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How Does a Short Sale Work

Guide to How Does a Short Sale Work?

Today's real estate market is flooded with properties marked as foreclosures or short sales.  If you are in danger of losing your home, you may be wondering: how does a short sale work?  The answers may surprise you.  While some real estate investors may try to convince you that short sales are an easy way out of a bad mortgage payment, they have several ramifications you need to understand before you attempt to gain approval for a short sale from your lender.  This guide will answer the question of “how does a short sale work?” by explaining the basic concept and giving you a rudimentary overview of the financial, credit, and tax consequences of your short sale.

What is a Short Sale?

Many people in the current market have no way to sell their house for as much as they owe.  With real estate values in steep decline, and many homeowners defaulting on their mortgages, you may find yourself “underwater” on a mortgage you can barely afford—or can't afford at all.

In circumstances like this, many banks will work with homeowners wishing to sell their home for less than they owe.  A short sale works by forgiving any remaining debt beyond what the buyer pays for your home.

Banks do this because the foreclosure process is messy, expensive, and takes a long time in many states.  Foreclosing multiple properties in an area can force property values even lower, leading to a vicious cycle.  Accepting slightly less than you owe is a better deal for the bank than letting a bank-owned, foreclosed-upon house sit empty.

How Does a Short Sale Work With My Bank?

In order for your bank to approve your short sale, you will need to be able to show some very specific financial qualifications.  First, you will have to show your bank that you are experiencing an actual financial hardship for reasons outside of your control.  You'll also have to demonstrate that your house is worth less than when you bought it.  Talk to your bank's short sale department to understand more about how does a short sale work.

Credit Consequences of Short Sales

If you're wondering “how does a short sale work?” you may also be curious about the consequences to your credit.  Generally speaking, short sales will have a significant negative impact on your credit score, and may hurt your ability to get credit in the future.  However, a short sale has a significantly reduced impact on credit scores if the alternative is foreclosure or bankruptcy.  If these are your alternatives, a short sale can salvage some remaining credit for you.

How Does a Short Sale Work With the IRS?

It might sound unfair, but if your debt is forgiven, you may get a 1099 that counts the debt forgiveness as income, requiring you to pay taxes on it before April 15 of the following year.  Talking to an accountant or your lender may help you understand the possible tax consequences of short sales before you make an expensive mistake.

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