A short sale is something that many home owners have heard about, but few really understand. Even experienced real estate agents have a lot of bad information about the short sale process, how it works and how best to utilize it.
Recently a prominent real estate “expert” was on a national TV show and provided false information about short sales because they didn’t completely understand the rules.
So here is a quick guide to understanding what exactly is a short sale and how does it work?
A “short sale” is a sale of real estate in which the proceeds from the sale (sales price) fall short of the balance owed on the loan tied to the property being sold.
In a short sale, the bank or mortgage lender agrees to accept less than the loan balance for the house in order for it to sell. It is allowed due to a financial hardship by the seller, and the bank’s belief they would receive less money for the property if they foreclosed and tried to re-sell the home.
While a short sale will prevent a foreclosure and is better for a seller’s credit overall, because it is tied to the sale of the home, a home owner can not remain in the house and use a short sale to reduce their mortgage balance.
The typical process for a short sale is as follows:
- A home owner enters into a contract to sell their home with a real estate investor or retail home buyer.
- The real estate agent (or investor) contacts the lender’s Loss Mitigation department to negotiate the terms of the short sale.
- The lender will want to see proof of financial hardship by the seller, documents to show a value on the home lower than the loan balance, and will order a broker’s price opinion (BPO) or appraisal on the property.
- If the lender agrees to the short sale, the sale of the home will proceed, and the full loan amount will not need to be repaid. The lender will not allow the home seller to receive any money from the transaction, since they are forgiving a portion of the debt.
- The IRS does not collect tax on forgiven debt in a short sale (in general). It has been widely reported (incorrectly) that short sale debt forgiveness is taxed. The 2007 Mortgage Forgiveness Debt Relief Act allows individuals to exclude from income debt forgiveness on their primary residence. Prior to this act, if a seller was ‘insolvent’ the IRS may not view the debt as income. As always check with a CPA to ensure the rules apply to an individual situation.