Executing a Short Sale
What to Do When a Seller Owes More than their Mortgage
Real estate short sales have become far more common as real estate prices decline. Sellers could see short sales as a life line, but they are very hard to execute.
Short selling has become the new vogue word in the mortgage business. While many people at least vaguely understand the term in the stock market context, it tends to confuse many in the real estate arena. As home prices drop, however, many people should become more comfortable with the term short sale.
Short Sale Defined
Short selling occurs when a homeowner is allowed to sell his/her home below their mortgage value. If someone owns a home with a mortgage of $100,000, but can only sell the home for $90,000, the bank may allow this sale and forgive the $10,000 of mortgage they still owe. That is the simple version of the short sale; however, for many sellers this is a long and arduous process
Executing a Short Sale
In order to even be allowed to attempt a short sale, a homeowner must have permission from their bank. Without the bank's approval the sale cannot go through because the bank has the right to place a collateral lien on the house for sale. Until the mortgage is paid off the bank, for all intents and purposes, owns the house while allowing the homeowner to live in it.
The first thing to do when selling a house for less than the current mortgage is to contact the bank. Understand that short sells will take longer and will require significantly more paper work than a normal sell. This occurs because the bank is taking a financial loss by allowing the seller to do this. The seller must show financial hardship or some other plausible reason to be allowed to execute a short sale. In many markets (California, Florida, etc.) the dip in home prices makes it impossible for sellers to make up the price difference, which could be as much as $100,000 or more.
Remember, the bank is doing the seller a favor, so be prompt and patient with all of the bank's requests. Without their cooperation there is no way the seller can sell the house. Working with a mortgage broker and real estate agent familiar with the process will make this process go smoother. Call the bank often and, if possible, go down to see them in person. The more amenable the seller is to the bank, the more likely the bank will be to grant them a short sell.
Short Sales and Taxes
One very important watch-out in a short sale is the tax effect of a short sale. In many cases the amount of loan that is forgiven is considered TAXABLE INCOME. Yes, that is correct; the government looks at the bank's good favor as earned income, which therefore must be taxed. Consider a seller who gets a $100,000 break on their loan. This could result in a very large tax bill at the end of the year. Again, the best way to work this out is with a mortgage broker and a real estate tax accountant. Most of the time a consultation with a tax accountant is free. Get some advice before attempting a short sale because it may leave the homeowner owning the government a huge amount of taxes at year end.
