What is a Short Sale?

What is a short sale?

A short sale is when a seller facing foreclosure works with the lender and they agree to accept less than the amount owed as payoff on a home as a means of avoiding foreclosure.

Generally, lenders will only accept a short sale when the homeowner is behind on payments, and is facing a financial hardship. There are cases when a lender will entertain a short sale when the homeowner is facing a hardship but are not yet behind. If there is no financial hardship, the homeowner is not behind, and there does not appear to be an imminent hardship, the lender will not accept a short sale. The property simply being upside down in value does not constitute a hardship in the lender's eyes.

How does it work?

The first thing the borrower should do when they can no longer afford a property is to contact the lender immediately. The last thing a lender wants to do is foreclose on the property. Lenders typically have departments that work with people who are behind on their payments to resolve the situation. That department is called the "loss mitigation" or "workout" department, depending on the lender.

The lender will usually require the borrower to submit a lot of information to the lender in order to consider the short sale. The information required may include:

• Income documentation such as W-2s or tax returns (typically the last 2 years' worth) and pay check stubs (usually the last 2) to verify the borrowers’ income.

• Bank statements to verify the borrowers’ assets (last 2 months worth)

• Hardship letter – this letter will describe for the lender the reasons the borrowers are in the financial position they are in and will ask the lender to accept the short sale. Borrowers should make this letter sound as sad as possible and back up the story with any documentation you may have such as medical bills, etc.

• Fair market value for the property – The lender will order a BPO (Broker's Price Opinion) or sometimes a full appraisal on the property, depending on the lender, to determine their own value.

• Preliminary proceeds sheet from the sale of the property. (Sometimes called a Net sheet, HUD-1 settlement statement or "HUD" for short) This will show the proceeds of the sale of the property after the mortgage is paid off and all other closing costs and fees are paid. This will be negative in the case of the short sale and this negative amount is the amount of the shortage.

• Listing agreement and purchase agreement when they are available. (a lender will not even talk about a short sale in most cases until an offer is received.)

When the lender reviews all of this they may or may not approve the short sale. If they do not approve the short sale they will proceed with the foreclosure. If they do agree to the short sale you will close on the sale of your property and the lender will take the loss.

When the lender accepts a short sale, the bank will either pursue a deficiency judgment, or write the loss off. If the lender writes the loss off, they will issue a 1099-c statement. There are many situations and ways to avoid any tax on that 1099-c. I will create a separate post to address this issue as it deserves its own post.