What is a short sale in real estate

“What is a short sale in real estate?” is a question I hear a lot these days.

Basically, a short sale is when the total market value of your property equals less than the total amount of the mortgage loan owed. Whenever you have to sell your home or condo in this scenario, that’s a short sale.

So how does someone end up like this? There are two main reasons.

1. Real estate prices have dropped—a lot.

In San Francisco, and the rest of the country, home values declined as much as 40 percent over the past few years.

Imagine that you put 10 percent down on your home three years ago. And now, the value of your home has declined by, say, 15 percent. You’ve just lost your down payment. Plus, the value of your home is less than what you owe on your mortgage. Those who put zero percent down back in the early-mid 2000s may be in even worse shape.

2. You’ve got no choice but to sell.

Maybe you’re taking a new job in a new city. Or you’re getting a divorce. Could be you just can’t afford your home anymore because you’ve lost your job. Whatever the situation, we sometimes have to sell our homes, even though it’s not the optimal time to do so.

When these two events collide, you’re looking at a short sale.

What happens next?

Talk to your bank or mortgage lender. Explain why you must sell. Ask them to approve the sale and work out a plan with you. It might be that the bank issues you a 1099 form after the short sale is completed. This means you’ll have to pay taxes on the difference between the home’s sale price and your mortgage amount, because that difference is like income, in the eyes of Uncle Sam.

Also, a short sale will probably hurt your credit score, maybe causing it to drop 50 to 75 points right away. However, if everything else is good on your credit report, you can probably get your score back up by 30 to 40 points pretty quickly.

Keep in mind most lenders prefer a short sale to a foreclosure, because foreclosures cause lenders to incur hefty fees and they take a lot more time. Plus, lenders don’t want to be in the business of owning homes, which is what happens when they foreclose.

The bad news—and the good news

The bad news: The volume of nationwide short sales increased to 15.9 percent of home sale transactions in January, up from 12.4 percent in November.

And the good: Home price declines seem to be leveling off. U.S. home prices fell just 1.2 percent in the fourth quarter of 2009 compared to the same quarter of 2008, the Federal Housing Finance Agency reported Thursday.

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