What is a Short Sale?

Monday, March 10th, 2008

Piggy BankMarch 10, 2008

Short Sales are relativity new to the real estate/banking world.   What is a short sale and how do they affect buyer’s, seller’s, and banks.  Simply put a short sale is where a home sells for less money than the seller owes the bank and/or private lender.

For example, if you owe $500,000 on a house but it sells for $350,000 you are short $150,000 of the amount needed to pay off your loans.  Usually, because of commission, taxes, late payments, and expense the “short” amount might add up to another eight or ten percent, in this example the seller might be short $190,000.  What happens now, doesn’t the bank still want all their money?  Of course they want all their money but what are they to do if the seller does not have any money and the house value has declined?  What they do is eat the difference, the short amount. 

The bank will usually forgive the borrower the short amount and write it off as a loss.  They made a bad business decision and have to pay for it.  Usually they lent the buyer %100 of the money needed to purchase the home, and often without supporting documentation on the buyer’s income or assists.  It is called loose underwriting and those days are over.  It really was a dumb idea; when you think about it, even if the value of the home remained stable the bank would have expenses if they took back the home to sell.  In a declining market it just makes it that much worse.  Is this predatory lending, yes in many examples it is.  Did the buyer’s lie on their loan application?  Sometimes they did but other times the mortgage broker filled in the numbers.  Did the buyer’s know their interest rate was going to jump in a few years?  Many did but maybe he was not given all the information up front.

Okay, so we learned the bank eats the lost money but what happens to the buyer?  In the vast majority of cases the buyer does not owe the bank any of the shortfall, however, in most cases the buyer has a bad credit score as a result of the short sale.  Better than a foreclosure but bad none the less. 

Prior to a new law moving its way through the system (I think it is finally in effect – consult with your accountant for details) buyer’s that shorted a bank on a sale would owe tax to the IRS and state on the amount of money forgiven.  In the example above the buyer would have owed income tax on an additional $190,000 of income. 

Warren Carreiro, Broker

Marin County Real Estate
Homes You Love. Advice You Trust TM

Do not refinance your home!

Tuesday, December 4th, 2007

 If you are up-side-down on your home (owe more than it is worth) and are considering foreclosure or a short sale you need to know the ramification each option has.

If you purchased your California home in the past couple of years with 100% financing and the home is worth less than your purchase price foreclosure may be your best option.  This may also only be true if you have NOT refinanced your home.  You see, in California, in a foreclosure the bank has no recourse on your assets beyond your home (original purchase money only- does not apply to refinanced property).  So if you want to walk from the house -give it back to the bank, the hit you take is on your credit rating for seven years.

Option 2 might be to sell your property and ask the bank to forgive the difference between your loan and sells price.  Even if the bank will not forgive you the difference this is called a short sale.  In a short sale your credit is not hit as bad as a foreclosure.  However, the bank will likely come after your other assets AND (this is a big one) the IRS will tax you on any amount forgiven by your lender.  Don’t forget when the IRS wants your money they get it.

If you want to refinance your property to keep the payments low that will be hard to do at 100% financing and it may take away the best foreclosure on original purchase money has to offer.

Because this subject has such legal and financial ramifications if this article applies to your situation get professional legal (attorney) and financial (CPA) advice.
Warren Carreiro