A short sale is when a home is sold for less than the amount owed on the mortgage and the Bank has taken less than the full amount due on the balance. A seller may not have to be behind on a home loan to seek a short sale. If sellers wish to pursue a short sale, they must owe more than what the home is worth, demonstrate the house cannot be sold for the amount owed and suffer from an acceptable financial hardship that makes the mortgage payment unaffordable.
The first step in the short sale process is to assemble a short sale package. This package includes a financial statement showing monthly expenses, income documentation, bank statements, two years of tax returns, a listing agreement, purchase agreement, an estimated HUD statement and a financial hardship letter from the seller explaining their circumstances.
If the home is sold as a short sale, there will be a difference between the mortgage amount owed and what the bank collects. This is called the shortage or deficiency. Sometimes the deficiency may be negotiable. Some banks will seek a promissory note for the deficiency, meaning that the seller may be responsible to pay the difference between what the home sold for and what is owed to the lender. Some lenders might choose to file a collection or a judgment for the amount owed. The seller should be certain that any amount of debt, or release from debt, is received in writing. If the deficiency is forgiven, the lender can write off the shortage with the IRS, which means the seller may be responsible for paying taxes on the amount of the deficiency. However, the Mortgage Debt Relief Act of 2007 generally allows taxpayers the potential for relief from tax on mortgage debt forgiveness.
Challenges inherent in a traditional short sale often include unacceptable timeframes to list and complete the sale, and a relatively low rate of success in short sale approvals. There are currently no standardized forms used by lenders for traditional short sales, making it a challenge for Agents to navigate short sale paperwork. Lenders and servicers can also cut agent commissions.
A short sale will affect the seller’s credit score. To minimize the effect on their credit score, sellers should avoid making late payments on their mortgage when possible, and work with the bank to report the sale in the best possible manner. From a credit standpoint, a short sale is always a better alternative to foreclosure.