Is a Short Sale Right for You?

March 3, 2011

If you want to sell your house, and the amount you owe plus the costs of sale are more than it’s worth, then you will be faced with the choice of attempting a short sale or bringing in the cash to close.  Despite the fact that San Francisco home values have held up much better than in other areas, this was the case for about 30% of my business in 2010.  So if you find yourself considering either of these scenarios, you are not alone.

If you are in the position to upgrade your home or investment property, it can be a great choice to sell a lower value property at a loss and obtain a more valuable property.  This is called trading up in a down market and it makes sense because x% off a lower price is less than x% off a bigger price.  But for those who are faced with the need to simply exit the market entirely due to job change, job loss, divorce, a mortgage they can’t pay or neighbors they can’t live with, the market being down does not have the same silver lining.

If you have the cash to bring in, the process is the same as a straight-forward, normal sale, albeit more painful.  In some cases, you can even write the loss off your taxes.  If you don’t have the cash, though, you will need lender approval and a good explanation of hardship to get the short payoff approved by the lender.  The forgiven debt is considered potentially taxable income by the state and federal governments.  The good news is that under the Mortgage Debt Relief Act of 2007, the Feds are not collecting taxes on mortgage debt forgiven in 2007 through 2012 up to $2 million for a couple filing jointly and that under the Conformity Act of 2010, California is doing the same for debt forgiven up to $500,000, with partial tax relief up to $800,000 of debt forgiven.  Especially with San Francisco’s fairly low value declines, these exclusions will protect most people needing to sell their homes short in our market.

In approving a short sale, the lender can either forgive the debts or reserve the right to recover the monies at a later time.  The lender’s decision-making on this will be driven by the level of hardship the borrower is experiencing and whether the loans were recourse or non-recourse at the time of borrowing.  Loans used for original purchase are generally non-recourse, meaning that the property itself is the only security for them.  Many other loans, especially those that were called “home equity lines of credit,” obtained through refinancing may have recourse to the borrower personally.  This has not been a factor in the short sales I have done since 2007, and SB931 passed in August 2010 has converted all 1st mortgages in California to non-recourse even if they were the result of a refinance, but it does sometimes come up.  It’s important in this case for the borrower/seller to be very clear on whether the debt is being forgiven entirely or not and to get legal advice regarding this issue before finalizing a short sale.

The first steps are in deciding whether to list your home for sale as a short sale are to 1) talk to your Realtor about whether your value really is short based on recent comparable sales, 2) talk to your legal and tax advisors about all the potential consequences; and 3) determine if you have a hardship likely to be approved by the lender.  Examples of acceptable hardships are reduced income, increased expenses, relocation, marital difficulties, death and combinations thereof.  People who just don’t want to pay the mortgage because their house is “underwater,” may not make the grade.  If you have a home you can live in and you can afford the payments, you are not a good candidate for a short sale even if your home’s value is lower than the mortgage balance.

Once you have decided to sell your home short, it pays to list with a Realtor who is experienced in them and has a good track record of closing their short sales.  I recommend to my clients that they market the home as if it were a regular sale in terms of presentation and quality of marketing and that they do a full marketing period so that they can show the bank they really tried to maximize the value.  I have found that this works and also results in having a buyer in contract motivated enough to follow the process all the way through.  This is no small issue as it is taking a minimum of 90 days and as long as eight or nine months for some short sales to close.

I tell my clients that they can either pay with money or aggravation and time.  Many people – especially buyers – think they want to pay with aggravation and time, but about half way through they’re no longer sure!  No matter how good your Realtor, getting a short sale closed is rarely hassle free.  There can be stressful negotiations with the banks right up to the end about the terms and who is going to pay exactly what, but success can be achieved through the careful blending of patience, tenacity and information.