How Does a Short Sale Work?

If your home’s value is falling below the amount you owe on your mortgage and you need to sell the home as soon as possible because you can’t keep up with the payments, a short sale may be your best option.

Short selling is classified as a distressed sale for a reason – it’s often the last resort to avoid foreclosure. You have to convince your lender to accept a short sale as it will cost the lender money and if it goes through your credit history will be negatively rated which will hurt your credit score.

Thankfully, short sales are much rarer today than they were during the 2008 housing crisis. Here’s a guide for sellers and buyers on how to navigate and make the most of short sales.

[Read: Best Mortgage Lenders.]

What is a short sale?

A short sale occurs when a lender allows you to sell your home for less than you owe on your mortgage. In this scenario, a homeowner is “under water.” In today’s real estate market with soaring home prices, it’s unusual for homeowners to find their mortgages under water. According to the ATTOM US Home Equity and Underwater report, as of Q3 2021, only 1 in 29 homes (or 3.4%) was “seriously underwater,” with homeowners owning at least 25% more than the property’s appraised market value.

Being underwater isn’t enough to trigger a short sale — you also need to be forced to sell the house for some reason. Maybe you’ve suddenly changed jobs and need to move immediately, or you’ve fallen behind on payments because of a divorce, job loss, or serious debt problems.

“You’re selling your house for financial reasons,” says Frank Jacovini, associate broker at ReMax Central in Philadelphia. “The market value of the home is less than the mortgage. In this situation, you are appealing to your lender to accept a short sale, essentially accepting less than what is owed on the property.”

The story goes on

While short sales aren’t ideal for either the lender or the homeowner, they might be the best option for both — and certainly preferable to foreclosure. A bank could spend more money on legal fees for a foreclosure than it loses on a short sale, and homeowners could do more credit damage from a foreclosure than from a short sale.

“If a loan modification isn’t an option for the seller, the next best option is a short sale if the lender is okay with it,” says Jay Plum, head of mortgages at Fifth Third Bank. “There are situations where a salesperson has to move far away for employment, the borrower is financially overwhelmed due to a divorce, the main borrower dies, or income is reduced due to disability. In these cases, you should contact your lender for advice on short selling. A short sale is a much better option than foreclosure.”

In most cases, a lender doesn’t require the homeowner to cover the unpaid balance of the mortgage, Plum says.

[Read: Best Mortgage Refinance Lenders.]

How can you avoid a short sale?

If you are in financial distress and your home is less than the value of your mortgage, contact your lender immediately as you may have options other than a short sale.

Here are some of them:

Loan Modification. “A loan modification is a solid solution for sellers who want to keep their home,” says Plum. “Amendment programs are designed to reduce the monthly obligation to make mortgage payments more affordable. Homeowners should contact their lender when facing mortgage problems to determine which exercise option best suits their unique financial situation.”

Forbearance/Refund. A lender might allow you to suspend your mortgage payments for a period of time because of your difficult financial situation. This is an option that was offered during the coronavirus pandemic and may appear in other situations in the future. Be aware that once the grace period is over, you will need to set up a repayment plan with the lender.

deed instead of foreclosure. If you are unable to obtain a short sale, you can transfer ownership of your property to the loan servicer to avoid foreclosure. This should cover all or most of the mortgage debt.

For sellers: steps in the short sale process

There are two routes you can take to a short sale – get pre-approval from a credit servicer after submitting paperwork detailing your financial hardship, or list the home and get an offer, and then ask if short selling might be an option.

Here are the typical steps in a short sale:

Hire a professional. Before attempting to sell, you should enlist the help of a real estate agent and possibly a lawyer. “They need guidance through the sales process and maybe a little help coordinating with the lender,” says Jacovini. “You need the help of a professional.”

Get the best deal you can. It’s possible to get more for the house than you bargained for, which could help you avoid a short sale.

Make a suggestion. The lender who issued your main mortgage will review your proposal, the prospective buyer’s offer, real estate market information that puts the offer in perspective, and evidence that you have released any other liens (eg. You may also need documentation about your financial situation.

Wait. Short sales generally take longer than traditional home sales because a bank or loan servicer may need to obtain multiple internal approvals, engage an appraiser, and make a counter offer to the prospective buyer.

Close. Before the home closes, try to get a waiver from the lender to make sure you are not responsible for the amount of credit not covered by the sale. There could be tax implications if any of the mortgage debt is forgiven. Also keep an eye on your credit and score as both are likely to be affected by the sale.

[Read: Best Adjustable-Rate Mortgage Lenders.]

For Sellers: Pros and Cons of Short Selling

benefits

limit credit losses. A short sale could hurt your credit because you sold the home for less than its value, but you could limit the damage if you were up to date on your payments before the sale. A foreclosure often involves a series of missed payments and will remain on your credit report for seven years after the first payment you skipped that started the process.

Get a faster solution. Foreclosure involves a court action by the lender to foreclose on the mortgage for non-payment, and this can take years depending on state law. A short sale will likely last a few months, depending on the permits. “Sellers can avoid the foreclosure process, avoid additional attorney fees, and avoid having an actual foreclosure on their credit bureau report,” says Plum.

disadvantage

Long, sometimes difficult process. Lender approvals can lengthen the process and buyers can decline the offer. A lender might also choose to decline the short sale and proceed with foreclosure. “The lender has the final authority to decide whether or not to approve the sale,” says Jacovini.

Financial hit. Not only would you leave the sale with no proceeds to put down a down payment on another home, but you also have a declining credit score, affecting your ability to get the lowest interest rates available on loans.

For buyers: steps in the short sale process

If you’re looking to buy a home on a short sale, you need to be more careful now than in years past as property values ​​have risen and fewer homes are flooded.

A 2021 report by ATTOM showed that distressed home sales — which include foreclosures and short sales — accounted for 7.8% of all U.S. condo and single-family home sales in 2020, the lowest amount since 2005. The This is in stark contrast to 2011, when 38.6% of home sales were defaulted.

Here are some ways to get started and secure a short sale property:

Get pre-approved. It is important that at least one lender pre-approves you for a mortgage and verifies that you can get a mortgage based on your credit history and potential debt-to-income ratio.

Hire a professional. A buyer’s agent experienced in the short sale process is a valuable ally, helping you navigate the potential complications and negotiate with the numerous parties involved.

Find a home. Your agent should guide this effort, and you might also find homes online that are marked as short sale properties. You may wish to review local court records which may show the need for a short sale.

Do your due diligence. Be sure to schedule inspections — like a general home inspection, radon, and others — as soon as your agent assures you the process is moving forward.

Be patient. If you need a home ASAP, a short sale is probably not the best option as it can take up to four months. This is significantly longer than a typical sales process, which is normally completed in 45 days to meet the sales contract deadline.

“The buyer should follow the same steps as in a traditional home purchase,” says Plum. “Before making an offer, they should find out what they can afford, speak to a mortgage loan specialist, and pre-qualify for a loan.”

For buyers: the pros and cons of short selling

benefits

Patience can pay off. You will likely have less initial competition to buy a short sale home and could outlast other buyers if you take a long-term perspective and stay in the bidding game as long as possible.

Save money. Your home investment is more likely to pay off in the long run if you buy a home below its value. You may also have more cash on hand to make necessary repairs and upgrades on the property.

disadvantage

Long waiting. You may not be able to put off buying a home for a few months or more while the short sale is being considered.

Complicated process. Deals can fail for a variety of reasons, most notably because the lender and seller may not agree on the offer or the process.

“You might get a good deal, but you often get burned,” says Jacovini. “The waiting process for a short sale could be lengthy.”