What you should know about short sales

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shortsalesNot that long ago, short sales were so unusual that the term was rarely used. But ever since the recent housing bubble burst, short sales have become relatively common. Here’s what you should know about short sales:

A short sale is the sale of a property for less than the balance of the current mortgage on that property. Here’s a typical example:

John Doe bought a house a couple of years ago for $400,000. He put down five percent, or $20,000, leaving him with a mortgage of $380,000. With his timely mortgage payments, he’s brought the balance of the mortgage down to $365,000 today. Unfortunately, John lost his job and is unable to continue making his mortgage payments. To make matters worse, property values in the neighborhood have plummeted, so although his house appraised for $400,000 in at the time of purchase, today the most he could sell his house for is $350,000, which is $15,000 less than the remaining balance on the mortgage. Such a sale would constitute a short sale.

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Short sales can occur is other situations as well, since any sale of property in which the amount paid is insufficient to pay off all outstanding balances – i.e., in which there is a shortage of funds – is technically a short sale.

You need the bank’s permission for a short sale. The fact that a home has been listed as a short sale does not mean that an offer at the listing price will be accepted by the bank. Instead, it usually means that the homeowner (and his listing agent, if applicable) hope that the bank will approve a short sale. Banks are more likely to approve a short sale if the homeowner can demonstrate financial hardship (i.e., the inability to make mortgage payments), and there is documentation justifying the short sale price.

With a traditional short sale, the seller is required to pay the deficiency balance, which is the difference between the original amount due and the amount received from the sale. There are some federal programs which can assist you with a short sale and eliminate the requirement to pay the deficiency balance.

The effect of a short sale on your credit score can vary. There is no exact formula for determining what impact a short sale will have on your credit score, because there are many factors that determine your score. In general, you should expect your credit score to decrease somewhat due to the short sale, especially if your credit history is otherwise pristine. However, the impact of a short sale will likely be less than the impact of being late on your mortgage payments.

If you are current on your mortgage payments, a short sale is generally a better financial decision than a foreclosure. With a short sale, the negative impact on your credit report is smaller, you will be able to purchase a home again sooner, you may not owe any money to the bank, and there may not be any tax consequences. With a foreclosure, you won’t make payments for several months until the bank evicts you, but the impact on your credit score will likely be significant, the listing of a foreclosure on your credit history can have a negative impact on employment prospects, and you will not be able to purchase another home for as many as seven years. Additionally, you may still be liable to the bank and face tax consequences.

If you are the buyer in a short sale, you need to be patient. The bank’s approval process for a short sale takes considerably longer than the approval process for a conventional sale, and there is no guarantee that the bank will actually approve the sale. You should look for an agent who has experience with short sales, conduct thorough inspections of the property, and be prepared to walk away from the deal if the inspections turn up major issues that aren’t satisfactorily resolved.

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Cathy is the founder of Chief Family Officer, where you can get daily updates on the hottest deals, and tips to achieve financial freedom and family bliss.