An area of extreme interest, much discussion and a great deal of misunderstanding, a “short sale” is simply a real estate closing where the sales price of the real estate (single family home, condominium, townhouse, 2-flat, etc.) is not high enough (it is “short”) to cover the existing mortgage or mortgages. In order for the closing between Seller and Buyer to take place, the mortgage lender(s) needs to agree to release its mortgage lien against the property for an amount less than is owed on the mortgage, so that the Buyer can obtain a clear title. Except for this one aspect, a short sale is not any different than any other real estate closing.
The Seller needs to find a Buyer, whether through a realtor or on their own. The Seller and Buyer agree on a price and other terms ( when the closing will take place, when the Seller will move out, what goes with the property, etc.), a contract is prepared, and then signed by the parties. It is important for the Seller to have a clause in the contract that allows the Seller to back out of the deal if the Seller is unable to get his mortgage lender(s) to agree to reduce the mortgage balance(s).
The process of negotiating with the mortgage lender(s) is complicated, time consuming and frustrating. Having a realtor and/or an attorney experienced in negotiating with the mortgage lender(s) is quite important.
The value to the Seller in selling the property “short” (through a short sale) is to avoid having a foreclosure on the Seller’s credit report. If a foreclosure has been started and the property is subsequently sold “short”, the foreclosure is dismissed and would have no effect or very little effect on the Seller’s credit.
The Seller will generally not be allowed to “walk away” with any money from the real estate closing. This is because the mortgage lender(s) is reducing what is owed to it and will not agree to allow the Seller to have any proceeds. This is one of the common misunderstandings by many homeowners, thinking that they will be allowed to receive a monetary benefit from a short sale.
A second misunderstanding is that Sellers think they are entitled to sell short, that all they need to do is obtain a buyer and the mortgage lender(s) will agree to accept less money. This is a misconception and results in many disappointed Sellers. More often than not, mortgage lenders do not agree to a short sale. However, sometimes when they do, they require that the Seller signs a promissory note to repay to the mortgage lender the difference between what the lender receives at the closing from what is owed. This happens quite often with a second or junior mortgage or home equity loan. Unless the amount is small and affordable to the Seller, it is rare that it makes any financial sense to do this. In such a situation, it may make more sense to file a bankruptcy in order to avoid an deficiency that would be due on the mortgage(s).
A third issue to consider is that of income taxes. Unless the property is your primary residence, the Seller will be issued a 1099 for the amount of deficiency forgiven by the lender. Unless insolvent at the time, the Seller may be required to pay income tax on the loss to the lender.
From the perspective of the Buyer, be prepared for the process to take quite some time from the date of the signing of the contract to the date of the closing. Make certain that any down payment is held in escrow to make it easier to receive your refund if the deal falls apart. As with the Seller, you may also be disappointed that what you thought might be a great deal may fizzle out and die. There is no guarantee that the Seller will able to have the mortgage lender agree to a sufficient reduction of the mortgage to allow the deal to close.
Both Sellers and Buyers should be represented by experienced real estate attorneys and should check with their accountants with regard to any tax consequences.
