What is a Short Sale?

A short sale is when a mortgage is being sold “short” of what is owed, meaning the bank is taking a loss. The proceeds from the sale are used to repay the lender. The lender then accepts the less-than-full repayment of the mortgage (and the borrower may be released from the mortgage obligation) in order to avoid what would amount to larger losses for the lender if it were to foreclose on the mortgage.

Most short sales arise when a seller owes more on their house than they can sell it for. The owner of the home then attempts to make an arrangement with their lender to sell the house for less than what is owed. Despite popular belief, a seller does not have to be behind on their mortgage to request a short sale. They just have to demonstrate that the house cannot be sold for what is owed.

Is attempting a short sale a good idea for you?

First of all, when making an offer on a short sale, you must know if you are really getting a good deal. Many people think short sales are always good deals but in fact, if you don’t know what you’re doing, you could end up paying full retail or even more. How? For one thing, short sales take a very long time (in most cases six to eight months minimum). So, if you make an offer on a short sale and the neighborhood values continue to drop, by the time the bank makes a decision your offer could be higher than the value of the property.

And, rather than accept your offer, the bank may make a counter offer. This can happen even after you have waited months for their response. Of course, the bank may not accept your offer at all. And during your wait time, the homeowner may do a loan modification which means they will be able to keep their house. Point being, expect delays. Short sales are not easy or fast.

Before you decide to attempt a short sale, consider the following to determine whether you may qualify. You need to be able to answer “yes’ to these requirements or you may not qualify for a short sale.

1. The Home’s Market Value has Dropped
Comparable sales must show that the home is worth less than the unpaid balance due the lender.

2. The Mortgage is in or Near Default
It used to be that lenders would not consider a short sale if the payments were current, but that is no longer the case. In certain instances, they will work with a mortgagee before they are behind.

3. The Seller has Fallen on Hard Times
The seller must submit a letter of hardship that explains why they cannot pay the amount due, including why the seller has or will stop making payments.

Examples of accepted hardships are:

1. Unemployment
2. Divorce
3. Medical emergency / sudden illness
4. Bankruptcy
5. Death

The lender will want to see a copy of the seller’s tax returns and/or a financial statement. If the lender discovers assets, the lender may not grant the short sale because the lender will feel that the seller has the ability to pay the shorted difference. Sellers with assets may still be granted a short sale but could be required to pay back the shortfall. However, the lender might discount the amount the seller is required to pay back. Many entities profit from short sales, but there is no seller short sale profit.

Other things to consider:

A short sale is dependent on a buyer making an offer to purchase. If you do not receive an offer, you will not qualify for a short sale. Even if you meet all the other criteria, it is possible that no one will buy the short sale. A short sale 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, the lender may possess the right to issue a 1099 for the shorted difference. Many situations are exempt from debt forgiveness, according to the Mortgage Forgiveness Debt Relief Act of 2007.

Check with 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, if there are any.

A short sale will show up on your credit report. Short sales affect credit ratings. Your score may drop 75-100 points. While the damage to your credit report may not seem as bad as a foreclosure, creditors may not make a distinction.

Check your options. Talk with your lender and your real estate attorney as well as your tax adviser. Whatever you decide to do, make sure your decision is an informed one.

Whether you’re buying or selling with a short sale, let me know your experience and… good luck!