What is a Short Sale?
A short sale occurs when the sales price of a property is too low to pay off the mortgage balance(s) and all other necessary selling expenses (closing costs, other liens or judgments, etc). In this case, a lender may agree to accept less than what they are owed to allow the sale to proceed. Although there are exceptions, lenders will usually require some proof of a financial hardship before agreeing to discount the outstanding mortgage balance. There are also many other criteria that lenders consider in the decision to approve a short sale and that approval must be received for a sale to occur. Approvals are usually obtained by communicating and negotiating with a bank's loss mitigation department. If approved, the lender receives the proceeds from the short sale. Although the sellers receive no proceeds, they are usually relieved of at least a sizable portion (and many times all) of the mortgage debt.
What a Short Sale is Not - A Foreclosure!
A short sale is not foreclosure. In fact, a short sale is a means to prevent foreclosure. In Pennsylvania, foreclosure is the legal process that banks must follow in order to have a property sold at a Sheriff's Sale to recoup the debt owed to them by a defaulting borrower. The Sheriff's sale is the ending event of the foreclosure process and often takes 4 months or more from the initial filing of a foreclosure complaint by the lender. Because of the legal fees, filing fees, Sheriff's fees, and months of accruing mortgage interest, foreclosure is a very expensive process for the lender. In many cases, a bank would rather take a smaller loss via a short sale rather than risk an even greater loss after foreclosure. This is especially true if a short sale can be completed before foreclosure is initiated and foreclosure costs start to accumulate onto the debt owed to the bank.
What Information is Typically Needed to Facilitate a Short Sale
- Authorization - If a third party (Realtor, attorney, etc) is going to coordinate and negotiate a short sale on the borrower's behalf, the banks will usually require a written authorization in which the borrower gives the bank permission to discuss the loan and provide information to that third party. This authorization must be signed by the borrower and may require specific language depending on the particular bank. Once submitted to the bank, it can take as much as 2 weeks for the bank's short sale department to recognize the authorization in their system. Don't delay in submitting the authorization.
- Complete financial information summary - Banks typically have their own form and request information on income, assets, debts, and other expenses.
- Proof of income - Tax returns, W2's, and/or current pay stubs
- Bank statements - At least 2 most recent months
- Hardship letter - explaining the reason(s) for not making payments and requesting the short sale
- Appraisal or Comparative Market Analysis - showing appraised value or market value of the property
- HUD-1 Settlement sheet - Showing the net offer to the bank
- Agreement of Sale
- Listing Contract
- Potential taxes on the Forgiven Debt - The IRS may view the debt forgiveness as income and assess income tax on that forgiven debt. For example, if your outstanding mortgage debt is $200,000 and the lender agrees to accept $175,000, you could be responsible for income tax on the $25,000 of the forgiven debt (even though you never received $25,000). There are exclusions under the Mortgage Forgiveness Debt Relief Act of 2007 that allow borrowers to avoid these taxes if they are selling their principal residences. You should check with a competent CPA or tax attorney to determine if these exclusions would be applicable to your particular situation.
- Deficiency Judgment(s) - Unless you obtain a written, "full satisfaction" of the mortgage debt, the lender could sue for a deficiency judgment against you for any unpaid balance. Not only could you still be responsible for the unpaid balance, but there may be other consequences to a deficiency judgment. In Pennsylvania, lenders have 6 months from the date of sale to file for a deficiency judgment.
- Documentation, experience, and patience are keys to successfully completing a short sale.
Advantages to a Short Sale
Although there are many very detailed differences between the results of a short sale and the results of a foreclosure, here are a few general advantages of a short sale for home sellers.
- A short sale has significantly lesser impacts on your credit history and your ability to obtain future credit.
- Unlike a foreclosure, a short sale should also have no impact on your current or future employment and security clearances.
- With a short sale, you at least have the opportunity to negotiate for a "full satisfaction" of the mortgage debt and thereby may avoid a deficiency judgment. With a foreclosure, you have no such control of the situation and could be liable for deficiency judgment after the sale.