Recent History

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  For lenders, homeowners, real estate brokers and other stakeholders, short sales were difficult to do and unpredictable from beginning to end. Few understood them. Lenders' loss mitigation departments were understaffed and didn't process them efficiently. Real estate agents avoided them. The paperwork was (and is) enormous, and the risk of failure was high.
  
  Owners faced deficiency judgments, sometimes from more than one lenders. Federal and state taxing authorities viewed the forgiven debt as an income item.
  
  Loan servicers didn't have a code for reporting loans "shorted" in a short sale. Many reported the loans as paid, even though the lender had taken a loss. How they affected owners' credit scores was unclear.
  
  

Direct Impacts

• According to the Mortgage Bankers Association, lenders can lose up to to 60 percent of the outstanding loan value in a foreclosure. Lenders also lose in a short sale, but not as much, on average, as they do in a foreclosure. Second mortgage lenders lose the most, usually recovering pennies on the dollar.
  
  Homeowners associations can lose if their assessments aren't paid from a short sale. The amount will have to be made up by the other homeowners.
  
  Since appraisal reports rely on comparable sales, areas with significant short sales will see a decline in house values.
  
  The short-selling owner will not be able to buy an Federal Housing Administration (FHA)-insured home for at least two years. FICO indicates that a short sale should have the same impact as a foreclosure, but admits inconsistencies from credit reporting agencies, creating ambiguity.
  
  

Changes Under HAFA

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  Under the Home Affordable Foreclosure Alternatives (HAFA) program released by the U.S. Treasury Department, short sales and their effects may be different than they have been in the past. Its provisions allows borrowers to receive pre-approved short sale terms from their lenders; requires borrowers to be released from any liability caused by a deficiency; provides up to $3,000 in relocation assistance to borrowers, and up to $1,500 to the loan servicers; allows junior lien holders to receive three percent of their loan balances, up to a maximum of $6,000, and must also forgive deficiencies against the borrower.
  
  

Words of Caution

• First, not all lenders participate in HAFA short sales, including loans insured by FHA and the Department of Veterans Affairs (VA). People should check with their lenders. Incidentally, FHA and VA have their own programs.
  
  Second, it's not yet clear how mortgage insurers will participate. Many borrowers pay mortgage insurance premiums (M.I.P.), and the insurers are certainly stakeholders.
  
  Third, be mindful of deficiencies, which is the amount lenders lose in a short sale. Each state has its own rules. Many do not permit lenders to seek deficiency judgments against borrowers on purchase money first mortgages, but some do. These statutes generally don't cover junior lien holders, who can sue.
  
  Borrowers should have an attorney check the lenders' language in short sale authorizations with borrowers to insure that the lender can't come back and sue months later, or even turn it over to a collection agency.
  
  

Tax Consequences

• In many instances, short selling owners find some of their debt is forgiven on one or more loans. To taxing authorities, forgiven debt is income. The Mortgage Foregiveness Debt Relief Act of 2007 may offer relief from federal taxes, but not state taxes.
  
  In other scenarios where homes have been refinanced, short selling borrowers may find themselves with a taxable gain even if they've sold at a steep loss. That's because refinancing may affect the tax basis of the house.
  
  Owners engaging in a short sale should always have the paperwork examined by a qualified tax professional.