Question of the Week: What is a Short Sale?

Q: What is a short sale?

A: A short sale occurs when a seller does not have adequate funds to pay off their loan and the lender agrees to accept a lower amount, usually in order for both sides to avoid foreclosure.

In a normal sale, the seller must come up with the full loan balance in order to pay off the bank. In a typical short sale, the seller is allowed to sell the property for less than the outstanding loan amount, with the lender agreeing to accept the loss.

Banks will sometimes agree to a short sale when it will be cheaper and faster than going through the foreclosure process. However, not all lenders will even consider short sales, and even if they do, it is not a simple process.

In order for a lender to consider a short sale, the seller must provide proof of economic hardship to their lender, usually in the form of a written hardship letter as well as an exhaustive financial report detailing all earnings and spendings. According to Realestatejournal.com:

you must prove that you really can't pay your loans -- and that the reason is new, not something that you concealed from your lenders when you originally applied for the loan.

In addition, the seller must also provide the lender with an estimate of how much the sale will cost the lender. This is usually done by providing an estimated HUD-1, which tallies sales price, loan balance, accrued interest, closing costs - including agent commission if applicable, and unpaid property taxes.

If you have more than one mortgage, loan, or lien on your property, odds are you will have to go through this process for each lender or institution you owe.

While the essence of a short sale is that the lenders allows the seller to "come up short" when paying off their loan balance, not all lenders are so forgiving - and the government definitely isn't. According to Realestatejournal.com:

Some hard-nosed lenders may insist that you pay the difference between what the buyer pays for the house and what you owe on the mortgage. Others may forgive that portion of the debt -- but unfortunately, Uncle Sam won't. "Forgiven" debt is considered taxable income.

A short sale is not an easy way to get right side up in your upside down home. There are risks and downfalls. It will go on your credit report, although it will not be as devastating as a foreclosure would be. There is a lot of negotiating and hard work involved, and as the bank is often willing to pay a real estate agent's commission, having an agent help you through the process is a good idea.

Below are some more resources with information on short sales -keep in mind that short sale procedures vary from lender to lender and region to region, so make sure to check with a real estate professional in your area if you have any questions.

The New Exit Strategy: A Short Sale [Business Week]
After the Short Sale: Taxing What Isn't There [REALTOR.org]
Short Sales Set Sail Again [Realty Times]
Short Sales in Real Estate [About.com]