Short sales are increasingly used as a solution to a pending foreclosure. If you sell your house "short" -- for less than the value of the outstanding loan on it -- in effect you owe your lender the difference. Theoretically, if you still owe the bank money, and you have assets, the bank could compel you to sell those assets in order to pay the difference on your loan. This is called a deficiency judgment. But there are ways to avoid this.

Language to Look For

What you are looking to obtain is a full release at closing -- the bank agrees to approve the short sale and settle the loan through language such as "paid as agreed" or "full and final settlement of the debt." While some banks will approve a short sale, their approval paperwork will not automatically release you from the deficiency, and they may pursue you for it in the future.

What's in It for the Lender?

While it may seem to make no sense that the bank would willingly take a haircut on your loan and walk away from the balance, in these times of soaring foreclosures, the last thing a bank wants is another empty property that it then has to sell at auction, probably for much less than you will realize on your short sale, especially considering all the associated costs of foreclosure. And it may not be worth the bank's time and expense to pursue you for a deficiency.

Negotiate and Review

It is crucial that you negotiate with your lender, and carefully review the paperwork it issues. Although an extra expense, it's worth having an attorney review any agreement before you sign, to ensure the bank has not left itself a loophole to pursue the debt in the future. It is also essential to study your own state's anti-deficiency laws. Many states have some kind of protection for homeowners on the original loan for their principal residence. There's a list of the broad rules in each state in the Resources section below.

Tax Issues

Another essential element to understand if you are seeking to have a deficiency forgiven is your tax liability. If this is the original loan on your primary residence, then you should be covered by the Mortgage Forgiveness Debt Relief Act, and owe no tax on the forgiven amount. But there are situations in which the forgiven amount is treated as income, and you could be left with a hefty tax bill. The IRS has a good guide to this issue, also in the Resources below.

Source:

Lawyers: Selling Your Home for Less Than You Owe

More Information:

ForeclosureLawFirms: Anti-deficiency laws

IRS: Tax issues