Short sale basics | Housing | Finance & Capital Markets | Khan Academy

Short sale basics | Housing | Finance & Capital Markets | Khan Academy

You bought your house
recently for $200,000, and the way that you
were able to pay $200,000 is you were able
to put 25% down. So you made a
$50,000 down payment. And the balance, the other 75%,
you borrowed from the bank. So $150,000 loan from
the bank, and you pay it off with your
monthly payments that include paying down the
loan and the interest. Now something
happened in your life. Maybe, unfortunately, you
lost your job or your spouse lost their job. Or maybe you just
overestimated your ability to pay off your
mortgage payments, and so you're having
difficulty making them. Frankly, you can't make your
mortgage payments anymore. So in this situation, you have
a couple of options for you.

One option is you can
try to sell the house, so some type of a sale. Or the other option is you could
essentially give the house back to the bank, and that
we'll call foreclosure. In another video
we'll go more in depth of what happens in foreclosure. But the bank's going
to get the property, try to auction it off. If it can't auction it off, then
the bank will own the property. And then maybe they'll try
to sell it at a later date. And this is not a
good option for you. This will kill
your credit, which will make it very hard for
you to get a loan– really of any type of loan, but
especially a mortgage loan– anytime in
the near future, really over the next
several or many years. So you say, OK, I want
to do the sale option. Now unfortunately for
you, the housing market has deflated dramatically. And so when you
talk to a realtor, the realtor figures
out, well look, after all is said
and done– I mean, you try to sell it for
more than your loan amount, but you're not able to.

You're getting
really low offers. The offers are like
120,000, 130,000. And so when you really
sit with the realtor and you think about
what the market is willing to pay for
your house, you realize that the most you're
going to get for your house after you pay the real
estate commissions and all the other things that are
involved when you sell a house, you could get maybe
120,000 for the house. And let's say you still
owe pretty close to 150,000 on the loan for the bank. Your loan might have even
been an interest-only loan, but even after a
year or two you're probably not going to pay down
the balance of your loan too much. It might be like
140,000 or 145,000. And you're only able to
get 120,000 for the house. So what do you do? You don't want to
go to a situation where you sell the
house for 120,000, you still owe
150,000 on the loan. And so you're still going to
have to pay $30,000 for a house that you don't
even have anymore.

So what do you do? Well, one option–
and this is not always going to be an option– is
to go to your bank and say, can I do a short sale. And a short sale is
essentially selling the house for less than you
owe on the loan. So let me write this down. Selling for less
than what you owe. And the bank doesn't
have to, but the bank might– well, one,
the bank would have to agree to the short sale,
because their loan is secured by this property
that you're selling. And in most cases,
the reason why you would want to
do the short sale is that the bank may forgive
the balance of the loan.


So you try to convince
a bank to forgive. So for example, you
could go to the bank. And you say, look,
I lost my job. We're having trouble
paying for this house now. After paying real estate
commissions and all the rest, I could only get
120,000 for this house. I know that I owe you 150,000. Can you forgive the
extra 30,000 that I owe? And the bank might
choose to do that. Now, even in this
situation, you have to be very, very, very,
very, very careful. And this has to be
negotiated with the bank and all the rest is because
the bank could still report you to credit agencies,
which is really not going to be a whole lot better
than getting a foreclosure. So in part of this negotiation
process– and the bank is under no obligation to
either forgive your loan and let you go forth
with that short sale. And they're under no
obligation to hide it– I wouldn't say
hide it, but to not talk to the credit agencies.

But part of that negotiation
you should try to convince them, or you would ideally
try to convince them, not to report it to
the credit agencies. The other issue with a
short sale– and this is something that few people
think about– is when you have, let's say, in this
case $30,000 forgiven, the IRS might consider
that to be income. So you might have to pay income
tax on this right over here. And people always ask me, wait. If someone forgives a loan,
why is that considered income? And the best way
to think about it is if the IRS did not
consider that income, it would be a huge
loophole in how someone could
compensate someone. If I wanted to pay someone,
I could give them– so this is me. This is the person
that I'm trying to pay. I could give them a loan. Let's say I could give
them $100,000 loan, and then I could
forgive the loan.

And so it would essentially be
I gave them $100,000 maybe to do some work for me. It would be a transfer
of money by giving a loan and then keep forgiving
over and over and over. It would be completely
identical to giving someone a gift, which is taxed,
or giving someone some type of income. So a short sale,
you're not always going to be able to do
it in this scenario. But if your house is
selling less than the value of the loan, you might be able
to negotiate with the bank to allow you to sell the
house for less than the value of the loan. The bank's other
option is that they're going to have to go into
some type of a foreclosure proceeding and take
ownership of the house, which is expensive for
the bank as well. But they keys here
are even if the bank is willing to let you
sell the house for less than the loan amount,
the owner really needs to make sure
that the bank is willing to forgive the
balance and ideally not report to credit agencies..

As found on YouTube

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