Short Sales
How to Sell a House When It's Worth Less Than the Mortgage
A home with a market value that’s less than the principal left on a mortgage is “underwater.” Owning an underwater property can be problematic for multiple reasons, not least of which is the owner’s knowledge that they will be paying back more principal than they can receive by selling their home at current market value, and that interest is accruing based on the mortgage’s outdated and inflated valuation.
What Is a Short Sale, and When Will Lenders Approve One?
A short sale is when a mortgage company accepts the proceeds of a home sale at current market value and clears the remainder of the borrower’s loan despite the sale price being less than what was owed.
It’s called a “short” sale because the money paid to the mortgage company falls short of the full value of the mortgage. Homeowners who are underwater must formally request permission to conduct a short sale. If the lender approves, they will grant the borrower a deficiency waiver.
There are several reasons why a mortgage company might agree to accept less than what a homeowner owes to close out their debt. None of those reasons include charity, generosity or compassion.
Avoiding Foreclosure
The foreclosure process can take a long time and be expensive to pursue. The length of the foreclosure process is particularly problematic if home prices are still falling.
If local real estate prices are falling, every day a home isn’t sold equates to more money lost. The mortgage company would much rather the owner sell a house today for $400,000 than wait six months to foreclose on the house, at which point the home might only be worth $350,000.
This decision will be based on the comparison of the projected home sale price after foreclosure and the size of the loss the lender will take by waiving the remainder of the borrower’s debt after a short sale. The lender will also consider the borrower’s financial situation and the likelihood of them paying off their debt versus filing for bankruptcy or defaulting.
The mortgage company will pursue the option that allows them to minimize their losses. Homeowners who are underwater on their mortgage should not assume they will automatically be approved for a short sale and may need to be open to negotiating a solution with their mortgage company.
Loss Mitigation
Refusing to approve a short sale and deficiency waiver increases the likelihood the homeowner will take drastic, even illegal actions. Approving a deficiency waiver and allowing a short sale is more likely to prevent brash actions or damage to the property.
Tax Benefits
Mortgage companies that agree to grant underwater homeowners a deficiency waiver may qualify for tax advantages. Forgiving the remaining unpaid balance (deficit) of the debt qualifies as a loss, which can be deducted from the mortgage company’s taxable income. They can also “charge off” the forgiven portion of the mortgage, removing it from their financial statements as an asset.
Some mortgage companies and banks may also be entitled to regulatory credits for alleviating the financial distress of underwater homeowners.
The Tax Downside for Short Sellers
There are some potential tax consequences for underwater sellers who qualify for a short sale. The IRS considers the forgiven portion of your mortgage debt to be income, and that income may be taxable. The mortgage company that issues the deficiency waiver is required to file a Form 1099-C (cancellation of debt) with the IRS. However, some borrowers may be eligible for exclusions depending on their income or financial situation.
Can Anyone Who Is Underwater Qualify for a Short Sale?
No. A lender must approve a short sale and agree to issue a deficiency waiver. Homeowners can technically still sell their home for less than what it’s worth even if they are not granted a deficiency waiver, but they will still owe the entire mortgage amount to their lender.
The lender can exert far more influence than usual over the home selling process if a borrower pursues a short sale. The mortgage company is primarily concerned with maximizing the sale price since that will determine the size of their loss.
They will want to see a comparative analysis and appraisal to ensure the listing price accurately reflects current market conditions. It will be up to the lender to approve or disapprove the sale agreement, including not only the purchase price but also closing costs and any other concessions the seller makes to the buyer.
Home sellers should keep in mind that the mortgage company’s ultimate goal is to sell the home fast for as close to market value as possible. This means they may accept slightly less than the current appraised market price if it gets the sale finalized quickly before the home’s value drops any further.
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