There are some "infomercial gurus" that say they will teach you how to make a fortune in real estate by using the so-called "short sale" method. And they tell you it is an easy way to make a lot of money. But is that just a lot of hype, or is it factual? Just what is the truth?

To answer this, one must look at all the facts, not just the ones in the late-night spiels. One thing is certain, however - a short sale almost always does great harm to the seller.

A short sale will usually put the seller - already in financial trouble - in deeper trouble. The IRS code states that any discounted amount must be treated as income by the seller. For example, if the seller's mortgage gets discounted by $30,000, the seller will now owe the IRS the full tax on that $30,000, even though he has not received a dime! In most cases, this further debt will force the seller into insolvency from which he may never recover.
There are those who would counter that in certain cases, courts have found that the IRS cannot claim taxes in this fashion. But the fact remains that it is in the IRS code, which is backed up by law passed by Congress. The IRS can - and usually will - enforce collection.

Also, in many cases, the lender may still opt to go after the seller for the remainder of the mortgage (the discounted part), called a deficiency. So, the seller no longer has his home, but still owes a large sum to the bank on a property he no longer has, and also owes a large sum to the IRS that he probably cannot pay. Frankly, no investor worthy of the name would ever do this to a fellow human being.

For this reason, I do not teach this method of investing - it is unnecessary to cause such harm. Good profit can be made without it, and with methods that are simpler.

Some important facts about short sales: A "short sale" occurs when a lender "discounts" the balance due on a homeowner's mortgage if he is in financial trouble, if they so choose. The purpose, of course, is so the homeowner can find a buyer quickly, before foreclosure becomes necessary. Foreclosure is an expensive and time-consuming process that some lenders may want to avoid. But in most instances, lenders would rather foreclose, and then sell at nearly market value. Why take a discount if they can get full value? So, in most cases, a short sale is simply not going to happen.

But even in those cases where a lender may consider a short sale, the process is complicated and time-consuming, with an inordinate amount of paperwork. In other words, it is generally not worth the effort, when there are simpler methods of accomplishing the same thing, and without doing harm to the seller.

The paperwork involved is much more complex than in an ordinary transaction (see below), so one should wonder why anyone would bother? The fact is, most seasoned investors would not. It is the "infomercial gurus" who make money teaching this method that are responsible for the upsurge in attempts at short sales. Those gurus take advantage of naive, unsuspecting novices, and then those novices, armed with this method, will go out and try to apply it - and do substantial harm.

If still interested in using this questionable method, note that the lender will want documentation that includes a letter of authorization (lender's will not provide personal info about the seller or his mortgage without it); a preliminary net sheet (estimated closing statement that includes the proposed sale price, costs of the sale, unpaid loan balances, outstanding payments and late fees, and real estate commissions, if any); a hardship letter (statement of facts that show it is impossible for the homeowner to redeem himself and pay his debt, through no fault of his own); proof of income and assets (of both the homeowner and the investor/buyer); copies of bank statements (of both seller and buyer); a comparative market analysis showing the actual value of the property; and the purchase agreement from the buyer. See what we mean when we say this method is just too much trouble?

You may want to note that any property that has a second mortgage will probably not qualify for a short sale. This is because it is virtually impossible to get a second lender to remove its lien, thereby taking the risk of losing its investment.

So, now you know the truth about short sales. And you can probably determine that they are more trouble than they are worth, and will have terrible consequences for a seller who already has his share of trouble.

I have been teaching new investors for over 18 years, and I only teach ethical methods of investing. If you follow that example, not only will you be acting honorably, but you will not cause harm to anyone while you profit immensely, and earn yourself a solid reputation as a good person to do business with.

Copyright 2007

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