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What is a Short Sale?

short sale is when a bank or mortgage lender agrees to discount a loan balance due to an economic or financial hardship on the part of the mortgagor. The home owner/debtor sells the mortgaged property for less than the outstanding balance of the loan, and turns over the proceeds of the sale to the lender in full satisfaction of the debt. In such instances, the lender would have the right to approve or disapprove of a proposed sale.

Extenuating circumstances influence whether or not banks will discount a loan balance. These circumstances are usually related to the current real estate market climate and the individual borrower's financial situation.

A short sale typically is executed to prevent a home foreclosure. Often a bank will choose to allow a short sale if they believe that it will result in a smaller financial loss than foreclosing. For the home owner, the advantages include avoidance of having a foreclosure on their credit history and the partial control of the monetary deficiency. Additionally, a short sale is typically faster and less expensive than a foreclosure. In short, a short sale is nothing more than negotiating with lien holders a payoff for less than what they are owed, or rather a sale of a debt, generally on a piece of real estate, short of the full debt amount.
 
Negotiatons:

Lenders have a department (typically called a loss mitigation department) that processes potential short sale transactions. Typically, lenders do not accept short sale offers or requests for short sales until a Notice of Default has been issued or recorded with the locality where the property is located.

Lenders have a varying tolerance for short sales and mitigated losses. The majority of lenders have a pre-determined criteria for such transactions. Other distressed lenders may allow any reasonable offer subject to a loss mitigator's approval. "Red tape" is very common in short sales, similar to real estate owned (REO) and HUD properties, requiring potentially multiple levels of approvals and conditions. Junior liens - such as second mortgages, HELOC lenders, and HOA (special assessment liens) - may need to approve of the short sale. Frequent objectors to short sales include tax lieners (income, estate or corporate franchise tax - as opposed to real property taxes, which have priority even when unrecorded) and mechanic's lien holders. It is possible for junior lien holders to prevent the short sale.

Mortgage Forgiveness Debt Relief Act of 2007

When the lender decides to forgive all or a portion of a borrower's debt and accept less, the forgiven amount is considered as income for the borrower and is liable to be taxed.

However, after the signing of The Mortgage Forgiveness Debt Relief Act of 2007 by President Bush, amendments have been made to remove such tax liability and allow the borrower and lender to work freely together to find a common solution that is beneficial to both parties. This protection is limited to primary residences so consultation with a tax advisor is necessary ensure that a borrower qualifies.

Credit reporting:

A short sale does not adversely affect a person's credit report beyond documenting the short sale as "foreclosure proceedings started". But it does count against a person's credit to about the same degree as a foreclosure by similarly remaining on the report for 7 to 10 years[citation needed] and, most often, prevents the issuance of any mortgages for a number of years.[citation needed]

While it is frequent if not common for a lender to forgive the balance of the loan in question, it is unlikely that a lien holder that is not a mortgagee will forgive any of their balance. Further, it is common for a lender to omit updating the zero balance and settlement option on the mortgagor's credit report, or even flat refuse to do so "due to their financial loss."

Answers to Questions you may have about Short Sales:

Homes Sell "As Is".

If a mortgage company agrees to a short sale, it is most likely also paying the closing costs in the transaction. Lenders ask buyers to purchase the home in its present condition. Lenders typically will refuse to pay for:

Length of Time to Close
Depending on when the Notice of Default was filed, the lender's back-log of foreclosures and how much paperwork the seller has already submitted, it could take anywhere from two weeks to two months to get a response on a purchase offer from a lender. In addition, if two lenders are involved because there are two loans secured to the property, it could take longer to satisfy the demands of the second lender.

Lenders Can Change Conditions

Some lenders reserve the right to renegotiate the terms of the short sale at the last minute. If the market changes, new laws pass or new information crosses the lender's desk, the lender can attempt to change the terms of the contract. Lenders generally have lawyers at their disposal, and ordinary buyers do not.

Lose Control of Transaction
If you need to close escrow by a specific date, lots of luck with that. A short sale home closing process takes an indefinite amount of time. The seller's lender calls the shots, not the buyer nor the buyer's lender. If you are trying to close escrow concurrently with the sale of your home, it might not happen.

Homes Sell at Market Value
Lenders aren't naive or unaware of the value of a home. Lenders will insist on a comparative market analysis, known as a CMA, or broker price opinion, known as a BPO. If a lender believes a better price can be obtained by taking the property back in foreclosure over a short-sale offer, the lender may hold out for a higher price. That price will be close to market value. Lenders accept short sales when the home is worth the short-sale price, which means market value.
Stringent Qualifications
 
Inexperienced or unethical real estate agents might push a seller into considering a short sale when the seller does not qualify for a short sale. Sellers must prove a hardship and submit evidence of the hardship to the lender for approval. Some agents list homes as short sales without ever talking to the lenders or pre-qualifying the sellers.