Myths about Short Sales

As a consumer, you should be aware of a few common myths about Short Sales. I see two common mistakes in the short sale process fairly consistently. I will cover the two mistakes in this post and then will address the tax liability portion in a subsequent post.

1. "The only way you can do a short sale is if you are delinquent on your payments. So, if you are current, please stop making payments."

Yikes! Are you cringing in your seat like I am? There are several issues lurking here. First, REALTORS are not Attorney's. This is legal advice. And the fact is YOU CAN perform a short sale when a borrower is current on their payments. The key component you need in a short sale situation is a hardship from the borrower. There can be several reasons for a hardship. Some examples are job transfers, death and loss of employment. A borrower should stay current, if they are able to. The shorting lender will make the determination based on their hardship, and future financial status. Staying current on the mortgage will not decrease your chances of the short sale getting accepted, in fact, it can tremendously help the borrower in the long run with less damage to their credit. Staying current can allow the borrower's credit to bounce back sooner rather than later.

So, the bottom line here is: Before you stop making your mortgage payments, consult an Attorney. The Attorney will advise the best course of action. And you can do a short sale if the seller is current.

2. "You will not be responsible for the deficiency (the amount that is owed verses what the lender receives in the short sale) on the short sale, because President Bush passed Mortgage Forgiveness Debt Relief Act of 2007."

Untrue, there are two separate issues here; it is often confused as one. First there is the deficiency. Second, there is the tax on the deficiency. We will cover one at a time.

The deficiency, again, is the amount that is owed verses what the lender receives in the short sale. The seller very well may be responsible for the difference in that debt. In general, there are three things that can happen with that deficiency. First, the lender will give what is called a Full Release, not to be confused with a Lien Release. A Full Release is the lender waiving their right to any further recourse to the amount that is owed. In this case, the seller is not responsible to pay back the difference.

Second, is a Lien Release, or what I like to call "leaving their options open". A Lien Release will allow the seller to sell the property because the lender will "release the lien", but does not release them from the liability of the deficiency. The lender may not specifically state what they are going to do about pursuing the borrower for that debt, but the lender has left the deficiency to be determined at a later date. This does not necessarily mean they will, but it means they can. Third, the lender may ask for a promissory note to be signed at closing, for the balance or for a portion of the balance. Upon payment of this promissory note, typically, the lender will then allow a Full Release to be given to the seller. In any case, always remember every lender is different. Even doing multiple short sales with the same lender can result in different scenarios. The loan is most likely serviced by that lender and owned by an investor. Each investor has a different set of guidelines the servicing lender needs to follow. So, shorting with the same lender may result in a different option for each seller. Please make sure the letter is shared with an Attorney. The seller's Attorney should review the results of the short sale approval and advise the seller on the pros and cons of the outcome.

The tax deficiency portion will be covered in a subsequent post.

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