What is a short sale?

Short sales aren’t as common now as they were in the 2008 housing bust and recession, but they’re still an option for homeowners today. For sellers, a short sale presents a way out of a home that isn’t worth as much as they owe on their mortgage. For buyers, this type of sale could mean paying less for a home. Here’s what to know.

What is a short sale?

A short sale — sometimes known as a preforeclosure sale — is when a mortgage lender agrees to allow a borrower to sell their home for less than what’s owed on the mortgage. The lender accepts this payoff and forgives the difference, releasing the borrower from the debt.

Lenders allow short sales in order to avoid foreclosure, which is a time-consuming and expensive process. A short sale can only happen with the lender’s permission, and a lender won’t agree to it unless the seller successfully demonstrates hardship.

Short sales tend to pick up in times of declining home values, when borrowers have more to repay with their mortgage than what they can reasonably expect to get from a buyer. This is known as having an “underwater” mortgage or negative equity.

Short sale vs. foreclosure

Both a foreclosure and a short sale hurt your credit, but they’re not the same thing. Foreclosure is the process by which a lender repossesses a home from a borrower who has stopped making mortgage payments. If the borrower doesn’t bring the loan current, the lender can sell the home, typically at auction, to try to recoup its losses. Some borrowers facing foreclosure try to negotiate a short sale or other relief option with their lender first, while others simply walk away from the home and the mortgage and allow the lender to foreclose.

Who benefits from a short sale?

The reality is that short sales are a mixed bag for the buyer, the seller and the lender or servicer. Everyone gains something but gives up something, too:

• Seller: Through a short sale, the seller avoids foreclosure and eviction. However, their credit also takes a hit, and they’ll walk away from the sale with no cash for a new home.
• Buyer: Buyers of short sales might get the home at a reduced price — but the property, in all likelihood, has its share of problems. The deal also comes with more red tape than your standard real estate transaction.
• Lender/servicer: The lender or servicer loses out on full repayment of the mortgage, but it doesn’t have to pay and wait for foreclosure proceedings before selling the home.

Overview: Short sale process for sellers

1. Provide a hardship letter

The first step of the short sale process is negotiating the sale with your mortgage lender or servicer. Write a hardship letter explaining that you’ve come up against a legitimate financial hardship that prevents you from continuing to pay your mortgage. This might be a situation such as losing your ability to work due to disability, a health-related issue, divorce or even the death of your partner.

Along with the letter, your servicer might require documentation verifying your hardship, such as bank statements and copies of bills.

2. List your home with disclosures

Unless you plan to go it alone, you’ll need a real estate agent to help price and list your home for sale. Keep in mind, not every agent is experienced in the complexities of short sales. Before committing to a listing agreement, ask at least three agents for a listing presentation to get a sense of their knowledge, skills and selling plan.

When it’s time to put the home on the market, make sure the listing description discloses that the property is a short sale. From there, your agent will market your home to buyers much in the way they’d market a regular sale. If your home needs considerable work, your agent might target more house-flipping or investor clients.

3. Submit the offer to your lender

Once you accept an offer, you’ll submit it to your lender or servicer for review and approval. This process can take time, and the lender might not necessarily accept the initial offer price. There could be additional negotiation between the lender, the buyer and you as the seller, as well. There’s no guarantee the lender will ultimately approve the offer.

Overview: Short sale process for buyers

1. Figure out the financing

Whether you’re buying a short sale or other type of home, you have to know how you’re going to pay for it. In a short sale, you often need the flexibility to move quickly — some lenders, for example, require closing in as few as 20 days.

2. Identify which properties to go after

Before touring short sale properties, decide how much renovation work you’re comfortable paying for. This — along with your financing — can help you narrow down your budget and upper limit. A real estate agent can help you find preforeclosures, which are prime candidates for short sales.

3. Put together a proposal

When you find a home you like and you and the seller agree on a price, your agent will organize a proposal for the seller’s lender or servicer. This package includes the purchase and sale agreement, the appraisal report and an authorization letter — signed by the seller and notarized — that permits the lender to discuss the seller’s loan with you. Additionally, many lenders require the buyer to fill out an application specifically for a short sale request.

While the lender reviews the proposal, you’ll have the home inspected. If it’s in exceptionally poor condition, consider walking it with a contractor, as well. Your lender will also order a title search to confirm there are no undisclosed liens on the home.

The lender might reject your offer or return with a counteroffer. If it’s accepted, you’ll then work with your own lender to get your loan underwritten and closed.

What to consider when buying a short sale home

A short sale isn’t as straightforward as a traditional real estate transaction. You might need to work with an experienced real estate agent to find properties, and potentially with an attorney who specializes in these types of deals. Here are some other considerations:

• Short sales need to be disclosed. The seller or listing agent must disclose upfront that the home is a short sale.
• The home’s purchase price should align with market value. While you might see a lower price on a short sale due to the condition of the home, you won’t be able to buy one for next to nothing. If you want the home — and the lender to green-light the sale — your offer should be in line with today’s market value.
• Skipping formalities can cause big problems. Don’t skip steps in the process of buying a short sale. It’s unwise to forgo a home inspection, for example, or skim over disclosures and closing documents. These could uncover serious issues that might derail the sale.

Common reasons short sales fall through

Short sales are complex, which means they fall through on a fairly regular basis. There are many reasons why a short sale might not move forward:

• The seller doesn’t establish hardship. When requesting a short sale, your hardship letter and supporting documentation need to explain why you’re truly unable to continue paying your mortgage. If your lender doesn’t agree you’re experiencing hardship, it won’t permit the sale.
• The seller has other assets at their disposal. If you’ve lost income but have other assets that can help pay your mortgage, your lender might not allow a short sale.
• The seller’s home hasn’t declined enough in value. Home values fluctuate all the time. If your home’s worth has decreased but you still have sufficient means to pay your mortgage, it’s unlikely you’ll be approved for a short sale simply because you want to unload the property. Likewise if your home’s value hasn’t dropped by a significant amount.
• The seller’s home has too many liens. If there are multiple liens on your property, the proceeds from a short sale might not be enough to resolve all of the outstanding debt. In addition, even if the lender of the primary mortgage allows the sale, the lender of the second mortgage might not.
• The buyer’s offer is too low. The seller’s lender can reject the buyer’s offer for any reason, including when the offer price is too low.
• The buyer’s financing doesn’t work out. If the buyer ends up unable to obtain a mortgage due to credit or financial issues, the short sale can’t go through.
• The lender is well into the process of foreclosure. The lender might not permit a short sale if the home is already in the later stages of foreclosure. Generally, the time to do a short sale is in the preforeclosure period.

FAQ about short sales

• Is a short sale good or bad for buyers?

  Short sales can provide an opportunity for buyers to purchase a home at a bargain price. However, the approval process with the seller’s mortgage lender can be complicated, and the home might need considerable repair work.
  

• Can you negotiate a short sale price?

  While it’s possible to negotiate the purchase price for a short sale, there’s no guarantee the seller’s mortgage lender will approve the price. It’s also unlikely the seller will be able to make concessions or assume additional closing costs.
  

• How long does a short sale take?

  A short sale can take as little as a few weeks or as long as several months. Because short sales are complicated transactions, they tend to be more time-consuming.
  

• Should I sell my home through a short sale?

  Whether you should proceed with a short sale depends on your situation, whether your lender will allow it and what’s likely to work best for you in the long run. If you can no longer afford your mortgage and home values have dropped in your area, you might not have much of a choice. A short sale might help you preserve your credit to some degree by avoiding a foreclosure on your record.
  

• What are the alternatives to a short sale?

  One alternative to a short sale is moving out and allowing the mortgage lender to foreclose the home. A foreclosure makes it hard to get a mortgage and other types of credit in the future, however, so this should be a last resort, not your first option. If your hardship is temporary, your lender might offer you forbearance instead. In this arrangement, the lender agrees to suspend or reduce your monthly mortgage payments for up to one year. You’ll then pay back what you missed with a repayment plan. You also can try refinancing your mortgage, though that might be difficult if your finances are shaky. Another potentially better option is a loan modification, which permanently changes your loan terms so that the monthly payments become more affordable. Unlike a refi, a loan modification often doesn’t require a home appraisal, making it easier to get when your mortgage is underwater.