Short Sales

In real estate, a short sale is when a bank or lender agrees to discount a loan balance due to an economic hardship on the part of the homeowner. The homeowner sells the mortgaged property for less than the outstanding balance of the loan, and turns over the proceeds of the sale to the lender in full satisfaction of the debt. In such instances, the lender has the right to approve or disapprove of the proposed sale.

Extenuating circumstances influence whether or not banks will discount a loan balance. These circumstances are usually related to the current real estate market and the individual borrower's financial situation.

A short sale typically is executed to prevent a home foreclosure. Often a bank will choose to allow a short sale if they believe that it will result in a smaller financial loss than foreclosing. For the home owner, the advantages include avoidance of having a foreclosure on their credit history. Additionally, a short sale is typically faster and less expensive than a foreclosure.

Briefly, a short sale is nothing more than negotiating with lienholders a payoff for less than what they are owed, or rather a settlement of their debt, generally secured by real estate, at less than the balance of the loan.

Lenders have a department (typically called a “loss mitigation” department) which processes potential short sale transactions. Typically, lenders do not accept short sale offers or requests for short sales until a Notice of Default has been recorded in the county recorder’s office. Lenders have to approve of any buyer's or listing agent's commission in advance, a primary reason for non-brokered short sales with a specialist or facilitator to save on the margin. Many of these facilitators work with a private lending party for their financing, such as a partner or syndicate.

Lenders have a varying tolerance for short sales and mitigated losses. The majority of lenders have a pre-determined criteria for such transactions. Other distressed lenders may allow any reasonable offer subject to a loss mitigator's approval. "Red tape" is very common in short sales, similar to REO and HUD properties, requiring potentially multiple levels of approvals and conditions. Junior liens, such as second mortgagees, HELOC lenders, and HOA (special assessment liens), may also need to approve of the short sale. Frequent objectors to short sales include tax lieners (income, estate or corporate franchise tax - as opposed to real property taxes, which have priority even unrecorded) and mechanic's lien holders. It is possible for junior lien holders to prevent the short sale. It is also possible that senior lienholders may prevent a short sale by refusing to allow a junior lienholder to receive any of the sale proceeds.

It is frequent, if not common, for a lender to forgive the balance of the loan in question. But it is also common for a lender to omit updating the zero balance and settlement option on the mortgagor's credit report, or even flat refuse to do so "due to their financial loss."

When the lender decides to forgive all or a portion of a borrower's debt and accept less, the forgiven amount is considered as income for the borrower and is liable to be taxed. However, after the signing of “The Mortgage Forgiveness Debt Relief Act of 2007” by President Bush, amendments have been made to remove such tax liability. This now allows the borrower and lender to work freely together to find a common solution that is beneficial to both parties. However, at this point, this protection is limited to primary residences only. So consultation with a tax advisor is necessary ensure that a borrower qualifies.