Lenders are facing a liquidity dilemma as the number of foreclosures continues to rise. As a result, more banks and other financial institutions are becoming amenable to a short sale by the borrower to prevent the property from becoming a real estate owned asset.

What Is a Short Sale?

A short sale means that the lender has agreed to accept the proceeds from the sale of a piece of property, when the sale price is less than the current principle balance of the property loan, as the full payment of the mortgage debt obligation.

Why Would a Bank Agree to a Short Sale?

Holding and managing real estate is not in a bank's best interest; a bank's main business is making loans and collecting interest on those loans. Making loans requires cash liquidity and real estate is not a liquid asset. The Federal Reserve regulates how much the bank can have in outstanding loans at any given time—they base this number on many different factors. Bank owned real estate that is not used as part of a bank’s daily operations is actually a liability when it comes to the bank’s lending limit authority. Based on how much real estate a bank holds on the books, banking regulations will penalize a bank by adjusting their overall lending authority downward.

A short sale also gives the lender an opportunity to get at least the majority of their money back without the time and expense of a foreclosure action—which can take several months to accomplish and thousands of dollars in legal fees and court costs.

The Short Sale: Impact on Borrower and Lender

A short sale accomplishes objectives for both the borrower and the lender. For the borrower whose property is in foreclosure or about to be foreclosed upon, it permits an orderly sale of the property to a third party at a fair market value, albeit one that is less than what the purchase price was. By short selling, the borrower also prevents or lessens the impact that a foreclosure will have on their credit history.

The lender shares the financial burden in a short sale. Because the sale of the property is short of the principal balance of the existing first mortgage and the lender has agreed not to pursue the borrower for the deficiency, the lending institution has to write off part of its loan. Since the bank agreed to the short sale, a deficiency judgment cannot be sought against the borrower, which can happen in a foreclosure sale if the amount paid is less than that of the mortgage balance.