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Short Sale Basics

The term “short sale” has become a household term in the post real estate bubble market. But what exactly is a short sale, and why would a property owner or a bank want to do a short sale?

A short sale is simply a sale of real estate with a sales price of less than the outstanding balance on the mortgage loan. The problem, of course, is that the bank holding the mortgage will generally not allow a sale to take place if the bank is not going to receive full payment for its loan. This makes a short sale seem quite impossible, yet they are happening on a regular basis in today’s economy. This is because the banks do not want to foreclose on bad mortgages, as explained in more detail below.

As a property owner with an upside-down property (which merely means that the mortgage balance is greater than the value of the property), you may be tempted to just walk away from an unwanted home or business property and let the bank take it in foreclosure. The problem with this strategy is that, in some jurisdictions, foreclosure does not prevent the bank from suing the borrower to recover the deficiency (the difference between what you owe and what your property is worth). Foreclosure could also destroy the property owner’s credit rating. So, the motivation for the property owner to enter into a short sale transaction might be to negotiate a contractual elimination of the mortgage loan deficiency, or it might be that the owner wants to preserve his or her credit rating. Often it is both.

The banks have a great deal of motivation to agree to a short sale, as well. It costs the bank a lot of money and time to foreclose on real estate. After a foreclosure, the bank is left with an illiquid asset, the real estate, which it does not want. The bank wants cash, and in order to convert the real estate into cash, it will cost the bank even more money and even more time to sell the foreclosed property. Banks hate repossessed properties (or REO properties) and usually end up selling them at a discounted price to get rid of them. The banks would often rather have you sell the property for them, at a reasonable price, than to spend all the time, money and effort to foreclose on property they do not want to own. This is true even when the bank stands to lose money on its loan.

The three main goals when considering a short sale transaction, whether it is your home or a business property, should be: (1) a contractual elimination of the bank’s right to sue for the deficiency; (2) minimization of the tax consequences of walking away from debt (yes, having the bank forgive debt can be taxable income, and the banks will report it to the IRS); and (3) minimizing the negative impact of the transaction on your credit rating.

Penzien & McBride, PLLC is a Michigan law firm serving Michigan businesses and individuals primarily in Macomb, St. Clair and Oakland Counties, near Detroit.

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