Tucson Short Sales - Part 2 - I Am Ready to Short Sale My Home.. What Are The Repercussions?

This is part two of my Tucson Short Sales series. If you haven’t read part one (Tucson Short Sales - Part 1 - What are Short Sales?) please read it first for the proper background.

In this article of the series we will go over the ramifications of a short sale. Keep in mind that you should not go ahead with this decision lightly and I would recommend exhausting every other possible avenue before considering a short sale. Also keep in mind that I am not an accountant, a lawyer, or anything other than a Realtor.

Alright, here we go. You’ve called up your accountant, talked to your lender (or tried to), asked your Realtor for advice, asked your friends and family for advice, and you haven’t had much luck. You’re upside down on your mortgage and/or you can no longer afford your mortgage and/or your job is transferring you and/or you’re PCS’ing to another base. The truth there is there are many possible reasons why you may be considering a short sale. Here are the issues we will be going over:

1. Credit Impact
2. Tax Implications
3. Personal Liability

Credit Impact

This is the first question to pop into many homeowners’ minds; Will my credit be affected? The short answer is: YES! A short sale is reported differently then a foreclosure to the credit bureaus but can still result in a 200 to 300 FICO score decline.

Now keep in mind, we are assuming the homeowner doesn’t have the assets to cover the difference between their mortgage and whatever they are able to sell their home for. These assets can include: 401k, IRA, Money Market Accounts and Mutual Funds. If you can come to the closing table with a check to cover the difference then there will be no issues at all!

After a short sale your credit report will show a “settled for less than owed” connotation which essentially prevents you from getting any sort of loan for a 24 month period. Fannie Mae recently changed their guidelines for lending to previous short-sale homeowners in the wake of the recent credit crunch. Effective June 1, 2008, for loans to be considered by Fannie Mae from any potential borrowers their credit history must be cleared from any foreclosure activities for at least 5 years. And after those five years, a borrower would have to have a Fair Isaac Corp. (FICO) credit score of 680 and put 10 percent down.

National trends suggest that banks are becoming more willing to negotiate new terms with homeowners facing foreclosure, so please call up you bank if you are having trouble making payments!

Tax Implications

The tax implications in a short sale are actually quite complicated and exist in several layers. We will begin by discussing federal income tax implications. Let’s say you bought your house for $200,000 three years ago. You now owe $195,000 but it is only worth $165,000 and you short sale the home.

Now, the bank has a couple of options here. One is to sue you for the difference ($30,000). If you can’t pay this difference your credit is hit with a “deficiency judgment” which hurts it even more (in addition to the short sale.

Another option is for them to choose not to sue but instead to claim a “tax write-off” of the $30,000. But in the eyes of the IRS the $30,000 difference between what you owe the bank and what you paid the bank (from the proceeds of the sale) is seen as “phantom income“. The IRS would actually kick the homeowner while they were already down, forcing them to pay income tax on $30,000. Assuming a tax bracket of 25%, that is a whopping $7,500!

Fortunately for homeowners, in December 2007 President Bush signed into law IRS Revision Bill HR3648. In a nutshell, this bill removes the tax liability from the homeowner in the event of short sale. In addition, this bill also extended the tax deductibility of Mortgage Insurance through December 31, 2010.

Also remember there may be further tax state implications. Check with your local state laws for further information.

Personal Liability

The amount of your personal liability depends heavily on several factors and here is the quick explanation:

A “non-recourse” loan is one in which the borrower does not have personal liability for the loan; the property is the collateral. A “recourse” loans is where the borrower does have personal liability for the loan.

What this means is, if you obtained a non-recourse mortgage and foreclose or short-sale the home, the lender cannot go after your personal possessions (car, boat, other homes, kids) to satisfy the debt. If you have a recourse loan, they can (except probably for the kids).

Now how do you know what type of loan you have? Go read your loan documents! It should be spelled out quite clearly. Here is an unofficial list of states that have non-recourse loan laws:

Alaska
Arizona
Arkansas
California
Colorado
District of Columbia (Washington DC)
Georgia
Hawaii
Idaho
Mississippi
Missouri
Montana (as long as non-judicial foreclosure is used)
Nevada - note that the lender CAN get a deficiency judgment
New Hampshire
Oregon
Tennessee
Texas (but even in a non-judicial foreclosure, the lender can pursue a deficiency judgment)
Virginia
Washington
West Virginia

The other thing to remember is that refinancing or second mortgages typically are not covered under non-recourse loan laws; check with you lender or loan documents for further clarification.

Summary

I hope the information I provided above is useful to some of you homeowners out there. Please keep in mind that these are merely guidelines to begin your quest for information, be sure to follow up with more qualified individuals.

In light of the magnitude of this issue I will be adding one more article to my Tucson Short Sales series, the outline will now be:

• Tucson Short Sales - Part 1 - What are Short Sales?
• Tucson Short Sales - Part 2 - I’m Ready to Short Sale My Home.. What Are The Repercussions?
• Tucson Short Sales - Part 3 - How to Short Sale My Home
• Tucson Short Sales - Part 4 - The Offer Is In To The Bank
• Tucson Short Sales - Part 5 - End Game Short Sales

If you would like to search the Tucson MLS for Short Sale, Bank-Owned, or Foreclosure homes, search my Tucson MLS or contact me for a comprehensive list.

If you would like assistance in avoiding foreclosure feel free to contact me for a no-cost consultation.

-> Trackback URL for this post <-