A “short pay-off”, also called a “short sale” occurs when an owner sells his or her property for an amount less than what is owed on it, and the existing mortgage lender agrees to accept less than the full amount due.
For a hypothetical example, let’s say Mary Doe purchased a home in 2005 for $590,000 and she now owes $570,000 to ABC Savings and Loan. She must sell it and move, but due to a decline of the real estate market, the most she can now sell it for is $450,000.
In order to sell, Mary must pay the $120,000 difference in cash at closing (plus the costs of sale) or ABC Savings must agree to settle for whatever the net proceeds are from the sale.
ABC Savings will require Mary to complete a "short pay-off application" in order to make the decision whether or not to accept a loss on this transaction. If it is determined that Mary does indeed have a financial hardship, ABC Savings will probably agree to accept the loss. If, on the other hand, the financial information that Mary provides in her "short pay-off application" indicates she has other assets and sufficient income, her request for a short pay off will probably be denied.
Having the short pay off approved does not mean that the loan amount is immediately reduced. Mary must find a buyer for the property first.
It is also extremely important that Mary consult with her tax advisor or accountant at this point, since a "short sale" may affect Mary's income tax liability for capital gains or "debt relief income".
When a buyer does make an offer on Mary's home, Mary and her realtor will first discuss the offer with ABC Savings. The realtor will prepare an estimate of all the costs of sale based on the offer than has been received: Escrow fees, transfer taxes, city or county fees, any loan costs paid for the buyer by the seller. All proceeds remaining after the costs of sale are deducted will go to ABC Savings. Mary will receive nothing from a short sale.
ABC Savings may advise Mary to accept the offer, or they may insist on obtaining additional opinions of the property's valve. Once the final price and terms are accepted, the sale will proceed in a conventional manner, Mary will sign all needed documents throughout the escrow period: She is still the legal owner. ABC Savings will submit a payoff demand for "all net proceeds". The payoff demand may set limits on other fees, such as the real estate broker's commission, or fees paid by the seller for the buyer. And it may be good for a limited time period, meaning Mary's buyer must move quickly towards closing.