If you can no longer make your mortgage payments and your home is now worth less than you owe on it, foreclosure may not be your only option. There is another, last ditch option – the short sale.
A short sale is the sale of a house for less than what the owner still owes on the mortgage. If the lender agrees to a short sale, the rest of the homeowner's debt typically is forgiven. Lenders sometimes agree to the procedure in order to take a small loss and avoid the lengthy and costly foreclosure process.
The benefit of a short sale is that it can be a win-win-win situation for seller, buyer and lender because:
•The seller gets out of the mortgage liability without facing
•The buyer gets the home at a reduced price;
•The lender agrees to a minimal loss without going through
foreclosure and/or getting stuck with a property that will not sell.
While it may seem surprising that lenders would agree to accept less than what they are owed on a property, they benefit from a short sale because it saves the costs associated with the foreclosure process - attorney fees, the eviction process, delays from borrower bankruptcy, damage to the property, and costs associated with resale.
For a buyer, a short sale is a benefit because he or she is getting a property at a reduced price. However, the process of waiting for a lender to decide whether to agree to a short sale can make a lengthy home-buying process longer and more risky. When you go into a short sale deal, you have an lender and it is an you don't get a chance to talk to these people, you don't know what their guidelines are, you don't know what their time frames are, and you don't know if your contract will be approved in six weeks or six months. You simply try and make the best offer on the property you can and hope to get their attention.
For sellers in financial distress, lenders are most concerned with the financial situation of the seller when they ultimately make their decisions. If a seller can handle the mortgage payment, there's no motivation for the lender to let the seller out of the mortgage at a lower price. A lender is not going to consider a short sale unless it the homeowner is in financial distress. Also, if the home has a second mortgage, a short sale is less likely to be approved, since that second institution would have to agree to forfeit all or part of the money it's owed.
While getting a lender to agree to a short sale may seem like an answer to the prayers of a homeowner who wants to unload a house, it's usually a last resort when the only other option is foreclosure. It depends on how deep a financial crisis the seller is in and how likely it is he or she will be able to overcome it. If a seller is just having a short-term financial problem, the lender most likely will not agree to a short sale. The seller must be ready to show the lender that the situation is serious.
Sellers should take the following steps to protect themselves in a short sale:
1. Get Everything in Writing. Make sure the lender agrees in writing that the short sale will absolve all debts. Most lenders will put in the agreement that they're not going to come after any shortfall;
2. Protect Your Credit. Ask the lender how it will report the short sale on your credit report. Most of the time, a short sale shows simply that a debt is satisfied. But a short sale could reflect on the credit report as 'settled for less than the full balance.'" Such a designation is a negative mark on your credit report, though it wouldn't hurt your credit as much as a foreclosure would.
3. Get Professional Advice. Short sales often have tax repercussions, since lenders can claim the forgiven debt as income that they provided you. That means if a seller agreed to a short sale for $50,000 less than what was owed the lender, the lender could issue a 1099 for $50,000, which the seller would have to pay taxes on. But there are two "outs." First, if the seller meets the IRS' definition of insolvency at the time the debt was forgiven, then he or she generally does not have to pay taxes on it. Second, if the home loan is a non-recourse loan, the seller can also likely to escape this tax. With a recourse loan, whoever signed the note is personally liable for the debt, and in a short sale, the debtor would have to pay tax on the difference. A non-recourse debt is one secured by the loan collateral -- such as the house itself -- and the debtor would not have to pay tax on the sale shortfall.