Investors used to make a lot of money buying up foreclosed homes.
Recently, the trend is the “short sale”. A short sale can actually save a homeowner from going through the painful process of foreclosure.
A short sale can sometimes even save the homeowner from having to pay out money when selling.
The homeowner (or his representative) approaches the lender with an offer in hand from a buyer who will purchase the property for less than the amount owed by the homeowner. This may sound like something that the lender would not accept, but lenders are overwhelmed with foreclosed accounts on their books, which is bad for business. Foreclosing on a property is not cheap for the lender.
There are legal fees involved, marketing fees to sell the property, real estate fees, etc. –not to mention the time involved for the lender to foreclose and then wait for the house to sell.
If the lender is approached with a chance to get that bad loan off of their books, they often will accept the offer— even if the offer is as little as half the amount owed by the homeowner.
For example, Mr. and Mrs. Smith are behind on their payments and facing foreclosure. They owe $150,000 to the lender. The Smiths contact a short sale investment company for help. The company puts them in touch with an investor who offers $80,000 cash for the house and can close the deal in two weeks. The offer is submitted to the lender. The lender has to decide between the bird in the hand ($80,000 of quick cash), or two in the bush (a long costly foreclosure procedure in which the lender may not get much more than $80,000 anyway). If the lender takes the $80,000 offer, the remaining $70,000 owed by the Smiths is forgiven. The win for the lender is that they are saved the trouble of a lengthy expensive foreclosure process, and the Smith’s bad loan account is taken off the lender’s books. The win for the Smiths is that they are off the hook for the mortgage, and they have avoided a foreclosure on their credit.
There used to be laws that would require the Smiths to pay taxes on the $70,000 that the lender had to forgive. Mortgage forgiveness was considered income by the IRS. However, congress passed the “Mortgage Relief Act” abolishing the mortgage forgiveness tax.
Rather than forgiving the $70,000 shortage, the bank will usually try to arrange for the homeowner to pay back some, or all, of the shortage. If the homeowner pays the shortage, he can save his credit. The lender will offer to set up a repayment schedule for the homeowner. One friend of ours went through a divorce and sold his home through a short sale. He jokes that he will be paying the bank $100 a month for the rest of his life to make up for the shortage. Our friend wanted to do as much as possible to save his credit. His good credit is worth $100 a month to him.