The lender can forgive the remaining debt between the sale price of the home and the balance on the mortgage. The short sale can save your credit score as your credit history will not reflect a foreclosure.
The forgiven amount of debt must be reported on your federal tax return. However, under the Mortgage Forgiveness Debt Relief Act of 2007 you may exclude the forgiven amount when calculating the federal taxes you owe. Contact the irs.gov for more information about the Mortgage Forgiveness Debt Relief Act of 2007.
In some cases the IRS may still consider the forgiven debt as income. It is best to consult an accountant or tax attorney to figure out the federal tax issue. Some lenders will pursue you for the difference between the amount owed on the mortgage and the amount paid through the short sale.
Your mortgage contract may include a provision for the lender to sue you for any deficiency after a short sale is completed. You or an attorney should review your mortgage contract to determine if there is a deficiency clause. If so, the lender can get a judgment against you to collect the deficiency.
If your contract contains a deficiency clause request the lender waive its right to a deficiency judgment. The lender may readily agree because of your financial situation. It would make no sense for the lender to sue you for something you clearly do not have.
The lender can issue you a 1099 instead of pursuing a deficiency judgment. A 1099 would allow the lender to write off the deficiency as income to the homeowner. For example: The mortgage balance owed is $300,000 and the lender agrees to a short sale of $250,000. The deficiency balance is $50,000.
The lender gives the homeowner a 1099 for the deficiency of $50,000 as if the homeowner actually made $50,000 (the short sale amount). Keep in mind the lender cannot pursue a deficiency judgment and issue a 1099. They can only do one or the other, not both.
The Mortgage Forgiveness Debt Relief Act of 2007 may provide relief from you having to claim the deficiency as income. Under this Act, the homeowner can exclude certain cancelled debt on principal residence from income. The amount of debt forgiveness from a lender can be up to $2 million.
The short sale is not always an easy process. Not all lenders will accept a short sale if foreclosure would bring them more money. It may take several calls to your lender to get to the right person to make a decision about a short sale. Always ask for a supervisor or manager as you want to speak directly to a decision maker and simply not a representative.
You may have to submit a hardship letter along with your financial information to be approved for a short sale. If you have to submit a hardship letter, fully explain your financial situation. Explain your loss of income, employment, disability, illness with you or a family member, divorce, even death of a spouse.
Be prepared to submit your financial information, including income and asset disclosure. If you have no money in your stocks, mutual funds, retirement, savings or money market accounts, that may be a blessing in disguise. At least the lender can see you are not hiding money and assets. Be honest about your finances. Less is better in this case.
Submit real estate comparables or appraisals showing your house and other homes in the immediate area are declining in value or not worth as much as you owe. You want to make a good case to sell your home for less.
Once you get a solid offer and submit it to the lender be prepared for the lender to renegotiate some of the terms of the agreement. They want to give as little as possible on the contract, including commissions to your real estate agent.