller and their agent have to try and resolve with the short sale lender.
The cause of “over valuation” by short sale lenders can be based on a number of factors which can include the use of an out of area appraiser or broker not familiar with the market where the subject property is located and\or the use of simplistic per square foot comparable sales (“Comps”) with out giving consideration to factors such as condition, upgrades, views, noise and nuances about location.
In order to dispute the lender’s valuation the seller’s agent needs to submit a “brief” which includes the following elements where applicable:
- At least three valid current Comps including MLS sheets
- Discussion of any and all negative factors concerning the subject property such as condition, lack of upgrades, yard size, street noise, and the need for repairs.
- Supporting documentation regarding negative factors such as pictures inspection reports and repair estimates.
The goal is to make the lender understand that if they fail to approve a short sale at a reasonable price based on all of these factors and choose to foreclose they will be stuck with these conditions in their efforts to resell the property after it becomes REO.
An effective presentation of valid arguments as to the proper value of the property can often lead to the successful closing of a short sale transaction.
Are Short Sales Getting Easier?
It depends who you ask. Brokers who handle a lot of short sales each have their own anecdotal experiences and short sale war stories. Masterpiece Realty Associates has successfully closed dozens of short sales and I can report that generally speaking the system has improved considerably from what it was in past years. A combination of learning curves within both the lending and brokerage communities has been helpful plus many lenders have streamlined their procedures but problems persist including the following:
- Many lenders can still take way too long to process short sales.
- This creates ironic situations where after a 45-60 day delay by the lender they say the seller’s documentation such as bank statements are outdated and have to be updated
- The most serious impact of delays is that buyers run out of patience and cancel on the eve of lender approvals or even after approvals
- Lenders vary as to the procedure for substituting buyers in these situations. Some require that the process virtually start over whereas others allow the substitution of a new buyer with relative ease.
- Junior lenders can be uncooperative and often ask for more money than the 1st Lien Holder is willing to allocate to them thus creating an economic gap which sometimes results in the buyer having to come up with more money if they want to move forward with the transaction.
The Equator system which is used for gathering information and processing short sales is used by Bank of America, Wells Fargo Bank and a few other lenders. Equator has continued to improve but there are still occasional glitches.
The message here is that short sales require patience and persistence and above all competent parties handling both sides of the transaction.
Mortgage Forgiveness Debt Relief Act of 2007 to Expire on December 31, 2012
It is very important for a Homeowner considering a Short Sale and who might be eligible for relief from the income tax consequences of the Short Sale to initiate the process as soon as possible in order to close escrow prior to December 31, 2012, at which time the Mortgage Forgiveness Debt Relief Act of 2007 will expire.
A Short Sale or Foreclosure can have adverse income tax consequences under certain circumstances. Where debt has been forgiven (i.e. cancelled) as a result of an approved Short Sale the lender will send the Homeowner a Form 1099C stating the amount of debt that has been cancelled. To avoid taxation of cancelled debt the taxpayer must be eligible for an exemption. The primary available exemption is under the Mortgage Forgiveness Debt Relief Act of 2007. To qualify for this exemption the loan in question must be a Qualified Principal Residence Indebtedness which is defined as a loan used to buy, build or substantially improve a principal residence and be secured by that residence. Refinanced debt proceeds used for the purpose of substantially improving a principal residence also qualify for the exclusion. Proceeds of refinanced debt used for other purposes – for example, to pay off credit card debt do not qualify for the exclusion. More information about this law is available on the IRS Website.
IMPORTANT DISCLAIMER: Homeowners should always consult directly with their own tax adviser regarding any and all tax consequences of any real estate transaction. There are other exclusions available relating to Insolvency and Bankruptcy
HAFA Short Sales
The Home Affordable Foreclosure Alternatives (HAFA) Short Sale Program provides incentives for those who qualify and participate as follows:
- $3,000 to the Homeowner at COE
- $1,500 to the loan servicer
- 6% of the outstanding balance not to exceed $6,000 to the 2nd Lien Holder
- Reimbursement to the 1st Lien Holder of 1/3 of the contribution to the 2nd Lien Holder not to exceed $2,000.
To qualify for the HAFA Short Sale Program the Homeowner must meet the following requirements:
- Live in the home or have lived there within the last 12 months
- Have a documented financial hardship
- Not have purchased a new home within the last 12 months
- Have a outstanding balance on their first mortgage of less than $729,750
- Obtained their mortgage on or before January 1, 2009
- Not have been convicted within the last 10 years of felony larceny, theft, fraud, forgery, money laundering or tax evasion in connection with a real estate transaction.
The 2nd Lien Holder is not required to participate in the HAFA Program but many do especially where the same lender holds both the 1st & 2nd Mortgages.
Eligible homeowners faced with a short sale are well advised to take advantage of the HAFA Short Sale Program
For consultation with regard to these factors and in order to make an informed decision please contact Peter Lewi at 858.525.3256 or fill out the form below: