Mortgage Information

Matthew Foley

Matthew Foley

Esq. & MBA

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Short Sales in Arizona

Before foreclosure can take place, a short sale may be initiated by the homeowner. In a short sale, a property owner who has fallen behind on a mortgage can sell the property for the amount of money left on the loan.

short sale, also known as a pre-foreclosure sale, is a sale of real estate in which the proceeds from selling the property fall short of the balance remaining on the mortgage. A short sale allows the owner of the property to sell the property before a trustee sale at a foreclosure auction takes place. Simply put, because the net dollar amount to the lender in a short sale is usually higher than the net amount in a trustee sale, lenders are usually more inclined to accept the offer and let the sale take place.

Homeowners may pursue a short sale because the amount owed on their house is greater than what buyers are willing to pay in this market. Additionally, homeowners may have a hardship, and may be unable to continue making payments due to divorce, loss of job, health, death of a family member, etc.

Preliminary Issues:

Choosing a Short Sale Specialist:

While five years ago, few real estate professionals would understand the ins and outs of a short sale, that number has risen dramatically since the recession:

This website allows interested sellers to search Arizona’s Dept. of Real Estate to search for qualified short sale experts: http://services.azre.gov/publicdatabase/

Also, sellers can check if the real estate professional has obtained a short sale certification, such as the Short Sales and Foreclosure Resource Certification (“SFR”) at www.realtorsfr.org/

Documents and Information for a Short Sale:

  • Documentation & eligibility criteria varies depending on the lender, but sellers must prove that they are incapable of paying the loan, and that a short sale is the best option. Normally, documents will include:
    • A handwritten hardship letter or hardship affidavit
    • Financial statements
    • 2 years tax returns
    • 2 months bank statements
    • 2 months pay-stubs
  • Attorneys with experience in short sales may best understand how to frame hardship letters. Issues can arise, for example, if the borrower is continuing to make regular monthly payments. A lender may view this as negating the borrower’s assertion of a hardship.
    • Determine the Amount Owed on the Property: this includes the delinquent loan, home equity loan, past due homeowner’s association fees, unpaid property taxes, and the costs of sale.
    • Determine the Fair Market Value of the Property: Sellers must prove to the lender that the home is worth less than the unpaid loan balance. Consult a real estate professional for an appraisal.

Short Sale Considerations:

1) Reasons a Bank May Deny a Short Sale:

  • Offer is not fair market value according to the lender: A lender offers a short sale because they can be less costly than foreclosures. However, when an offer is too low, a lender could stand to lose more money than they would if proceeding with foreclosure. Thus, short sales are cheaper for the lender only up until a certain point.
  • Insufficient information: Lenders require a lot of documentation to approve a short sale, as listed above. Sometimes the sellers aren’t willing to cooperate or simply are unaware of all the information they must provide.
  • Not an arm’s length transaction: if sellers are going through with a short sale, they can’t benefit from the short sale. For example, if the seller’s parents buy the house for a low price, and then the son or daughter still lives in the house, this is not arm’s length. Such a transaction must be disclosed to the lender.
  • Investor/insurer/or subordinate lien holder won’t agree/won’t accept the loss: If you have more than one loan on the property, a short sale will generally require the approval of all lenders.
  • Seller will not contribute to the loss or sign a promissory note: This gets to point (2) below, but unless the short sale documents have language that releases the borrower from liability beyond the short sale price, sellers aren’t really benefitting from short sale over foreclosure.

2) Deficiency After the Short Sale:

Brief Foreclosure Overview:

In many states, if a foreclosure (or trustee’s sale) does not fully compensate the lender, the lender may sue the borrower for deficiency— the difference between what is owed on the loan and what the home sells for at the foreclosure sale. However, Arizona has anti-deficiency laws that bar a lender from pursuing collection of the deficiency in certain situations as delineated in A.R.S. § 33-729(A) (judicial foreclosures), and A.R.S. § 33-814(G) (trustee’s sales, or non-judicial foreclosure). Anti-deficiency protections apply only if the property being foreclosed is (1) Located on 2½ acres or less; and (2) Limited to and utilized as a single one-family or single two-family dwelling. Furthermore, there are potential issues of “voluntary waste” and additional requirements that the loan be a “purchase money loan” for the borrower to get anti-deficiency treatment.

Short Sale:

There is no Arizona case law that directly holds that a borrower is afforded the same protections after a short sale that they would be after a foreclosure. During the short sale process, a lender will typically send an “approval letter” which outlines the short sale terms. Often in the approval letter a lender simply agrees to extinguish their deed of trust (the security instrument) but not the actual promissory note. In addition, the lender will sometimes include language that attempts to waive the protections of the anti-deficiency laws.

Generally, there are three types of short sale documents:

  1. The lender agrees to release its lien to allow the short sale, and the lender expressly agrees to release the borrower from any further liability on the loan; 
  2. the lender agrees to release its lien to allow the short sale and the borrower signs documentation agreeing that a portion of the debt is still owed after the short sale; &
  3. the lender agrees to release its lien to allow the short sale but the documents do not address whether or not the borrower remains liable for the remainder of the debt which is unpaid as a result of the short sale.

While many attorneys believe that a borrower is protected by Arizona’s anti-deficiency statutes after a short sale, sellers should have their short sale approval letters reviewed by an attorney before agreeing to the buyer’s terms. In some cases, even though lenders have potentially no legal right to sue the borrower in the first place, borrowers agree to be held liable for the portion of the debt still owed. Experienced real estate agents representing the borrower often agree to complete the short sale only on the condition that the lender expressly agrees to release the borrower from any further liability on the loan.

3) Effect of Short Sale on Credit and Ability to Purchase a Home in the Future:

This is a somewhat contentious subject. Many real estate agents stand to profit from completing a short sale, and may overemphasize the benefits of short sales on your credit score as compared to foreclosures.

A short sale probably will adversely affect a seller’s credit rating or FICO score. As addressed above, the problem sellers may encounter is that lenders may not even consider a short sale until homeowners are actually behind on payments. Showing delinquency or a difficulty paying shows up as “late payments.” Beyond that, FICO outlined the impact of mortgage defaults, a short sale, a foreclosure, and bankruptcy on credit scores. There is no difference in a normal short sale and a foreclosure on the score.

However, short sales offer a large advantage over foreclosures in how soon a seller can obtain another mortgage. On a conventional loan, FNMA has different waiting periods according to down payment. The following guidelines apply: 2 year waiting period with 20% down payment, 4 year waiting period with 10% down payment (primary residence only), and 7 years to obtain maximum financing. This is compared foreclosure, where the standard waiting period for buying a home after is seven years.

Foreclosures also may have a greater impact on security clearances and current or future employment.

4) Tax Consequences:

In many cases, if you owe a debt to the bank and they cancel or forgive that debt, the canceled amount may be taxable. In a short sale, normally the mortgage lender will issue a cancellation of debt for any deficiency they incur and send a 1099 C to the IRS in the year following a short sale transaction. This forgives short sellers for any money the bank may have lost, but the event could be deemed taxable. There are several possible exemptions for homeowners completing short sales:

  1. A) The Mortgage Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Issues may arise if the property has been refinanced. This provision expires at the end of 2012, and caps debt forgiveness at $2 million.
  2. B) Homeowners file for insolvency with an IRS Form 982.
  3. C) Filing for bankruptcy.

Consultation with a tax attorney is essential for advice on a case by case basis.

5) Short Sale Fraud:

Flopping:

Normally occurs when a buyer misrepresents the value of the property to a lender, and the lender approves the short sale based on this artificially low value. The buyer then profits by selling the property at its true fair market value.

    • According to CoreLogic Inc., which tracks real estate data, flopping occurs in about 2% of all short sales and may cost lenders hundreds of millions of dollars a year.
    • Sellers can also be hurt by flopping, because lenders may hold sellers responsible for the deficiency, or the amount of the difference between what the seller owed and the sale price. If a lender forgives a seller for the deficiency, the seller may owe taxes on the amount of debt that is forgiven.

Undisclosed Payments:

Distressed homeowners’ desire to complete a short sale may expose them to increased risk of fraud. If sellers make payments outside of escrow—to junior lien holders, agents, negotiators etc.—they may be a party to loan fraud. Thus, sellers should disclose all payments made as part of a short sale transaction to the lenders and other parties approving the short sale.

False Short Sale Experts:

Con artists may capitalize on a homeowner’s situation by offering expert advice or certain outcomes for a fee while doing nothing in return.

6) General Risks Inherent to Short Sales:

A number of factors can influence whether or not you can complete a short sale. For example, there may not be enough time to complete the short sale before foreclosure. The short sale process is becoming more streamlined, but it is still a long process. Once borrowers miss payments, the clock starts ticking on foreclosure.

Another important, potentially frustrating issue for sellers is when a buyer cancels a short sale while waiting on the lender’s approval. After waiting for the lender’s approval for many weeks, a buyer could cancel the transaction because they purchased something else or lost interest. This could force the seller to put the home back on the market, and the process might start from scratch.

Here are other reasons a buyer may cancel an approved short sale:

  • Home needs too many repairs, and the bank won’t pay for repairs.
  • The appraisal came in low, and the bank may refuse to approve a lower sales price.
  • The buyer does not qualify for the loan and is unable to satisfy the lender’s funding conditions.

7) Additional Legal Considerations:

Important dates: There may be a maximum amount of days under the agreement to:

  • List property with a broker
  • Find a buyer
  • Close

Listing Agreement: Cancellation and contingency clause

Arms Length Transaction– mentioned above, but there may be restrictions on resale of the property

Maintenance of the property

Privacy: Sharing confidential information, such as personal and financial data with parties in the transaction

Termination clause

1099 Debt Forgiveness Income

If you have sold your primary residence or your residence was foreclosed, you will receive a 1099 tax form known as debt forgiveness income. To understand the ramifications of a sale or foreclosure and how this tax form will affect your taxes, work with our team.

The tax ramifications of letting a home go are less complicated than the anti-deficiency laws. First, if it is your “primary residence”, there is no tax liability for debt forgiveness under the Mortgage Forgiveness Debt Relief Act. However, this Act is set to expire, unless Congress chooses to extend it.

“Debt forgiveness” is the tax principle that if you owe money, and this money is then forgiven, a tax payer benefits by this amount, and such amount should be treated as income. When letting your primary residence go, via foreclosure or short sale, the lender will provide the resident with a Form 1099-C for “debt forgiveness.” Though this is a taxable event, the forgiveness income is “excludable income” – meaning you are not actually paying taxes on the amount forgiven.

Second, 1099 income is excludable on either a primary home or investment home, if the resident is otherwise insolvent at the time of the short sale or foreclosure. “Insolvency” is demonstrated with a simple worksheet, available on Publication 4681, showing that an individual’s liabilities exceed their assets.

During a short sale, my experience has been that the lender will almost always pressure homeowners with inaccurate threats of “1099 Income.” This is misleading. Speak with a knowledgeable attorney or CPA to know your specific liability. Also, the IRS offers a great publication regarding “debt forgiveness” at: http://www.irs.gov/pub/irs-pdf/p4681.pdf

In my experience, most foreclosures and short sales do not generate taxable income.