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How does a short sale work?

| Jul 15, 2020 | Firm News |

Homeowners who are behind on their mortgage payments and owe more than their property is currently worth may benefit from a short sale. While this solution results in the loss of the property, it may prevent foreclosure and rescue people from the pressures of overwhelming debt. 

Going the short-sale route is not necessarily quick, as the process often takes longer than a traditional sale due to the extra steps involved. 

Putting the property on the market 

The seller puts the property on the market listed as a short sale and notes that any offers are subject to the approval of the lender. Many buyers look for investment opportunities in short sale listings, so it may not be difficult to receive offers. However, the approval of the lender may not be so easy to acquire. Mortgage companies generally weigh whether they will lose more from the short sale than they would a foreclosure before accepting an offer. 

Gaining approval from lenders 

The seller typically has to prove financial hardship to the lender, such as the following: 

  • A divorce that leaves either spouse unable to make the payment 
  • Reduced income from unemployment or underemployment 
  • A medical emergency 
  • The death of the primary income provider of the household 

In addition to the letter explaining the hardship, the request package also may include tax returns for at least two years, payroll stubs, a financial statement, bank statements and other documents as outlined by the lender. 

The lender does its own determination of the value of the property and hires negotiators. The seller may hire a professional to negotiate with the lender, and a buyer may also choose to have a negotiator. 

Once the lender approves an offer, the sale can go through, and at the end of it, the seller receives relief from the full amount of the debt. If the lender forgives the entire debt, the seller should check to make sure that the account on his or her credit report says the debt is “paid in full.” 

Identifying potential drawbacks to short sales 

One possible disadvantage to a short sale is that the lender could hold the seller responsible for any difference between the amount of the mortgage and the amount of the sale. For example, if the amount owed on the mortgage is $350,000 and the house sells for $300,000, the seller could still have to pay the mortgage company $50,000. However, companies frequently are willing to forgive the balance. 

In some cases, the IRS charges income tax on the forgiven debt. Often, sellers qualify for exemptions, though, so a significant tax burden is not a foregone conclusion. The former homeowner may still be able to leave the situation unencumbered by debt after a short sale.