What is Short Sale in Real Estate?

A short sale in real estate is the sale of a property, which was held as a mortgage, at an amount 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 property sale are given to the lender. In such a scenario, the debt is not fully paid. The lender can either choose to waive off the remaining amount or opt for a deficiency judgment against the borrower, which requires them 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 the mortgage.

A deficiency judgment is a court order against a defaulted debtor or borrower on a mortgage or a secured loanSecured LoanSecured loans refer to the type of loans approved and received against a guarantee or collateral. If they fail to do so, the lending institution acquires the collateral to compensate for the amount that the borrowers were allowed.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 estateReal EstateAt its most basic principle, Real Estate can be defined as properties that comprise land and its tangible attachments. The land includes the actual surface of the earth and any permanent natural objects such as water, dirt, or rock and any minerals or particulars under the surface. read more for better understanding.

John bought a villa in a new project 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 the 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 making the mortgage payments 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, John will pay his lender (the bank) for the mortgage which will be $1,000,000, and the remaining difference of $250,000 is the deficiency.

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Banks usually waive off the remaining amount considering the borrower’s financial condition, 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 income by the Internal Revenue Service (IRS) 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 property’s value is undermined and has to be sold at a lower value.The property buyer 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 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 shortly 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 made to purchase the property.Banks sometimes lend additional mortgages to borrowers over their limit in a rising market. When the market falls, neither the borrower nor a 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.

 Important Points about Short Sale in Real Estate

  • A financially distressed borrower has two options to close the mortgage – (a) short sale and (b) foreclosure.A short sale is initiated by the borrower in which they decide 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. 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 borrower’s credit score; however, it is less than a borrower whose property was seized, and the mortgage was foreclosed.If 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 selling a mortgaged property at a price lower than the actual mortgaged value. In other words, the property’s value 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 borrower’s financial circumstances and in some cases. In contrast, 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 distressCause Of The Financial DistressFinancial Distress is a situation in which an organization or any individual is not capable enough to honor its financial obligations as a result of insufficient revenue. It is usually the result of high fixed costs, obsolete technology, high debt, improper planning and budgeting, and poor management, and it can eventually lead to insolvency or bankruptcy.read more 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 cannot allow the short sale option.If 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 of the remaining amount after a short sale is considered an income and can be taxable, which differs from country to country.

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

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