Short sales are all the buzz in the real estate market today, but as with anything else they aren't for everybody.  How do you determine if a short sale is right for you?

Look at your Financial Situation

If you're considering a short sale, then I am going to assume that you are having financial difficulties and are unsure about whether you will be able to continue making your mortgage payments.  However, there are other ways to remedy the situation if it is only temporary.  Considering the vast amounts of foreclosures and short sales going on now, most banks are willing to work with their borrowers to avoid both of those alternatives.  The first step is to call your bank, explain your financial difficulties and see if they are willing to defer a couple of payments.  Alternatively, they may be willing to offer you forbearance, which is a great option if your setback is temporary, because it allows you to keep your home.  By calling your bank and reviewing your options (and I only mentioned a couple of the many available), you demonstrate that you want to follow through with your obligation and you have a better chance of finding the least painful path to remedy the situation.  A great place to start exploring your alternatives is www.workitout.com as they have contact information for many banks and also go into the process in more detail than I can here.

Note:  If you have a first mortgage and a second mortgage from different banks, you must consult with both of them prior to beginning the short sale process.  If you do end up doing a short sale, they must both agree or you won't be able to proceed.

Consider the Costs

If you have determined that a short sale is your only alternative to foreclosure, then you must consult with a licensed Real Estate Agent.  Banks do not allow sellers to represent themselves for a short sale transaction.  Besides, the bank will pay your agent's comission when you do a short sale, although it is added to the amount that they "forgive". 

Your agent will complete a market analysis to give you a realistic idea of what your home can sell for in today's market.  You already know that you will be getting less for the home than you owe on it, but it is important to get expert advice so you know exact numbers.  Keep in mind that you will likely have to reduce your price in increments over time because a "distressed" property such as a short sale does not sell as quickly or for as much as other properties on the market.  Short sales are a lot of work and you have to finesse the bank, so to speak, to get things done in a timely manner.  There is also additional paperwork to file at all stages of the transaction. 

The "Short" Part of the Short Sale

When a bank forgives an amount (the "short" amount), they will most likely issue a 1099 to you, the homeowner, for the difference.  Uncle Sam will see this as an amount of money earned, but paying taxes is usually preferable to paying the whole thing.  It is important to consult an Accountant because in many cases there is an exception for a nonrecourse debt and you may not be held responsible for the taxes on the amount the sale was short.  This is not always the case, however, and it is VITALLY IMPORTANT that you consult your Accountant beforehand so that you are fully advised as to the consequences of selling your house short.  If you'd like to read about the IRS policy regarding the cancellation of debt on a home sale, here is a link for you:  http://www.irs.gov/publications/p553/ch01.html#d0e399.

In Arizona, the bank's only recourse is to accept the home as full payment of the debt as long as the loan(s) you have are considered to be "purchase money".  This would be done by foreclosure and if they foreclose, they can't issue a deficiency judgment against you.  Other states have different laws, so if you live elsewhere check with a local expert.  At times, the bank will request that the Seller sign a promissory note for part of the deficiency.  This is voluntary, but there are times when it is a wise choice in order to entice the bank to accept a short sale so you can avoid foreclosure.  Keep in mind that if you sign a promissory note it will appear on your credit report and will leave you with an unsecured loan to pay off.  Some people choose not to pay these, but then you end up with poor credit, which is what the short sale was trying to minimize to begin with.  It's important to find out the procedure for your bank and your Real Estate Agent can help you do that.

Move Forward

Once you have decided that a short sale is your best option, you need to call your Real Estate Agent and get your home listed on the market.  In many ways the sale is the same as a normal sale.  You will have open houses and your agent will market the home as usual.  However, when you get an offer, not only do you have to accept it, but the bank has the final say in whether or not the offer is accepted or countered.  Once the bank approves of the sale, you will continue in the same way as if you were selling your house without doing a short sale.  For details on what happens during a short sale see What to Expect During a Short Sale.