A short sale provides a way for homeowners to get out of mortgages in which they owe more money than a property is worth. Homeowners may find that they can no longer afford their mortgage payment because of a job loss, transfer, divorce or a newly adjusted mortgage. However, lenders may still be able to hold the borrower accountable for the loss that they incurred.
A short sale is an agreement between a lender and a mortgage holder in which the lender agrees to sell the property for less than the amount that is owed on it. A short sale is an alternative to the lengthy and expensive process of foreclosure. Because you originally agreed to pay the entire balance of the loan, the lender may still go after you for the difference even if the bank's agent agreed to the short sale. The bank may seek a deficiency judgment against you. To ensure that you are free from the debt, have an attorney prepare a release form in which the lender agrees to legally release you from the debt.
Whether a lender will require you to pay the difference depends on a variety of factors, such as the lender's perceived ability to get a judgment against you, whether there is a second mortgage or lien against the property and what state you live in. Some states, such as California, Minnesota and Alaska, do not allow deficiency judgments.
A lender does not have to seek recourse against you immediately. It is possible that you can sell the house, move on, improve your financial situation and then suddenly be hit by a lawsuit from the lender. Some states provide long statutes of limitations in collecting debt of this nature, such as Florida's law that allows lenders five years to seek deficiency judgments.
Even if a lender chooses not to pursue legal action against you, you can still suffer tax consequences. The general rule is that the amount of cancelled debt is considered to be taxable income. If the property is your primary residence and the debt that is forgiven is $2 million or less, you might be able to avoid this tax under the existing tax laws at the time of publication.
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