Beware Short Sales

We hear a lot about short sales these days. A "short sale" is a term that generally means a lender accepts less than what is owed on a mortgage loan and in return releases its mortgage. There's a lot of confusion about the effect of a short sale. Is the borrower free and clear after a short sale, or can the mortgage company still sue her for what wasn't paid in the short sale?

To understand this, you have to know there are two parts to a mortgage loan. The first part is the promissory note. That evidences the debt that was created when the borrower borrowed money from the bank. The second part is the mortgage, or lien (pronounced "lean") on the borrower's house. That is the security for the loan and is what lets the bank foreclose and sell the house if the borrower doesn't pay.

Most borrowers think that when the bank releases its mortgage, which is the point of a short sale, the underlying debt is fully paid. In some cases this is true. But it is possible for the bank to agree to release its collateral (the house) without considering the loan to be fully paid. In that case, the borrower remains liable for the unpaid balance and can be sued.

The lesson is, if you're considering a short sale, make sure that the bank will accept the proceeds of the sale in full satisfaction of the loan.