Friday, November 23, 2012

Short Sale's Impact on Credit History and Income Tax

What is a short sale? 
A short sale occurs when a homeowner who is behind on his or her mortgage payments, and who owes more on his home than it is currently worth, contacts the mortgage lender asking the lender to allow him to sell the home for less than the balance of the mortgage. If lender agrees to proceed, the 'short sale' occurs.

Effect on credit score
In regards to your credit score, the negative credit impact of a short sale is generally significantly less than that of a foreclosure. A short sale will not appear as a foreclosure on your credit report, and therefore only the previous delinquency on your mortgage will appear.

How much of a plunge your credit score will take exactly knows only one agency:  Fair Isaac, who created FICO scoring. Unfortunately, they keep the formula quite secret. It is fair to say, that your credit score might be lowered by something in the neighborhood of 75-185 points. The higher the borrower's initial credit score, the steeper the drop.

It is very important to understand how much proper negotiating can prevent a steep drop in your credit rating. The key to getting the best result is to have your agent negotiate out a "Paid as agreed" or "Paid in full" reporting to the credit company. If this is how it is reported, then the impact is minimal. Is your short sale is reported as “settled for less than amount owned”, you credit score will suffer more.

Experts do advise that the missed payments will hurt more than the short sale itself. The most dramatic difference between the effect of short sale and foreclosure on your credit worthiness is the waiting period before you can qualify for a new loan. Going through foreclosure will make it very difficult for you to get a loan for at least three to five years; if you've done a short sale, you may be able to qualify for a new mortgage within two years.

Short sales and income tax
In most cases the lender by agreeing on a short sale agreeing to settle the debt for less than the amount owed. The lender is allowed to write off this loss against their income. When a loss of $600.00 or more is written off, they are required to send the borrower a 1099-C (Cancellation of Debt), for the amount that they wrote off. The IRS considers “debt relief” to be income for tax purposes. The income must be reported by the borrower on their tax return the year that the debt relief has occurred.

The Mortgage Forgiveness Debt Relief Act Of 2007 provides Federal tax relief under certain criteria, relieving borrowers of the obligation to pay taxes on the amount of “debt relief” reported on the 1099-C received from the lender. The Act provides relief for debt forgiven in tax years from 2007 through 2012. It applies to debt forgiven up to $2,000,000 for a married couple and $1,000,000 for an individual tax payer or a married person filing separately. It is always a good idea to talk to your real estate agent, short sale negotiator and tax professional regarding such matters.

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