A short sale in Louisville happens when your home is worth less than the debt you owe on it. You ask the bank to accept less than the full payoff so the home can be sold without resorting to a foreclosure sale. A relative or an insider can buy the home, but you must prove the offer is the best price the lender will get. Homes at a foreclosure sale often sell at a commissioner’s auction for 30 to 40 percent below the assessed value.
A short sale works best when there is only one lien on a home that is worth less than the loan. With more than one lien, it gets much harder because second lien holders will want some of the sale proceeds.
Making a Reasonable Offer to the Lender
To make a reasonable offer, you show the lender you are offering more than it would collect at the auction. Past sales and current listings for similar homes give you the proof.
There is not always a clear advantage to a short sale unless you want to keep the home in the family and a relative is buying it. Selling through an agent is a lot of work that you do for free for the lender. Having a relative buy the home at the commissioner’s auction is often cheaper and simpler. This is sometimes called a white knight purchase.
How a Short Sale Affects Your Credit and Next Mortgage
A short sale hurts your credit less than a foreclosure. It is also a little easier on your credit than a bankruptcy. A foreclosure does more damage than a bankruptcy or a short sale.
How soon you can get a new mortgage depends on the loan program, not just your score. These are the general minimum wait times:
- After a short sale: about 3 years for FHA, about 2 years for VA, about 4 years for a conventional loan.
- After Chapter 7 bankruptcy: about 2 years for FHA, about 2 years for VA, about 4 years for a conventional loan.
- After a foreclosure: about 3 years for FHA, about 2 years for VA, about 7 years for a conventional loan.
So a short sale does not let you buy again sooner than bankruptcy. On an FHA loan, bankruptcy is the faster path. Lenders can add stricter rules on top of these minimums.
There is one rule you cannot get around. When a borrower does not repay in full and on time, that borrower becomes a higher risk. A higher-risk borrower does not get the lowest rates or the best programs. If someone claims they can erase this, they are likely trying to scam you.
The Issues That Complicate or Improve a Short Sale
Servicers often prefer a loan modification that lowers the rate. To get a short sale approved, you must prove your offer is the highest price the lender can get. Past sales and current listings show this.
To sell, you must give the buyer clear title. A second mortgage or lien makes this harder, because then two lenders must accept your offer. The first mortgage has little reason to share with the second. The second mortgage often refuses unless it gets more than a foreclosure would bring it.
What Makes a Lender Accept a Short Sale?
The hard part is convincing the lender to take less than payment in full. Filing bankruptcy and listing the home as worth far less than the loan can help. It shows the lender you will not keep the home. The lender then faces the cost and delay of foreclosure, or it can take the quicker short-sale offer. The home keeps showing as bad debt until the matter is resolved, which costs the lender too.
When a Short Sale Still Leaves a Deficiency
Most lenders will agree there is no deficiency in a short sale. However they will still issue a 1099 and claim a tax deduction for the loss. A short sale does not eliminate a possible tax debt. It means the lender agrees not to chase you for the deficiency. If you do not get this promise in writing, the lender may sell the debt. A debt buyer may still sue you for the deficiency.
Watch the fine print. Some local lenders, including Fifth Third and BB&T, ask the borrower to sign a new unsecured note for the deficiency. They can then sue on that note later.
If there is a second mortgage or judgment liens, those parties must also agree to release their liens. Sometimes there are so many liens that getting everyone to release is almost impossible.
Bankruptcy can help here. Chapter 7 can strip a judicial lien when there is no equity to support it. In Chapter 13, a second mortgage can be stripped when the home is worth less than the first mortgage.
A deficiency judgment is not short-lived. In Kentucky a judgment can be collected for 15 years and renewed for another 15 years under KRS 413.090. For example, a judgment entered in 2005 can be renewed in 2020 and collected for years after that. Lenders rarely chase a deficiency after a sale, but it is legal and it does happen.
Short Sales and the IRS
The IRS treats forgiven debt as income. When the lender reports its loss, it must send you a 1099-C. That creates a tax bill for you unless you bankrupt the debt.
Any promise the lender makes not to collect is not binding on the IRS. The IRS did not agree to it. Do not rely on a real estate agent for tax advice unless that person is also a CPA. Many people are told a short sale avoids the 1099 problem. It does not.
The one sure way to avoid this tax is to file bankruptcy before the sale. By law, you do not owe income tax on the canceled debt if you wipe out the debt in bankruptcy or prove you were insolvent before the sale.
Warranties You Give When You Sell
When you sell a home, you usually promise it is habitable and that you know of no hidden defects. You give the buyer some warranties, such as good title and no known hazards. If the buyer later pays to fix a defect you knew about and hid, you can be liable.
In one case, a seller did not report a plumbing problem at closing. The buyer sued for about $20,000 in repairs and roughly $100,000 in attorney fees. Because the court treated it as fraud, the debt could not be wiped out in bankruptcy. Sometimes you also need to make repairs so the buyer can get financing.
Timing and Buying More Time
Timing decides whether a short sale works. It takes time to find a buyer, qualify the buyer and home for a loan, and close. Meanwhile, the lender’s attorney may keep pushing the foreclosure forward. This is why you may need to file an answer, and sometimes discovery, to slow the case enough to close the sale. Bankruptcy can also give you time to work on a sale or modification of the loan.
Your answer is due 20 days after you are served. You can be a few days late only if you ask the court for more time, and you can lose these rights if you wait too long. Filing an answer can add about six months, and discovery can add several more. If the lender already has a judgment or sale order, you may need to file bankruptcy to delay the sale.
Always have a backup plan in case the short sale falls through. Each month you stay also saves the rent you would pay elsewhere. A short sale does not erase other debts or judgment liens, but you can work on a short sale or a loan modification during a Chapter 7 or Chapter 13.
Thinking About a Short Sale?
A short sale has real costs and real risks. If you want to weigh it against bankruptcy, foreclosure defense, or a loan modification, talk with someone who handles these cases every day. Nick C. Thompson can review your situation and help you choose the best path.
Call 502-625-0905 to set up a free consultation.