What is a "Short Sale"?

When real property is sold for less than the amount owed on the loan(s) against the property it is called a “short sale.” It is called this because the proceeds of the sale are “short” of the full amount needed to pay off the loan(s) which are secured by a lien against the property. Lender approval is therefore essential for a short sale to successfully close escrow because the lender(s) must agree to accept less than the full amount owed to them and release their liens. Legally, a short sale approval letter is essentially a debt settlement agreement between the lender(s) and their borrower(s).

How long does it take for a lender to approve a short sale?

It is our experience that short sale approvals generally take between three to four months from date of submission of all documents to the lender to issuance of an approval letter from the lender. However, the length of time may vary from as little as one month to as much as one year depending upon the specific lenders involved, number and type of liens against the property, and complexity of each homeowner’s particular circumstance.

Why does it take so long to complete a short sale?

Lenders are currently overwhelmed with both loan modification and short sale requests. They simply don’t have the staffing and resources to efficiently handle such a large volume of requests. The short sale process itself consists of brief periods of activity followed by long periods of waiting for a lender to take action or make decisions at each step of the process. Another reason is because the loan servicers are often not the owners of the loan but simply servicing the loan on behalf of the investor who actually owns the note. As a result, servicers must obtain final approval of the short sale terms from the investor, which can cause additional delays.

What is a “deficiency”?

A “deficiency” in a short sale refers to the difference between the balance owed on a loan and the pay off amount received by the lender from the proceeds of the sale. This difference is the amount the sale proceeds are “deficient” in paying off the total amount owed on the loan.

Will I be responsible for any “deficiency” amount after the short sale closes escrow?

Whether a lender can justifiably retain legal rights to collect a deficiency after a short sale depends upon a number of factors, such as the state where the property is located, the priority position of the loan (first or second), the character of the loan (recourse or non-recourse), the nature of the property (residential or non-residential), type of ownership (owner occupied or non-owner occupied), and what method of foreclosure the lender pursues (judicial or non-judicial). This is why it is critical to have legal representation in a short sale.

However, for California residents, the answer to this question has become much easier now that SB 458 went into effect on July 15, 2011.  Under the new law, any lender, regardless of priority position of the loan, who approves a short sale in writing on a residential property, is barred by law from pursuing collection of any deficiency amount remaining after the short sale closes escrow. If you are represented by the Rasmussen Law Firm, we will ensure the lender complies with this law.

What is the difference between a “recourse” and “non-recourse” loan?

A “recourse” loan means that in the event of a default the lender has recourse against the borrower personally to make good on the balance owed, not just foreclose on the property. If a loan is recourse, the lender will generally retain the right to pursue collection of any deficiency after the short sale is completed. Refinanced loans, equity loans, and lines of credit are typically recourse loans.

A “non-recourse” loan means that in the event of a default, the lender can only foreclose on the property securing the loan. The lender cannot pursue the borrower personally for any deficiency balance. Loans used to initially purchase a residential property in California that are occupied by the purchaser are “non-recourse” loans.

The good news for those with property in California is that if a foreclosing lender uses a trustee’s sale to foreclose on a property (as opposed to a judicial foreclosure) they cannot seek any deficiency on that loan even if the loan is recourse. However, as to any other loans secured by the property, those lenders can pursue a deficiency after foreclosure if it is a recourse loan.

Why should I do a short sale instead of just letting the lender foreclose on the property?

A short sale is generally a better option than a foreclosure for two primary reasons: (1) a short sale is much less damaging to your credit rating than a foreclosure, and (2) a short sale will result in any deficiency amount remaining on your loans being forgiven. This is not the case in a foreclosure. A non-foreclosing lender with a recourse loan will still have the legal right to pursue a deficiency judgment against you after a foreclosure.

Can my lender demand a cash contribution or promissory note as a condition of approving a short sale?

For California properties, the answer is now no thanks to the enactment of SB 458. Under the new law, lenders cannot demand cash contributions or promissory notes from sellers as a condition of short sale approval.

What are the tax consequences of completing a short sale?

The answer to this question can be complicated and we recommend that you consult with a tax professional regarding the tax implications for your particular circumstances. As a general rule, any time secured debt over $600 is forgiven or cancelled after a foreclosure (unless debt is non-recourse) or a short sale, the lender must issue to the borrower and the IRS a Form 1099-C that reports the amount of cancelled debt.

In general, cancelled debt is treated as taxable income to the borrower. However, the federal government has enacted the Mortgage Forgiveness Debt Relief Act of 2007, which exempts from federal tax up to $2 million (married/joint filing) in cancelled debt if it was used to buy, build, or substantially improve a borrower’s principal residence. This law stays in effect through the end of 2012. The State of California has also enacted partially conforming legislation for state income taxes through the end of 2012 as well. The Conformity Act of 2010 limits the qualified principal residence indebtedness to $800,000 (married/joint filing) with an exemption for cancelled debt taxation of up to $500,000.

What is the impact to my credit rating from doing a short sale?

Generally, a short sale is reported to credit agencies as “debt settled for less than full amount owed.” While this is a negative credit mark, it is not nearly as devastating as a foreclosure. A short sale on your credit could allow you to repurchase a home within two years. It may take at least five years to qualify with a foreclosure. Late payments will also fall off your credit record within two years. If you continue to pay all your other debts on time, your credit score will improve considerably within this same time frame.

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