How to apply for a short sale

How to apply for a short sale

Short selling a home can be an option for homeowners trying to sell their homes whose values have dropped, or when struggling to make payments; however, not every homeowner in these situations qualify for a short sale. A short sale is when a home is sold for less than the amount that is owed on any liens against the property. This option is generally used in lieu of foreclosure.

A short sale has to be approved by any lenders who have a stake in the property being sold, and the seller and property have to meet certain requirements to qualify.

Short Sale Definition

A short sale happens when the lender is shorted on a mortgage, meaning the lender accepts less than the total amount that is due. If your mortgage is $100,000, but your home value dropped to $90,000, you are short $10,000 plus the costs to close the sale. It might be possible to sell your home short if your mortgage balance matches the sales price because there are still closing costs that will bring the home into the short sale category.

Many entities profit from short sales, but there is no profit for the seller in a short sale.

Qualifications for a Short Sale

Before you decide to pursue a short sale, consider the following to determine whether you may qualify for one. If you don’t meet all four requirements, you may not qualify to sell your home in this manner.

  • The home’s market value has dropped: Hard comparable sales must substantiate that the home is valued at less than the unpaid balance due to the lender. This unpaid balance may include a prepayment penalty.
  • The mortgage is in or near default status: In the past, lenders would not consider a short sale if the payments were up-to-date. Currently, lenders are eager to head off any future financing problems, no matter the payment status. A high risk of default will generally sway a lender toward accepting a short sale.
  • The seller has fallen on hard times: The seller must submit a letter of hardship that explains why they can not pay the difference due upon sale, including why the seller has stopped or will stop making the monthly payments.
  • The seller has no assets: The lender will probably want to see a copy of the seller’s tax returns and/or a financial statement. If the lender discovers enough assets, they may not grant the short sale because the lender will feel that the seller can pay the shorted difference. Sellers with assets may still be granted a short sale but could be required to pay back the shortfall.

Some examples of hardships are unemployment, bankruptcy, divorce with the loss of income, or a medical emergency with the loss of income. Assets could be IRAs, savings accounts, or other real estate.

Steps in a Short Sale

Sometimes, to avoid going through the cost of foreclosure, a lender will sanction a short sale by letting a buyer purchase the home for less than the mortgage balance while the home is in the pre-foreclosure stage, one of the three stages of foreclosures. Some sample steps of a short sale are:

  • The seller signs a listing agreement with a real estate agent subject to approval from the bank as a short sale.
  • The agent finds a buyer who makes an offer based on market value, which is often less than the amount of the mortgage.
  • The seller accepts the buyer’s purchase offer.
  • The seller’s lender accepts the buyer’s purchase offer.
  • The transaction closes when the buyer delivers the funds, the lender releases the lien, and the seller delivers the deed.

Short Sale Consequences

A short sale is dependent on a buyer making an offer to purchase. If you do not receive an offer, you won’t qualify for a short sale. So even if you meet all the other criteria, it is possible that no one will buy the short sale. It is also dependent on the lender accepting the buyer’s offer. If the lender rejects the offer, a short sale will not take place.

If the lender agrees to the short sale, they may possess the right to issue a 1099-C to the buyer for the difference (where the difference is viewed as income for the seller), due to a provision in the IRS code dealing with debt forgiveness.   Many situations are exempt from debt forgiveness, according to the Mortgage Forgiveness Debt Relief Act of 2007.  

You should speak to a real estate lawyer and a tax accountant to determine the amount of short sale tax consequences, and whether you can afford to pay those taxes.

While a short sale will not show up on your credit report, the loan status will. For those in default, it’s a pre-foreclosure that has been redeemed, which is often reported as Paid in Full for Less Than Agreed.

Short sales affect credit ratings. While the damage to your credit report may not seem as significantly bad as a foreclosure, creditors may not distinguish between the two.

How to apply for a short sale

The short sale process can be confusing to some home buyers and sellers. It can be difficult to explain how a short sale is originated, and the process of receiving approval from a lender can be lengthy.

A seller and home both need to meet certain criteria to be sold short. All information regarding the seller’s finances and the home’s value will need to be gathered and presented to the lender along with other items in a packet, as well as having a prospective buyer.

Defining a Short Sale

When a lender approves a short sale, they’re agreeing to sell the property for less than the outstanding mortgage balance against it.

Lenders will generally only approve short sales when foreclosure appears to be inevitable. With a short sale, the lender doesn’t have to take the property back and bear the expenses of maintaining it until it can be sold. They’ll also avoid risking that the property won’t sell again at a price high enough to recoup their losses—as it more than likely would in a foreclosure.

Foreclosure auction sales are generally much lower than the market value of a property. A short sale is a chance for a lender to receive more than it would have in a foreclosure—but they are not going to want to release any mortgage obligations at rock-bottom prices, either.  

The Typical Process

This is the typical short sale process from the bank’s end of things, once they receive the seller’s package:

  • They acknowledge receipt of the file. This can take longer than 10 days; sometimes, it is a month or more.
  • A negotiator is assigned, which might take up to 30 days.
  • A broker price option (BPO) is ordered, where a broker generates an educated opinion on the value of the home.   Banks generally will refuse to share the results of the BPO.
  • A second negotiator might be assigned, taking an additional 30 days.
  • The file is sent for review based on the pooling and services agreement. This can also take up to 30 days.  
  • The bank might then request that all parties sign an “arm’s-length” affidavit, which is a document signed by the buyer and seller stating that neither party knows the other, nor is there any type of pre-existing relationship between the two.  
  • The bank will then issue a short sale approval letter if the sale is approved.

The Basics for the Seller

While there are more than a few requirements to qualify for a short sale, banks generally grant short sales for two reasons. One, the seller must be experiencing financial hardship and two, there isn’t enough equity in the home to pay off the mortgage after closing costs.

Some examples of hardship include reduced income from unemployment, divorce, a medical emergency, bankruptcy, or the death of the sole income provider.  

The seller must prepare a financial package for submission to the short sale bank. Each bank has its own guidelines, but the procedure is similar from bank to bank.

The Seller’s Package

A seller’s short sale package will most likely consist of:

  • A letter of authorization for your agent to speak with the bank.
  • A preliminary closing statement.
  • A completed financial statement or request for mortgage assistance (RMA).
  • A hardship letter from the seller.
  • Tax returns for the previous two years.
  • W-2s for the previous two years.
  • Payroll stubs for the last 30 days.
  • Two months of bank statements.
  • A comparative market analysis or list of recent comparable sales in the area.  

Writing an Offer and Submitting It to the Bank

As a buyer, ask your agent for a list of comparable sales before you write a short sale offer. The bank will want to receive an offer as close to the amount owed as possible.

The short sale listing price might not reflect market value. In fact, the property might be priced below comparable sales in an effort to encourage multiple offers. Some short sales can begin prior to an offer but banks will most often start the procedure upon receipt of an accepted purchase offer.  

After the seller accepts the offer, the listing agent will send the listing agreement, the executed purchase offer, the buyer’s preapproval letter, a copy of the earnest money check, and proof of funds to the bank. They’ll also submit the seller’s short sale package.

The short sale process will be delayed if the package is incomplete. They may not send it back to you, attempting to reduce as much of the cost for themselves as possible.  

The Bank

Buyers might wait a long time to get a short sale response from a bank. It’s important that the listing agent call the bank regularly and keep careful notes of the progress.

Some short sales get approval in two to eight weeks. Others can take 90 to 120 days on average. A top short sale agent can help to speed up the process a little by keeping informed of the offer’s progress and holding the bank accountable.  

Checking in with the bank at least once or twice a week is imperative. Recognizing the behavior of incompetent negotiators and requesting a replacement is often necessary as well. Never be afraid to advocate for yourself, or escalate your actions up the management chain of the bank.

Some Final Tips

Buyers might become tired of waiting for short sale approval and threaten to back out if they don’t get an answer within a specified time period. The process can be frustrating—both buyer and seller agents may need to work to reassure the buyer and seller that patience is necessary, as the wait can be lengthy.

A listing agent will often have some idea of when approval will arrive as the file is sent for final review. At that point, buyers might want to start the loan process and other due diligence so they’ve got a head start in case the bank allows only a few weeks to close.  

How to apply for a short sale

The worst of the housing crisis appears to be over, but many homeowners are still struggling to meet their mortgage obligations. According to RealtyTrac’s Year-End 2013 U.S. Residential & Foreclosure Sales Report, there were 256,000 short sales, a slight increase over 2012. The total number of short sales and foreclosures accounted for 16.2% of all residential home sales in 2013.

Losing a home to foreclosure can be emotionally and financially devastating, but negotiating a short sale can minimize the damage. Essentially, when your lender agrees to a short sale they allow you to sell the home for less than what you owe. Since this usually means a loss for the bank, getting them on-board can be difficult.

If you can no longer keep up with your house payments here’s what you need to know about sealing the deal on a short sale.

Check Your Eligibility

Generally, you have to be in default on your mortgage before your lender will consider a short sale. If you’re still making payments but you want to get out of the home, you’ll have to explore traditional sale options. You may also run into trouble if you’ve already filed for bankruptcy protection. Some lenders may not be willing to discuss a short sale until your filing is resolved.

If you’re applying for a short sale through a specific program like the Home Affordable Foreclosures Alternative Program, there are additional eligibility criteria to consider. You must have gotten your mortgage through a participating lender and there must be a documented financial hardship. If you’re not sure whether you qualify, you’ll want to get in touch with your lender for more information.

Prepare Your Short Sale Package

How to apply for a short sale

A short sale involves a certain amount of risk from the lender so they’ll want to see something from you that demonstrates why they should okay your request. Your short sale package includes some important pieces of financial documentation but more than that, it’s your chance to convince the bank that a short sale is in their best interest.

Before you start working on your package, you’ll need to find a real estate agent who’ll represent you throughout the process. Ideally, it’s best to choose someone who’s familiar with the local market and specializes in short sales. You’ll need to include a letter that notifies the bank of who your agent is and authorizes them to make decisions on your behalf.

Your package should also document your financial reasons for seeking a short sale. Specifically, the bank will want to see a written explanation of the circumstances surrounding your current hardship and any paperwork that supports your claim. This may include W-2s, pay stubs, tax returns, bank statements, a list of all your monthly expenses or copies of medical bills if your hardship is due to an illness or disability. The more information and detail you can provide, the better.

Find a Buyer for Your Short Sale Home

Lining up a buyer before you turn in your short sale package to the bank can greatly improve the odds of getting approved. If you’ve already got an offer in place, the lender will want to see a copy of the buyer’s preapproval letter at minimum. They may also ask for more specific financial information, such as how much the buyer is putting down, before moving ahead with the negotiation process.

Be Patient

How to apply for a short sale

Selling a short sale house often involves a lot of back-and-forth between the bank, your agent and the buyer before it’s complete. In some cases, it may be several months before you get an answer from your lender about whether the short sale has been approved. If you’re worried about the outcome, the best thing you can do is be patient and stay aware of where you’re at in the process.

Make sure you answer the lender’s requests for information in a timely manner and be proactive about sending in updated documents like pay stubs or bank statements when they become available. If you think there’s a chance that your request will be denied, you can also take this time to explore other options, like refinancing or modifying your mortgage.

Consider the Drawbacks

A short sale can help you avoid foreclosure, but there are some downsides. Your credit will take a hit and there’s a chance that the bank may expect you to cough up the remaining balance on the loan. Even if they don’t, you may still have to report the deficiency as income on your taxes. Learning the ins and outs of how to buy a short sale home and sell one beforehand can help you decide if it’s the right choice for your situation.

How to apply for a short sale

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What Is a Short Sale?

When you owe more on your home than it’s worth and you need to sell, the transaction in which you will sell your property is called a short sale. You need your lender’s approval to do a short sale because they’ll be accepting less than they’re owed at closing. There are many reasons homeowners opt for a short sale, but one of the most common is to avoid going into foreclosure.

If you’re a buyer, a short sale can enable you to buy a property at a discount because the seller is distressed and has fewer options. But you’ll need to be patient because buying a property in a short sale may take some time. Let’s review more details about how short sales work for sellers and buyers.

How Do Short Sales Work for Sellers?

Short sales are an option for homeowners who are underwater on their mortgage to sell their property, and to avoid going into foreclosure. For many distressed homeowners, short sales are an alternative to foreclosure. Here are the steps sellers need to take in order to sell their properties in short sales:

  1. Provide proof of hardship: When you owe more than your home will sell for, you can’t just list your home to start. You first need to provide proof of hardship to your lender. The two most accepted hardship cases are proof that lower income has made your home unaffordable, or that you’re subject to a mandatory job relocation. When reviewing your hardship case, your lender will analyze your income and assets. If your debt-to-income ratio has risen, it will help your short sale approval. If you have money saved, they’ll require that you contribute these funds to minimize their loan payoff loss. You will also need to provide a market analysis as well as indicate any liens on your property.
  2. List your property: Once the lender has approved the short sale, you can list your property with a real estate agent. You’ll need to present any offers to the lender for approval. This process can take two weeks to several months. If you have a second mortgage, both lenders must approve each other’s terms, making the process longer.
  3. Lenders approve the sale of the property: The lenders will review the buyer’s offer and decide if they will approve the sale. Once approved by the lenders, the short sale can close as soon as the buyer can get their loan approved, funded and closed.

What Happens After Closing for the Seller

Typically, your credit score will drop by 75 to 200 points after selling your property in a short sale, which is less severe than a foreclosure. (Experts estimate that a foreclosure will lead to a dip in your credit score of about 200 or 300 points). Lenders often won’t consider a short sale approval for your property until you’re two to three months behind on your payments. This means your credit score drop will be at the higher end of the range if this is the case. The rest of the drop will depend on whether the lender reports the short sale as “settled” debt or “paid” debt. You should try to negotiate for the latter, but the former is more common, and hits your credit score harder.

The short sale will stay on your credit report for seven years, but you can finance a new home purchase within one to four years of a short sale depending on credit score, loan type and down payment. Again, a foreclosure is even more severe. With a foreclosure, that time ranges from three to seven years. Ask your lender to advise on options. Prior to the housing crisis, the lender’s loss was taxed as income for the seller, but now short sellers have no tax liability.

How Do Short Sales Work for Buyers?

Buying a short sale property can allow buyers to purchase a home at a discount, but the downside is that the transaction can take significantly longer than the sale of a property that is not a short sale. Here are the steps a buyer needs to take in order to purchase a property in a short sale:

  1. Get pre-approved for a mortgage: Buying a short sale property begins the same way as buying any other home: get pre-approved by a lender. They will tell you how much you can afford, how much cash you need, and what your monthly costs will be.
  2. Shop for properties: If you find a short sale property that you want to purchase, you must work with your real estate agent to identify how much the seller owes, how many loans they have, and whether they’ve been approved by their lender(s) for a short sale.
  3. Make the offer: Making an offer on a short sale is the same as offering on any other property. However, it may take more time, so be patient. You work with your agent to identify fair market value based on recently sold comparable homes nearby, and write your offer price accordingly.

Locking in Your Rate

Locking in a rate for a short sale property can be tricky. The short seller’s lender will often require that you make a loan application with them to ensure you’re qualified, but that lender cannot require you to use them. Most rate locks are only for 30 to 60 days, but the seller’s lender can take months to review and approve your offer. As such, you won’t be able to lock your rate right away, so ask your lender to brief you on the rate outlook and what it might mean for your final terms and costs.

See the latest mortgage rates on Zillow

Moving the Sale Forward

While waiting to lock, you’ll need to advance the loan process for purchasing the property. Appraise and inspect the property as your lender requires, because the seller’s lender may also require these reports. And of course, you’ll need to be patient. Taking these steps ensures that when the seller’s lender has finally approved the short sale, your loan will be mostly done and you’ll be able to close quickly. Short sales are known for taking more time than usual to complete, so it’s a good idea to do everything you can on your end. Your lender and real estate agent should be very familiar with short sales, and they can help you understand all the steps you need to take for the short sale transaction.

How to apply for a short sale

Mario Gutiérrez. / Getty Images

Many factors make the financing of a short sale property purchase unique. As if short sales weren’t enough of a hassle to buy for most people, the type of financing a buyer uses has a huge impact on the sale, for a variety of reasons.

If you try to get the wrong type of loan, even if your short sale is approved by the seller’s bank, you might not be able to close that transaction because of financing problems. Unfortunately, not every type of available financing in the United States can be used to buy a short sale property.

Waiting for Short Sale Approval

Unless the short sale you plan to buy is a Wachovia short sale or a preapproved Home Affordable Foreclosure Alternative (HAFA) short sale, you can pretty much count on waiting a while for short sale approval.   Getting a short sale approved takes longer than a regular real estate sale, but when working with a competent real estate agent, it can take several weeks to months.  

During this period, interest rates may fluctuate—sometimes to your favor but often not to your benefit. Many lenders will not lock in a loan rate for longer than 30 days without charging you additional fees for the privilege. Some won’t give you a loan lock until you get short sale approval. If your interest rates bounce upward, you could find that you are no longer qualified to buy that home.

Try to buy below your means. Don’t stretch your preapproved loan amount to the max. Leave yourself some flexibility.

Not Closing Before Loan Approval Expires

Many short sale banks want to close within 30 days of short sale approval. If you are getting a loan that requires a longer approval period such as a Section 184 loan, you might not be able to close within the time specified and your approval will expire.

Sometimes, even with a conventional loan, delays with your short sale financing are inevitable. Maybe the appraisers are backed up and the appraisal can’t be completed in time or underwriting takes longer than usual. If the loan rep did not obtain a breakdown of approved fees, and some of the fees the seller is not allowed to pay were transferred to the buyer, revising the Good Faith Estimate could delay the process, too.   Some banks will not issue an extension for their short sale approval letters.

Ask your lender upfront if the company can guarantee a 30-day closing. Moreover, if you hear that the approval letter is coming, start your loan early.

Necessary Repairs Can be Roadblocks

Many lenders have loan conditions. FHA repair guidelines can call for a lot of repairs such as fixing chipping paint from a pre-1978 home or installing handrails. A VA loan will undoubtedly call for a pest report and a clear pest completion certificate.

Even if your loan is conventional, the appraiser might note a failing roof and ask for a replacement before agreeing to finance that short sale. Banks will rarely pay for repairs. Short sales are sold in “as is” condition. Moreover, the bank won’t let the seller pay for repairs, because if the seller has any extra money, generally the bank will want those funds.

Ask your agent to pre-inspect the home and discuss potential problems in advance.

Closing Costs May Not Be Covered

Often, buyers will ask a seller to pay their closing costs. If the buyer doesn’t have enough money to pay for closing costs and the bank refuses to allow the concession, the buyer might not be able to buy that short sale.

Sometimes, Wells Fargo FHA short sale banks will reduce the amount typically paid by other banks because Wells Fargo says its guidelines for FHA prohibit a full 3% credit in some circumstances. Also, some short sale banks will automatically reject a buyer closing credit if the buyer is putting down more than 3.5%.

Ask the listing agent if the bank will pay a concession toward closing costs when you write the offer or offer more than list price to compensate.

Dealing with Two Lenders and Getting Approval

If there are two loans on a short sale, you will need the consent from both lenders to close. You are taking a risk if you move forward with an appraisal or home inspection before you receive approval from both lenders. One lender might agree while the other might reject the short sale or object to the seller contribution on the HUD.

Ask to see a preliminary title report or title commitment to determine how many loans are secured by the property. There could be a paid-off loan that was never reconvened.

At the time of writing, Elizabeth Weintraub, DRE # 00697006, is a Broker-Associate at Lyon Real Estate in Sacramento, California.

Jul 3, 2018 2:59 PM EDT

Homebuyers looking for a good deal on a property purchase can get a price break on a short sale – if they understand the short-sale process completely.

What Is a Short Sale?

A short sale is when a home owner sells his or her property for less than the amount owed on their mortgage. In other words, the seller is “short” the cash needed to fully repay the mortgage lender. Typically, the bank or lender agrees to a short sale in order to recoup a portion of the mortgage loan owed to them.

Short sales are becoming increasingly rare as the economy improves. They were much more prevalent during the Great Recession, when many U.S. homeowners were “underwater” on their home loans; i.e., they owed more on their homes than the homes were worth in value.

How a Short Sale Works

In a real world, short-sale scenario, a home seller puts his or her property on the market, while formally designating the home for-sale as a potential “short sale/subject lender” deal to any potential buyers.

Once a buyer agrees to make a short sale offer, the homeowner contacts his or her bank, and completes an application asking for short sale status on the home. There is no guarantee the bank will green light the application, but a short sale does eliminate many hassles associated with the mortgage loan, such as closing the books on the homeowner loan, and the bank or lender gets a portion of their loan repaid.

Home sellers involved in a short sales can expect to file several firms and documents to their mortgage lender. Those include a hardship letter stating why you can’t fully repay your mortgage loan, along with the filing of records like pay stubs and tax returns that back your case as being unable to repay the home loan.

The bank will then review your application, send out an appraiser to estimate the full value of the property against the short sale offer, and then either approve or reject the short sale request.

Benefits of a Short Sale to a Home Seller

If the property seller is presented with a short sale opportunity, it’s a good idea to thoroughly vet all the options on the table, and calculate the risks and opportunities and look at other relative personal financial options, before making a decision.

Nobody is saying a short sale is a perfect solution to a home seller who has suffered a financial setback and owns a home with where the mortgage exceeds the property’s value – but it might be the best option.

Consider these benefits of a short sale:

1. Credit score advantages

A short sale is highly preferable from a personal credit score point of view, especially when weighed against any potential home foreclosure. Credit scoring firms take a dim view of a foreclosure, and will issue a credit score much lower than when a home seller turns to a short sale instead. That not only protects the seller’s score, it keeps them “in the game” and better able to buy another home down the road, without the burden of a significant foreclosure-induced credit score decline.

2. Emotional advantages

In many instances, a home mortgage is the biggest financial event of a person’s life – at least before retirement. The seller avoids a “worst case scenario” of foreclosure and can honestly say they sold their home and moved on with their life.

3. Saving on home sale fees

With a traditional home sale, the seller bears the burden of fees and charges, including real estate agent commissions, which can be 3%-to-6% of the total home sale. In a short sale, those fees and commission are paid by the bank.

Negatives of Short Sales to a Home Seller

Short sales can create issues for sellers such as:

1. No cash-out

A short sale means they won’t earn any profit from the sale of the house – the bank or mortgage lender gets all the sales proceeds.

2. Dependence on the lender

Home sellers also need a green light from their lender on a short sale – they can’t make that decision on their own.

3. Less cash for a future home purchase

Since the seller earns no profit on a home short sale, they won’t be able to steer home sale assets toward the purchase of a new home. Instead, they’ll be starting from scratch.

Benefits of a Short Sale to a Home Buyer

Home buyers can take good advantage of a short sale, as well, with several advantages:

1. Reduced price

Primarily, the big benefit is the increased odds of getting the home for a reduced price, knowing that the house is in short sale mode, and that the owners, and likely even the bank or lender in many cases, will want to sell the home and get out from under the home loan. As any real estate agent will say, a motivated seller is a seller who wants to cut a deal, so a low-ball offer has a better chance of being accepted in a short sale than in a traditional home sale negotiation.

2. Less competition

Many home buyers, especially first-time buyers not used to the complexities of the process, may not want to get involved with a short sale. That opens up the field for home buyers with more patience for a short sale, and who’ll face less competition for the home.

Negatives of Short Sales to a Home Buyer

Short sales can have negative repercussions for buyers such as:

1. A longer home-purchase timetable

For buyers, the paperwork process is significantly longer in a short sale (usually up to 120 days) than in a traditional home sale (usually up to 45 days) and that may be a deal-breaker for home buyers.

2. Lender interference

Lenders may also get directly involved in the home price negotiations, often asking for a higher sales price than the home seller (including the insistence that the buyer make all or most of the closing fees), in order to recoup more money on the home loan.

3. The property may be in disrepair

It’s also highly advisable for a short sale buyer to work with a real estate agent well-experienced in the short sale process. It’s also strongly advised that a short sale buyer hire a home inspection professional to thoroughly examine the property, as short sellers may not have the financial resources to keep up with home maintenance and repairs.

How to apply for a short sale

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In this article:

  • Credit Score Impacts
  • Getting a Conventional Loan After a Short Sale
  • Getting an FHA Loan After a Short Sale
  • Each Lender Is Different

When you owe more on your home than it’s worth and need to sell, the transaction is called a short sale. Because your lender must agree to accept less than they’re owed when a short sale closes, it negatively impacts your credit profile and your ability to finance a home in the future. Here’s how a short sale impacts your credit, including how long it will take to get a new loan after a short sale.

Credit Score Impacts

A short sale will be reported on your credit report with remark codes such as “settled for less than the full balance”. This could cause your credit score to drop as little as 50 points if you don’t incur any late mortgage payments during the short sale process. Your score could drop as much as 200 points if you do incur late payments during the short sale process. The short sale will stay on your credit report for seven years, but you can finance a new home purchase within one to seven years of a short sale depending on credit score, loan type, down payment, and the circumstances that led to the short sale.

Getting a Conventional Loan After a Short Sale

You can get a new conventional mortgage backed by Fannie Mae or Freddie Mac after a short sale, as long as they meet the agency’s specific requirements.

For Freddie Mac loans, the mortgage must be for a primary residence with a maximum loan-to-value of 90%. For a refinance, it must be a “no cash-out” refinance mortgage that meets Freddie Mac’s requirements.

For Fannie Mae loans, you can get a mortgage four years after the completion date of the deed-in-lieu of foreclosure, preforeclosure sale, or charge-off. A two-year waiting period is permitted if extenuating circumstances can be documented.

The credit impacts of a short sale can cause material rate differences on conventional (non-FHA loans). Rates are lowest for borrowers with top-tier credit scores of 760 or higher, and rates rise as credit scores drop. Rates are lower for larger down payments. Credit score and down payment factors can cause conventional rates to swing as much as 0.5 percent.

Getting an FHA Loan After a Short Sale

FHA normally requires a borrower to wait three years after a short sale to get a new mortgage. This three-year waiting period starts on the date of transfer of title by Short Sale.

However, in August 2013, FHA guidelines were amended to ease the waiting period for borrowers who have experienced financial hardship and household income dropped 20 percent or more for at least six months. Borrowers that fit this profile can get an FHA loan after just 12 months. They need to document their hardship in detail, as well as complete one hour of HUD housing counseling in person, on the phone, or online.

The credit impacts of a short sale won’t cause as much of a swing on FHA mortgages. Because the government backs lenders on these loans, the rates offered by lenders don’t rise as much when credit scores or down payments drop.

See the latest mortgage rates on Zillow

Each Lender Is Different

The guidelines above are based on Fannie Mae, Freddie Mac, and FHA guidelines. Individual lenders can choose to “overlay” more stringent qualifying guidelines and short sale timelines on top of this guidance. You should find a lender to look at your specific short sale profile and advise on the best timelines and loan products for your situation. You will also want to ask your lender if they have any overlays on their short sale qualifying guidelines, or if they’re able to be as flexible as Fannie, Freddie, or FHA will allow.

The wash sale rule can apply to trades involving short sales.

The wash sale rule prevents you from deducting a loss from selling stock if you acquire replacement stock shortly before or after the sale. The rule here is so confusing that even the IRS seems to get mixed up in Publication 550.

Background

When you sell short, you borrow stock from an unknown person’s account and sell it in the market. You have an obligation to return identical shares to the account from which you borrowed the shares. You can fulfill that obligation by delivering shares you already own at the time of the short sale, or by purchasing shares in the stock market.

The general rule for short sales for many years has been that you don’t report gain or loss until you close your position by delivering stock. It’s only then that you can determine whether you had a gain or a loss on the transaction. That was true even if you sold shares identical to shares you already owned — or to use stock market lingo, sold short against the box.

Recently the law changed so that if you sell short against the box, you can be treated as if you sold the stock you already owned. This rule applies only if a sale of your stock would produce a gain and certain other things are true. When these constructive sale rules apply, you have a gain at the time you make the short sale, so we’re obviously not talking about deducting losses. In the discussion that follows, we assume at all times that the constructive sale rules don’t apply to the short sale.

Full coverage of the constructive sale rule appears in Capital Gains, Minimal Taxes.

Two Different Questions

Most of the difficulty surrounding the application of the wash sale rule to a short sale stems from a failure to recognize that it involves two different questions:

  • Under what circumstances will a replacement purchase of stock cause a short sale to be a wash sale?
  • Under what circumstances will an additional sale of stock cause a short sale to be a wash sale?

We have these two different questions because a short sale can be used in two different ways. First, it can be a funky way to sell stock you already own. If you end up with a loss, you lost money because the price of the stock went down while you held that stock. In this case a replacement purchase would produce a wash sale.

A short sale can also be a way of taking a negative, or bearish, position on a stock. If you lose money from a short sale that’s closed with stock you didn’t own at the time of the wash sale, it’s because the price of the stock went up while you were short. Just the opposite of the previous case! In this situation, you should get a wash sale when you make an additional sale of stock within the wash sale period.

Buying Replacement Stock

Suppose you bought 100 shares of XYZ at $80 only to see its price plummet to $30. You want to report a loss on your tax return, but you feel the stock is poised for a rebound so you don’t want to part with it. You come up with the following scheme.

First, you enter into two simultaneous transactions. You buy another 100 shares of XYZ at $30, and you sell short 100 shares of XYZ, also at $30. Overall your position hasn’t changed: instead of simply owning 100 shares, you hold 200 shares and have an obligation to deliver 100 on the short sale. You wait 31 days, then close the short sale with your original shares.

The overall result? You’ve never changed your position in the stock. You started out owning 100 shares and ended up owning 100 shares. In between you owned 200 shares and you were short 100. But now the old shares are gone and you have other shares in their place. It’s clear that the wash sale rule should apply.

And, in fact, the regulations confirm this. They say you use the date you entered into the short sale, not the date you closed the short sale, to measure the wash sale period if you close the short sale by delivering stock you owned at the time of the short sale. In the transaction described above, you bought replacement stock at the same time you made the short sale, so the wash sale rule applies.

What if you close the short sale at a loss using stock you didn’t own at the time you entered into the short sale? The regulation implies that you would have a wash sale if you bought replacement stock within 30 days of the date you closed the short sale. This doesn’t make any sense, because your loss in this case results from a short position, not from a long position. You’re not replacing the position that produced the loss if you buy more shares within 30 days of closing the short sale. Nevertheless, it’s possible the IRS would take the position that the wash sale applies in this situation.

Making Another Sale

Suppose you’re expecting a stock to go down, and you decide to sell it short without owning any shares. You have an overall short position in the stock. To your chagrin, the stock’s price rises, so you’re holding a losing short position. You still expect the stock to fall, so you want to remain short on this stock. What happens if you buy stock to close the short position, then immediately establish a new short position?

That’s just the mirror image of a classic wash sale. Curiously, although the wash sale rule harks back to the 1920s, this particular transaction wasn’t covered until 1988. Still more curiously, the Treasury hasn’t seen fit to provide regulations explaining how this “new” rule works, all these years later.

There’s no question the rule applies in the situation described above. In fact, it appears to apply any time you close a short sale at a loss and, within the wash sale period, either enter into a new short sale or even simply sell additional shares you already owned.

There’s one situation where it shouldn’t apply. It’s the flip side of the situation described earlier for new purchases. If you close a short sale at a loss by delivering shares you held at the time you entered into the short sale, your loss was incurred on the long position, not on the short position. It shouldn’t matter if you make another sale (short sale or regular sale) within 30 days of closing the short sale. But the law appears to treat this situation as a wash sale.