Short Sale in Real Estate

What is Short Sale in Real Estate?

Short Sale in real estate is the sale of a property, which was held as a mortgage, at an amount that is less than the actual value of the property to repay the debts owed by the borrower. The property is sold to a third party and the proceeds from the sale of the property is given to the lender. In such a scenario, the debt is not fully paid and the lender can either choose to waive off the remaining amount or can opt for a deficiency judgment against the borrower which requires him/her to pay the lender a portion or all of the difference between the sale price of the property and the original value of the property that was held mortgage.

A deficiency judgment is a court order against a defaulted debtor or borrower on a mortgage or a secured loanSecured LoanA secured loan is one where the borrower pledges his/her assets as a collateral to the issuer as a security. In the event of nonpayment of the loan, the issuer has the right to sell or transfer the secured property in order to recover the balance owed.read more which indicates that the sale of the property which was mortgaged did not cover the complete amount to pay back the mortgage.

Example of Short Sale in Real Estate

Let’s discuss an example of the short sale in real estate for better understanding.

John bought a villa in a new project that was on the outskirts of the city and took a mortgage to pay for the property. John owned the villa on which he procured a mortgage of $1,500,000 and due to loss of the job he is currently selling it for $1,000,000. The outstanding on the mortgage is $1,250,000. John has already delayed in making the payments for the mortgage and fears his property will be seized or foreclosed. He decides to sell the property and finds a customer for his villa, Joe, who is willing to buy the property at $1,000,000.

The difference between the outstanding amount and the sale price is calculated as below:

= Outstanding Amount of Mortgage – Sale Price of Property

= $1,250,000 – $1,000,000

= $250,000

In this transaction, the amount that John will pay his lender (the bank) for the mortgage will be $1,000,000 and the remaining difference of $250,000 is the deficiency.

Private Equity-Careers

You are free to use this image on your website, templates etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Short Sale in Real Estate (wallstreetmojo.com)

Banks usually waive off the remaining amount considering the financial condition of the borrower although this might result in the credit score of someone like john taking a hit.

In the United States, If the borrower is waived off completely from the repayment of the mortgage after a deficiency judgment, the debt that was forgiven or waived off is considered as income by the Internal Revenue Service (IRS) which is taxable as per the income tax slab.

Disadvantages of Short Sale in Real Estate

The following are the disadvantages of a short sale in real estate.

  • The value of the property is undermined and has to be sold at a lower value.
  • The buyer of the property may not always make a good deal out of the property even though the property was bought at a much cheaper rate.
  • A credit score of the borrower will be affected adversely even though the mortgage is waived off.
  • Since the credit score will be affected, no other banks will be willing to provide a loan in the near future unless the credit score for the borrower is brought back in a good state.
  • A short sale in real estate refers to a property that was once sold at a higher rate in a rising market and since the market has fallen it will not fetch even the initial investment that was made to purchase the property.
  • Banks sometimes tend to lend additional mortgage to borrowers over their limit in a rising market and when the market falls neither the borrower nor the lender makes any money out of the transaction.
  • Affects the surrounding properties adversely, since the value of one property in a locality can decide the value of other properties around.

 Important Points about Short Sale in Real Estate

  • A financially distressed borrower of a mortgage has two options to close the mortgage – (a) short sale and (b) foreclosure.
  • A short sale is initiated by the borrower in which he/she decides to sell the mortgaged property at a rate that is less than the outstanding mortgage amount.
  • A Foreclosure is initiated by the lender in which the bank seizes the property after the borrower fails to make payments for the mortgage for a long period of time. This is usually the last resort for banks when they are convinced that the borrower is in no condition to make any payments for the mortgage.
  • A short sale in real estate has a negative hit on the credit score of the borrower however it is less than a borrower whose property was seized and the mortgage was foreclosed.
  • In case the mortgage has a co-applicant, then the lender can hold the co-applicant responsible for default in the payment and may not allow a short sale.

Conclusion

  • A short sale in real estate refers to the selling of a mortgaged property at a price lower than the actual mortgaged value. In other words, the value of the property did not rise as expected and the borrower failed to make payments for the mortgage at the pre-decided intervals.
  • The remaining amount after a short sale is usually waived off looking at the financial circumstances of the borrower and in some cases whereas in some cases, the lender can get a deficiency judgment on the lender which requires the borrower to make the payment for the difference in the sale price and the outstanding amount of the mortgage.
  • The cause of the financial distress should be new which can be deterioration of health, loss of a job, divorce, etc. which justifies the failure in making payments for the mortgage.
  • If the lender assumes that it can make more money by foreclosing the mortgage, the lender can opt not to allow the short sale option.
  • In case the mortgage has a co-applicant, then the lender can hold the co-applicant responsible for default in the payment and may not allow a short sale.
  • The waived off the amount of the remaining amount after a short sale is considered as an income and can be taxable which differs from country to country.

This has been a guide to what is short sale in real estate and its definition. Here we discuss an example of how short sale works in real estate along with disadvantages. You can learn more from debt financing the following articles –