What is a Short Sale?

A short sale is a type of real estate transaction in which a property is sold for an amount less than the bank is owed. As the term “short sale” implies, the bank comes up “short,” but it may decide that allowing the property to be sold is a better deal than foreclosing on it and handling the sale that way. Short sales are typically used by people who owe more on their homes than the home is worth, or by individuals who have difficulty making their mortgage payments.

In order for a short sale to take place, the mortgage holder must approach the bank and request a short sale. In some cases, this may be done after the bank has started issuing notices indicating that the borrower is in default on the loan, and in other instances, the borrower may recognize that a problem is looming, and opt to get proactive about contacting the bank. Essentially, the borrower must ask permission from the bank to sell the property for less than the borrower owes, with the borrower then turning over the amount of the sale to the bank.

Banks usually want to recover the full amount of a loan, if at all possible. However, they also want to avoid foreclosing on a property, because foreclosure can be time consuming and expensive, and the bank does not want to end up owning the property and having to sell it. For this reason, if a borrower can put forward a persuasive case to the bank, the bank may indicate that it will consider a short sale.

In a short sale, when the property is listed with a real estate agent, the sale is described as “contingent on short sale agreement.” Every offer tendered to the seller also has to be submitted to the bank, and the bank has the right to refuse offers. Once the bank accepts an offer, the sale of the property can happen as it normally would, and when the sale is complete, the bank gets the proceeds.

For borrowers, going through a short sale is definitely better than being foreclosed on. Short sales will still negatively impact a credit report, but not as severely, and they allow a borrower to get out from under the debt. Borrowers should be aware that the debt is not necessarily always forgiven in the sale, and it pays to have a lawyer review the terms of the short sale agreement to determine whether or not the bank is forgiving the debt. If the debt is forgiven, it is also treated as taxable income, which means that the borrower will need to declare it and pay taxes on it come tax time.

People interested in buying real estate can sometimes get a good deal with this type of transaction. However, the process is slightly more involved, and subject to the bank's approval, which can be stressful. Furthermore, potential buyers should always take a look at the prices on comparable properties in the area, especially if there is a downturn in real estate values, as it may actually be cheaper to buy on the open market than to make an offer on a short sale or foreclosed home.