Short sales arise when a homeowner owes more on their house than they can sell it for.  This is called being "upside down".  The homeowner then attempts to make an agreement with their lender to sell the house for less than is owed.

The term "agreement" is broad because the agreement depends on the bank that holds the loan.  Though there are general practices, every bank does it differently.  Below are the most common agreements, but if you take part in a short sale, it's crucial you assume NOTHING until you have the bank's agreement in WRITING.  Different banks have different policies and agreements.

COMMON AGREEMENTS

#1: The best case scenario is to get the lender to actually "write off" the deficiency.  This results in the seller having some relatively minor derogatory statement on their credit report.  In this situation the seller doesn't actually owe the bank any more money.  The credit reporting can consist of anything from "account settled" all the way to "foreclosed".  This is the most common agreement and this is what we at the Home Source Group strive for everyday for our sellers.

In cases where the money is "written off," it is important to understand that the lender will never actually "write something off."  In most states (check Colorado law), the lender has the ability to show any deficiency as 1099 taxable income for the seller.  What this really means is that the seller might have to pay taxes on that income. 

You should check with your tax accountant and look into the "The Mortgage Forgiveness Debt Relief Act of 2007" to see what the effects of this legislation could have on your tax bill. 

Another way the deficiency could be "written off" is in the form of a judgment.  This will often occur in conjunction with the 1099 taxable income reporting.  It might say something on the seller's credit report such as "judgment filed against John Doe in the amount of $XY by ABC Mortgage Company".  This will appear in the public record section of the seller's credit report for 10 years.  The debt can either show up as satisfied or unsatisfied.  Satisfied is obviously the better option because it means the worst thing that can happen is the lender will report 1099 taxable income.  Unsatisfied could be a problem because it means that a court has found in favor of the lender to collect the deficiency from you.  Now, the lender might simply send you the 1099, or they might try to collect it from you.  They can keep trying to collect it from you until they get it.  They can garnish your wages.  Your only hope at this point is that you qualify for bankruptcy.

#2:  Many banks will do a promissory note for the deficiency, actually making the seller pay the deficiency amount. 

#3: Some banks may require that the deficiency be paid at closing.  Think about this.  This does no good because it's the same as the seller selling their house without doing a short sale and simply bringing cash to the table.  If a bank tells a seller they need to bring cash to the table in a short sale, they either don't understand the elements of a short sale, or more likely they are LYING.

NEVER ASSUME THAT A DEBT YOU OWE A LENDER IS GONE UNLESS YOU HAVE THE DETAILS OF THE DEBT RELEASE IN WRITING.

NEVER ASSUME SOMETHING IS WRITTEN OFF unless you have a formal, written, signed, unconditional release of lien and/or judgment from the lender specifically stating that no further action to collect this debt will be taken.

This is what we at the Home Source Group strive to do every day for our sellers.  We get short sales accepted from the bank with no further liability for the deficiency.  

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