What is a short sale?
“Short sales” allow property owners to sell their property for less than the amount they owe on their mortgage. A short sale is often a good alternative to foreclosure because it results in a better outcome for both parties. Short sales have become increasingly popular in recent years as property values have declined. That meant that many houses are now “underwater”; that is, they’re worth less than the outstanding balance on the mortgage.
A typical home loan involves a promissory note and a deed of trust
In North Carolina, buying real estate with borrowed money usually involves two legal instruments: (1) a “promissory note” and (2) a “deed of trust”. A promissory note is a contract where the borrower promises to repay the borrowed money to the lender. A deed of trust is often called a “mortgage”. A deed of trust creates a mortgage lien on the property that “secures” the lender’s right to be repaid. The mortgage lien allows the lender to foreclose on the property if the borrower fails to repay the debt. The promissory note and the deed of trust work together to protect the lender-the lender can sue the borrower to recover the debt, and the lender can foreclose on the borrower’s house.
You usually can’t sell your house unless you pay your mortgage in full
The mortgage lien also prevents the owner from selling the property unless the mortgage lender is either paid in full or voluntarily releases its lien. If it weren’t for the deed of trust and the mortgage lien it creates, an unscrupulous seller could sell their property and abscond with the sale proceeds instead of using it to pay the mortgage. The lender would be stuck with an enormous loss and no way to recover its money. However, the deed of trust prevents this because a mortgage lien remains attached to the property despite the sale-so in the situation above, the unscrupulous seller couldn’t convey “clear title” to a buyer.
In a short sale, you can sell your house without paying off your mortgage in full
In a short sale, a property owner obtains an offer from a prospective buyer to purchase the property for less than the outstanding balance on the mortgage. Then, the owner completes a short sale application and submits it to the lender for approval. If the lender approves the application, it agrees to cancel its deed of trust and thereby release the mortgage lien on the property-even though it won’t be paid in full. That way the owner can complete the sale and convey clear title to the buyer.
Here’s an example of a short sale
Suppose Sally Seller owns a house worth $150,000, but she owes $230,000 on her mortgage. Her house is underwater by $80,000. So Sally decides to apply for a short sale. Sally lists the property for sale and receives an offer from Peter Purchaser to purchase it for $150,000. The offer leaves an $80,000 “deficiency balance”. The deficiency balance is the difference between (i) the balance on Sally’s mortgage ($230,000) and (ii) the amount of Peter’s offer ($150,000). Sally can’t convey clear title to Peter unless she pays the mortgage in full, but Peter’s offer isn’t enough to allow Sally to pay the mortgage in full.
So Sally completes a short sale application and submits it to the mortgage lender. The lender approves the short sale and agrees to accept $150,000 in exchange for releasing its lien. With the lien released, Sally can sell the property and pay the lender most of what is owed on the mortgage-almost two-thirds.
The bank isn’t necessarily erasing the rest of your debt
Even though short sale is approved, the lender releases its lien, and Peter purchases the house, Sally still owes the lender $75,000. She’s taken care of the deed of trust and the mortgage lien, but, pursuant to the Promissory Note, she is still obligated to repay the deficiency balance.
When the lender approves Sally’s short sale, it will usually choose one of two options: (i) it will waive the deficiency balance and agree to release Sally from the remaining debt or (ii) it will require Sally to pay some portion of the $75,000 to settle the deficiency balance. For example, the lender might condition its short sale approval upon Sally paying $20,000 to the lender. It might allow her to pay that amount over an extended period of time or make some other accommodation based upon her assets and income. The lender’s decision is usually based on the seller’s particular financial situation.
Do I qualify for a Short Sale?
Short sale approval depends on many factors and is determined on a case-by-case basis. Typically, a short sale application will be approved if the owner is experiencing a financial hardship (through loss of employment, illness, divorce, death of a spouse, decreased property values, increased expenses, etc.) and can show that he or she does not have the funds to pay off the mortgage balance. This does not necessarily mean that every owner must be completely broke in order for a short sale application to be approved; it simply means that the owner must demonstrate to the bank that he or she cannot reasonably expect to pay the mortgage in full.
What will I have to do in a Short Sale?
A short sale involves a fairly extensive application process. Owners have to provide information about their assets, liabilities, income, and expenses. Owners also have to submit financial documents such as tax returns, bank statements, and pay stubs. Finally, owners will also have to write a statement explaining why they are experiencing a hardship. Oftentimes the lender will have follow-up questions.
What else do I need to know about a Short Sale?
Although a short sale allows owners to sell their property, there are some consequences owners should consider before proceeding with a short sale. Our clients generally decide that their inability to continue paying their mortgage and their desire to sell the home outweigh these consequences.
1. Deficiency Balance. As explained above, even if the lender approves a seller’s short sale application, the lender might require the owner to pay some of the deficiency balance. The short sale approval means that the lender will allow the owner to sell the property, but it does not mean that the lender will agree to eliminate the deficiency balance.
2. Tax Implications. If the lender does agree to waive its right to collect a deficiency balance (or part of the deficiency balance), the amount of debt that the owner doesn’t pay will be cancelled or “written off”. The IRS considers cancelled debt to be income to the owner, and the owner will have to report this “income” on his or her tax return. Owners considering a short sale should consider how any cancelled debt will affect their tax situation.
3. Credit Score. A short sale will lower an owner’s credit score, but probably less than a foreclosure will.
We have successfully guided our clients through a number of short sales in recent years. Please call Carter & Carter, P.A., to discuss whether a short sale can help you.
This article provides general information only. It is not intended to give, and should not be relied upon for, legal advice in any particular circumstance or fact situation. No action should be taken in reliance upon the information contained in this article without obtaining the advice of an attorney.