What Is a Short Sale?

Point of Interest: Short Sale

A short sale gives homeowners the opportunity to break free of a mortgage they can no longer sustain by selling their home for less money than they owe on it. However, short sales come with costs and credit penalties, so research all your options first.

While short sales can partially save homeowners from a bad investment, they still have long-term credit ramifications. The short sale process for buyer and seller is also cumbersome and can be difficult to navigate without assistance. For certain buyers, it can provide an opportunity to move into a property at a lower cost due to the seller and lender attempting to minimize losses on the original mortgage. For sellers, the need for a short sale typically follows a massive drop in home value, typically 20% or more.

What is a Short Sale?

“A short sale is when someone owes more than their home is worth and they don’t want to do a bankruptcy,” Coldwell Banker realtor Marla McIntyre said. She said the homeowner works with the bank to sell the home for less than is owed on the mortgage, but receiving an offer is not a guarantee that the bank will approve it. If you’re in a similar situation, it’s wise to consider all possible alternatives, including foreclosure, before attempting to negotiate a short sale with your lender.

In a short sale, the seller of the home works directly with the lender who financed their home to sell the property for less than the amount remaining on the mortgage. The seller has to qualify as a distressed borrower to be approved for a short sale and the lender is involved throughout the selling process. To complete a short sale, the home seller obtains permission from their lender to sell the home for less than the balance of the existing mortgage. The seller then lists the home with a realtor and buyers can make offers like they would with traditional real estate transactions.

Each offer is reviewed separately, McIntyre said. If one is declined or the transaction falls through, any subsequent offers must move through the same process, even if the price is the same as a previous offer.

Short Sale vs Conventional Home Sale

In a conventional home sale, a buyer makes an offer on a listed home. The seller reviews the offer and accepts it, rejects it or makes a counteroffer. In the short sale process, the lending institution also reviews the offers. The buyer and seller can agree on price and terms, but the lender may not sign off on it. If the lender makes a counteroffer, the buyer and seller must review the new terms and determine if they are acceptable. The lender may also reject an offer for any reason and has the final say in the short sale process.

Short Sale vs Foreclosure

In a short sale, the homeowner is still part of the selling process and works with the lender to accept or reject offers from potential buyers. In a foreclosure, the homeowner misses mortgage payments and the lender takes action by filing a default notice with the local government. The homeowner is evicted if payments are not brought up to date or an alternate agreement is reached, and the home is subsequently seized and a foreclosure auction is scheduled.

According to the Federal Trade Commission, homeowners who use a short sale may be able to qualify for a new mortgage in two years while borrowers who move through the foreclosure process may have to wait seven years for mortgage eligibility. The time difference can be significant if your financial situation rebounds quickly after you get out from under the bad mortgage.

How Does a Short Sale Work?

To start a short sale, you speak to your lender or to an agent, who then speaks to the lender with your permission. Most sellers who qualify for short sales can demonstrate long term financial hardship and show that the home is worth less than is owed on it. Be prepared to provide income documentation and other documents to substantiate hardship, such as proof of divorce, unemployment or a medical emergency.

After you prove financial hardship, you’ll list the home for sale. When a potential buyer makes an offer, the lender reviews it and accepts or rejects it. Your lender may be able to provide an appropriate selling price to help simplify the process, but it will still be a lengthy journey to closing, and the escrow process does not start until the lender accepts an offer. According to the Los Angeles County Consumer & Business Affairs Department, finalizing a short sale can take 120 days or longer — in addition to the time period required for a buyer to obtain financing.

Should I Consider a Short Sale on My Home?

If you find a buyer for your home and obtain lender approval, a short sale may offer a good way to move forward from an underwater mortgage. It provides an opportunity to reestablish your credit more quickly than a foreclosure by avoiding a full default. Always research your options, including foreclosure, before opting for a short sale.

If you are behind on an underwater mortgage and want to consider more comprehensive financial actions, such as Chapter 13 bankruptcy, you may be able to include your late mortgage payments in your repayment plan if you would prefer to stay in your home. Your bankruptcy attorney or financial counselor can help you consider next steps.

Should you move forward with a short sale, make sure you get all agreed upon terms with the lender in writing. You may be responsible for covering the difference between the original mortgage loan and the selling price in some states. Get it in writing when the lender agrees to waive this deficiency or you could be subject to collection attempts. When the amount is forgiven, it is taxable income. According to the FTC, you should also monitor your credit report to verify that the short sale is reported accurately. It could show up as a foreclosure and more negatively impact your score.

How Do I Buy a Short Sale Property?

If you are interested in a short sale property, review the home thoroughly. The condition of some short sale properties may be lacking due to the limited financial means of the owner. Look for deferred maintenance and repairs, such as water leaks, damaged woodwork or broken fixtures. Consider the costs of upgrades and repairs when making your offer.

A title search is a normal part of the buying process for any home, but before making an offer a short sale, research the title at your local courthouse to find the original mortgage and determine if there are additional liens. A more thorough review will still be necessary later, but you may choose not to make an offer on a home with several liens.

A traditional home loan can cover a short sale, provided it meets all inspections and appraisals and the title search is clear. Obtain preapproval for a loan and submit your offer. After the lender accepts, be prepared to finalize a mortgage as quickly as possible. You may also choose to obtain a new mortgage with the original lender.

In some instances, the seller may not have pursued a short sale before your offer. If not, the seller needs to provide you with permission to discuss the mortgage with the lender and provide a hardship letter and documentation. When you are attempting to secure a significant discount in your offer, be prepared to explain why the discount is merited and how your purchase benefits the lender.