A short sale is when the property is worth less than the debt owed on it. You are offering the bank less than what is owed so someone can purchase it. A relative or insider may be offering to buy your home for more than what would be obtained at auction. Personally I see very little advantage to the homeowner in doing a short sale unless you are attempting to keep the home and a relative is purchasing the property. Short sales require substantial proof that you are offering the lender more than what they will get in foreclosure.
A short sale forces you to do all of the work of selling the home for the mortgage company. Your credit receives virtually the same damage whether you short sale or have a foreclosure. In a short sale you do all the work. You locate the bank a fair offer. In the end, you often still have them refuse it or take months to accept it. Short sales can be a tool to keep the home by eventually buying it back from the purchaser. This is called a white knight purchaser.
Issues which complicate or improve a Short Sale
The primary and constant issue the bank is concerned with is what is the most profitable option for the bank. They resist the homeowner not keeping the property. They prefer to offer mortgage modifications which temporarily lower an interest rate. If the homeowner offers a short sale you must provide proof the short sale is the highest price they can obtain.
If there is a second mortgage you have to make two banks accept your offer. The issue when two mortgages occur is the first mortgage has no advantage to sharing less than what the home would bring at foreclosure with the second mortgage company. The second mortgage company will often refuse to accept a short sale unless they receive substantially more than a foreclosure.
The problem is always convincing the lenders to accept what is a better deal than what they would have gotten at the foreclosure sale. Often filing a bankruptcy still has to be done. For whatever reason, it seems if the homeowner has filed bankruptcy and listed the property in a bankruptcy as being abandoned the mortgage company will more easily accept a short sale. Filing a bankruptcy seems to convince the lender the homeowner will no longer retain the home. Then the lender has to accept the time and expense of a foreclosure or the immediate and better offer of a short sale. The problem for the lender is the home continues to be reported as a bad debt until it is resolved. This costs the lender higher rates for the money it borrows to lend.
Advantages and Disadvantages to a short sale.
A short sale can take a year to be approved. It often gets you out of the house sooner than if you had just stayed in it. A short sale will often still leave you owing the deficiency and definitely leaves you with an income tax problem for any deficiency.
The internal revenue service rules and regulations require the mortgage company to submit the 1099-c for any loss. Regardless of any agreement you have with the mortgage company or what you are told you cant get around the tax rules and regulations of the IRS. The reason for doing a short sale is to have a slightly better credit file. The advantage is very slight. Many people are sold on the idea they will avoid the 1099 problem. Short sales do not avoid the 1099 tax problem.
Still there are situations where a short sale to a relative or insider allow you to stay in the property. Many of my clients simply let the home go back in foreclosure living in it until the sale date and simply file bankruptcy to avoid the tax problem and any possible deficiency.