Short sales are all the rage in creative real estate circles today.

Books, tapes, and courses are being offered everywhere, purporting to show investors how to make “huge profits” in foreclosure investing, especially for those with no cash or credit.

What exactly is a “short sale?”

A short sale occurs when the bank let’s a distressed homeowner, who owes more than his property is worth, settle up by paying less than the total owed.

The investor makes his “huge profit” by helping the homeowner negotiate the short sale with the bank, then picking up the property at the lower pay off amount accepted by the bank.

Let’s look at the reality of short sales.

First of all, short sales are difficult to pull off, requiring negotiations with many layers of bureaucracy.

Frequently, the bank you are sending your payments to is not the bank that owns your loan. In fact, it may have passed through the hands of two or more banks. Therefore, more than one bank will be involved.

If the loan required private mortgage insurance, as virtually all mortgages with less than a 20% down payment require, the mortgage insurer is also involved in the negotiations.

The objective for the investor and the home owner is to prove to everyone that that the homeowner is basically destitute and will not profit from the reduced price and the home is worth less than the amount owed the bank.

It is also very time consuming. It is not unusual for it to take weeks for a short sale to be successfully negotiated.

In fact, a realtor friend of mine said he loses more deals than he wins, trying to sell homes on short sales because the houses sold at the foreclosure auction before the short sale process was completed.

Even if a short sale is completed however, there are problems.

The home owner’s credit is seriously damaged. He will also owe income tax on the amount of loan that is forgiven! The IRS considers forgiven debt to be income and demand the taxes owed on the forgiven amount to be paid in cash with the homeowner’s next tax return.

The investor will not get a “huge profit” on a short sale, in most cases.

The reason is that virtually all purchase money first mortgages issued by banks with less than a 20% down payment carry mortgage insurance; demanded by Freddie Mac and Fanny Mae, to be saleable in the secondary market.

Since the bank is protected by the insurance and the insurance companies themselves have a vested interest in the short sale negotiations, can you imagine any scenario which would make sense for a bank insurer, to agree to a drastic reduction of the mortgage amount?

The bank doesn’t care because they are protected by insurance. The private mortgage insurer is not going to let the bank write down the mortgage because that increases the claim they are going to have to pay!

The actual discounts that I have seen and have heard of from other investors is rarely more than 10-12%. In one case, the discount was $4,150 on a $75,000 loan!

Even at the reduced price, the buyer will have to put down cash and qualify for a loan to buy the property, which he may or not be able to do. The “short sale gurus” will tell you this is an excellent way for you to make money on real estate with no money or credit.

They advise an investor to contract for a property, negotiate a short sale and then “flip” the contract to another buyer for a higher price without owning the property himself.

As we have seen, with the actual discounts in the 10-15% range, this is a highly unlikely scenario.

In summation, the short sale is not the panacea for “huge profits” to be made by those with no credit or cash. It only leaves them “short” of the cash they spent to buy those courses!

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