How Short Sales Work


Tips for a Successful Short Sale
Real estate agent Shellie Young (right) shows a short sale home to David Sandlin in Miami.
Real estate agent Shellie Young (right) shows a short sale home to David Sandlin in Miami.
Joe Raedle/Getty Images

The first buyer tip for a successful short sale is to use a real estate professional with short sale experience [source: Freddie Mac]. Short sales are complex real estate transactions that require a deep understanding of determining fair market value, how lenders work and what they need to see before they approve a short sale.

In general, avoid homes that carry multiple mortgages and liens on the property. Every additional lender will add months to the approval process and decrease the chances that the deal will ultimately go through. Save yourself some heartache and stick to the properties with only one mortgage lender.

Don't make a lowball offer [source: Toy]. The best you can expect on a short sale is a price slightly below the established fair market value. Remember, the lender is already taking a loss on a short sale, so he's in no mood to be making deals. Keep all offers within a range of comparable sale prices in the neighborhood.

Show that you're a serious buyer. Come with your mortgage preapproval letter and a sizable earnest money deposit, as well as your purchase contract and comp information to demonstrate your offer is realistic [source: Freddie Mac]. The bank will be more likely to approve a sale with a fully committed buyer.

Don't attempt to cheat the system by buying a short sale home from a friend or relative and renting the house back to them. That's illegal according to the rules of arm's length transactions. In real estate, the sales price must be determined by fair market value, not a "friendly" arrangement between two relatives [source: Investopedia]. A short sale between two family members or close friends will not be approved.

Submit all paperwork and documentation in a timely fashion, whether you are the buyer or seller. There is a certain amount of bureaucracy with any real estate transaction (if you've ever attended a closing, your wrist probably still hurts from all of the documents you signed). Short sales add an additional layer of documentation, particularly to prove hardship.

Sellers, be aware of the tax implications of a short sale. In most cases, the IRS treats canceled debt as income. If your lender forgives the $100,000 balance that you owed on your mortgage, the Internal Revenue Service will tax that $100,000 as income. There are exceptions to this rule if the home was your principal residence or you were financially insolvent before the debt was canceled [source: IRS]. Either way, it seems like a good time to call your accountant.

Author's Note: How Short Sales Work

Every time I read about the millions of American homes in foreclosure and the damage inflicted by defaults and bankruptcies, I say a silent prayer of "thanks" to my buddy Sean. Back in 2005, my wife and I considered buying an investment property in Boise, Idaho. At the time, home prices across the western U.S. were skyrocketing. My brother-in-law had just cashed in on a place in Arizona and was convinced that Idaho was poised to explode.

In the dead of winter, we drove around suburban Boise with a real estate agent who was equally convinced of the city's prospects as the next Phoenix or Las Vegas. We found a modest two-bedroom in our price range with long-term renters. Before we knew it, we had signed an offer and handed over $1,000 in earnest money. While we waited for the seller to respond, we visited our friend Sean in nearby Salt Lake City, Utah. As we shared the exciting news of our pending plunge into real estate investment, Sean calmly took out a pen and paper.

He wrote down a few key figures, notably the difference between our rental income from the property and our monthly mortgage payment. Then he sketched a best-case scenario for how much property values would increase over the next two years. He reminded us that we would owe a 25 percent capital gains tax if we sold the home as an investment property rather than a principal residence. At the end of his calculations, we realized that home prices would have to skyrocket 10 percent or more per year for us to make a profit on this place.

Minutes later, our real estate agent called to say that the buyer had accepted our offer. We were the proud owners of a house in Boise! The only way out would be to sacrifice our earnest money. We call that our $1,000 class in Real Estate 101. Thank you, Sean. Without you, we'd be the proud upside down owners of an underwater property in Boise.

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Sources

  • Bank of America. "Traditional Short Sale Process." (Oct. 16, 2013) http://homeloanhelp.bankofamerica.com/en/short-sale-process.html
  • Consumer Financial Protection Bureau. "What is a 'deed-in-lieu of foreclosure?'" May 15, 2013. (Oct. 16, 2013) http://www.consumerfinance.gov/askcfpb/291/what-is-a-deed-in-lieu-of-foreclosure.html?gclid=CJD1wrXFm7oCFcZlOgod_wIAxw
  • Gaskin, Joanne. "Research looks at how delinquencies affect scores." FICO Banking Analytics Blog. March 24, 2011. (Oct. 13, 2013) http://bankinganalyticsblog.fico.com/2011/03/research-looks-at-how-mortgage-delinquencies-affect-scores.html
  • Guerra, Tony. "Basic Foreclosure Fees & Costs." Demand Media. (Oct. 16, 2013) http://homeguides.sfgate.com/basic-foreclosure-fees-costs-61248.html
  • Freddie Mac. "Buying a Short Sale Property: FAQs" (Oct. 16, 2013) http://www.freddiemac.com/purchasemarket/ssfaq.html
  • Investopedia. "Arm's Length Transaction." (Oct. 16, 2013) http://www.investopedia.com/terms/a/armslength.asp
  • IRS. "The Mortgage Forgiveness Debt Relief Act and Debt Cancellation." (Oct. 16, 2013) http://www.irs.gov/Individuals/The-Mortgage-Forgiveness-Debt-Relief-Act-and-Debt-Cancellation-
  • National Association of Realtors. "Record number of foreclosures in 2009." Jan. 14, 2010. (Oct. 16, 2013) http://www.realtor.org/rmodaily.nsf/pages/News2010011404
  • Toy, Vivian S. "The Roller-Coaster Ride Called a Short Sale." The New York Times. July 23, 2010. (Oct. 16, 2013) http://www.nytimes.com/2010/07/25/realestate/25cov.html?adxnnl=1&pagewanted=all&adxnnlx=1381935362-xblL0Av8FWMFQZTaiGPDuw
  • Weston, Liz. "Credit scores will plummet with a short sale." Los Angeles Times. April 10, 2011. (Oct. 16, 2013) http://articles.latimes.com/2011/apr/10/business/la-fi-montalk-20110410
  • White, Martha C. "Want to Buy a Foreclosure? Here's What You Need to Know." Time. May 16, 2012. (Oct. 16, 2013) http://business.time.com/2012/05/16/want-to-buy-a-foreclosure-heres-what-you-need-to-know/

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