A short sale occurs when home is sold for less than the total amount owed on all mortgages, the mortgage holders agree to accept the sales proceeds and the mortgage holders write off the remaining debt.

The difference between the amount that was owed and the amount that was accepted to satisfy the debt is known as cancelled mortgage debt or forgiven debt.

A short sales can occur if and when:

  • A homeowner has little or no equity in a house
  • A home was overpriced when it was originally purchased
  • Housing prices have dropped sharply since the home was purchased
  • The homeowner has to sell quickly and accepts a low offer
  • A homeowner is in danger of foreclosure

Homeowners must work with their bank's loss mitigation department to arrange for a short sale. The lender is only likely to approve a short sale if they determine that the forgiven debt is less than they would be likely to spend on foreclosure proceedings. If the lender does not approve the short sale, but the homeowner still sells the home for less than the amount owed on the mortgages, then the bank will expect the homeowner to pay the full balance that is owed on the mortgage.

Advantages of a Short Sale

A short sale offers an advantage to the homeowner because a portion of the debt is forgiven and homeowners can avoid foreclosure, if that was a possibility. Unlike a foreclosure, a short sale does not damage a homeowner's credit report. But if the homeowner missed mortgage payments or was late making mortgage payments, those will still appear on the credit report.

Home buyers who purchase a property during a short sale have the advantage of getting a discounted price on the property. However, if housing prices have recently declined or home sales are slow in the neighborhood, the buyer may have to wait several years before they can realize a gain on their investment.

Although lenders lose money when agreeing to a short sale, lenders are likely to approve the sale if foreclosure proceedings would be more expensive than the forgiven debt. In addition, foreclosure proceedings give lenders full ownership of a property, and most lenders do not want to own property. Many banks would prefer to forgive debt than to have to pay maintenance and real estate agent fees while trying to sell a home themselves.

Tax Implications

Traditionally, the Internal Revenue Service considered the cancelled mortgage debt to be taxable income. However, the Mortgage Forgiveness Debt Relief Act of 2007 changed the tax law. Between 2007 and 2009, the IRS will not tax cancelled mortgage debt on your principal residence. Forgiven debt on second homes and investment properties is still considered to be taxable income.

Questions for Your Attorney

  • Do you have experience handling cases like mine?
  • Is a short sale preferable to foreclosure or filing bankruptcy in my situation?
  • Should I try to sell my house at a higher price before pursuing a short sale, or is a quick sale more important?