If you've taken out a large mortgage, and perhaps refinanced to cover remodeling or other expenses, you may find yourself unable to keep up with your mortgage payment after a layoff, divorce or illness. More and more people are finding they need to sell their homes for less than they owe on the mortgages, known as a "short sale."

Selling short is definitely better than foreclosure, which stays on your credit record for ten years. But it's best to try to work things out with your lender before going through the embarrassing and laborious process of selling your home on a short sale.

Tax Issues

Before you put your home on the market for a short sale, talk with a tax advisor about possible tax repercussions. The IRS may consider the difference between the value at which you sell your home and the mortgage balance as "income" on which you have to pay taxes.

An exception to this rule is if you can prove that you were "insolvent" - that your debts were bigger than your assets- before your mortgage lender agreed to a short sale of your property. A tax advisor will be able to determine whether you're insolvent by IRS standards.

If you can't prove you're insolvent, and the tax bill on a short sale would be more than you can pay, you may have to let the mortgage lender foreclose, or declare bankruptcy.

Be Upfront With Your Real Estate Agent

If you find selling you house for less than you owe on the mortgage is an option short of foreclosure or bankruptcy, you'll want to find a real estate agent who understands your situation. Agents typically take a much lower commission on short sales, and it often takes much longer to actually close the sale once the seller accepts an offer. But many agents sympathize with financial problems brought on by unexpected circumstances and may want to help.

Convincing Your Mortgage Lender

The buyer will need your help in negotiating a short sale approval with your mortgage lender.

You'll need to convince your bank that you deserve approval for a short sale. Tell your mortgage lender about your financial hardships, including layoffs, divorce or medical issues.

While this may seem obvious, now is not the time to rack up the purchase of luxury items, like fancy cars or jewelry. Your lender will see these debts on your credit report and think you're a loose spender who doesn't deserve a break.

It may also be necessary to provide the lender, either directly or through the buyer or buyer's agent, documentation of your financial hardship, such as paystubs, bank statements and so forth. While this may seem like an invasion of your privacy, try to think of it as the fastest way out of an otherwise overwhelming debt.

Short sales take much longer to close than more conventional sales, so plan accordingly. If it works, you'll avoid bankruptcy and an ugly mark on your credit report. If it doesn't work, you'll know that you've done everything you could to avoid foreclosure and/or bankruptcy.  

Questions for Your Attorney

• Would a short sale be better than a foreclosure in my situation?
• Is bankruptcy a better option than a short sale for me?
• What does a buyer need to know about purchasing a short sell property? 

Related Resources on lawyers.com^sm

- Contact a Real Estate Lawyer in your area for specific legal advice, and read about Selecting a Real Estate Lawyer
- Need a form? Access hundreds of legal forms covering a wide range of personal and business needs, including a Home Sale Worksheet, Home Evaluation Worksheet, and Intent to Purchase Real Estate
- Read Home Purchase Agreements and Selling a Home FAQ, or access more Residential Real Estate articles and information
- Legal Dictionary
- Visit the Legal Forums for discussions on Real Estate Law topics and issues