If you’ve talked to any real estate agents recently, you’ve probably heard about the increase in short sales taking place. Surprisingly, there are people who short sale their home and are able to buy another home soon after. How is this possible?
If you’re finding yourself underwater in your mortgage, meaning that you owe more than what your home is worth, you’ve probably asked yourself the question “Should I short sale my home?”
It may be a difficult decision to make since it could affect your credit and potentially prevent you from getting another loan for several years. However, if you decide to go the short sale route with your home, now may be the best time to do so.
But before we go much further, let’s cover the basics.
A short sale occurs when you sell your house for less than your existing mortgage balance. This has to be done in collaboration with your lender (or lenders if you have a second mortgage with a different company). The lender has to approve any sale.
In 2008, the housing market crashed. Since then, property values have been steadily going up over time, but the market has definitely recovered faster in some areas than in others. That creates a problem if you want to sell your house and move on but don’t get enough out of this sale to pay off your mortgage.
A short sale is not a “get out of jail free” card. It’ll have some impact on your credit and could have an impact on your ability to get a future mortgage. However, it’s better than a foreclosure. We’ll get into some of this later on, but for now, let’s look at how a short sale works.
The first step is to contact your lender and explain to them that you need to sell your home for one reason or another but you know you won’t be able to get back the value of the mortgage balance. You and your lender will then talk about whether you’re qualified to do a short sale. Different lenders may have different standards.
The important thing to note is that the lender manages the sale. They have to agree to any sale, so the process can take some time.
Now that you know how a short sale works, let’s take the time to clear up a few misconceptions people have about short sales.
Myth: I won’t be able to buy another home for several years after a short sale.
Truth: In certain circumstances, you can get an FHA loan within three years of the short sale date.
If you want to qualify for an FHA loan, you can’t have been 30 days late on your mortgage or other installment payments (such as car and student loan payments) in the 12 months prior to the short sale date. Additionally, you can’t have been 30 days late on mortgage and installment payments in the year prior to application.
Guidelines are different for each mortgage investor. For example, you can’t get a conventional loan to buy another home for a minimum of four years, even if you’re current on all your payments.
Myth: I will need to pay income taxes on the forgiven mortgage debt.
Truth: While you’ll probably pay taxes, it’s not black-and-white.
The difference between the amount of the short sale and your actual mortgage balance is considered forgiven debt. The IRS considers this forgiven debt income and, in most situations, you’re taxed on it. However, there are exceptions.
It’s always wise to consult your tax advisor before making any tax-related decisions.
Myth: My credit will be ruined if I short sale my home.
Truth: Your credit score will suffer as a result of a short sale, but the impact is different for everyone.
There isn’t a sure way to know exactly how much your credit score will suffer if you short sale because there are many factors that determine your score. Generally speaking, if you’ve never been late on a payment (credit card, mortgage or car payment, for example), then your credit score will decrease as a result of a short sale but not as much as if you had missed payments.
Also, the way that the bank reports the short sale to the credit bureaus will make a difference in the severity of the impact on your credit score. This is why it’s very important that you understand the lender’s terms before you agree on how the mortgage loan will close and be reported to the credit bureaus. If your mortgage lender reports that your mortgage has been paid in full, then your score won’t be hurt as much as if it were reported as “settled for less than full balance.”
All these guidelines mentioned above could change at any time. Consulting a tax advisor, real estate agent and an attorney before making a decision will help you make a more educated decision.