A short sale is when you sell your home for less than what you owe on your mortgage. As a result, sale proceeds won’t be enough to pay off your mortgage, so you must make up the difference.
As you might imagine, there are some conditions that must be met to qualify for a short sale and pros and cons to consider. Here’s what you need to know about the short sale process to help you determine whether it’s a good option for your situation.
What Is a Short Sale?
A short sale is when your mortgage lender allows you to sell your home for less than your mortgage balance. Homeowners often pursue this option when facing financial hardship and must sell their home for less than the total amount due on the mortgage.
With a short sale arrangement, the lender collects the sale proceeds and can either forgive the deficiency balance (the difference between the proceeds and what you owe on the mortgage) or, if your state allows it, pursue a deficiency judgment requiring you to pay all or a portion of the remaining balance.
Short sale requirements generally include:
- Lender approval: The seller needs to get lender approval to sell their house for less than their outstanding mortgage balance.
- Proof of hardship: The homeowner needs to show their inability to pay their mortgage.
How Does a Short Sale Work?
For the most part, a short sale works like a typical home sale. The seller contacts a real estate agent, notifies them that they’d like to put their home on the market and waits until potential buyers start making offers. However, there are a couple of conditions that must be met.
Lenders Must Approve the Transaction
Unlike a traditional home-selling scenario, the seller has to notify the real estate agent that it’s a short sale and submit offers to their mortgage lender for approval. Since the homeowner is trying to sell the house for less than what they owe on the mortgage loan, the lender must be on board with the transaction.
Your lender may order a home appraisal to determine whether the offer is sufficient, even if the offer is below the market value. Keep in mind, lenders often approve short sale offers below market value to avoid a costly and time-consuming foreclosure.
Homeowners Must Show Inability to Pay
In addition to submitting the offer to the lender, the homeowner must also submit documentation that explains why they’re engaging in a short sale. In particular, the homeowner must prove that they can no longer make mortgage payments and that a short sale is the best solution for both them and the lender.
- Required documents: Be prepared to submit recent proof of income, including pay stubs, W-2s, tax returns and bank statements.
- Hardship letter: Your lender may require you to submit a hardship letter or affidavit explaining why you can no longer make full monthly mortgage payments.
Learn more >> Options if You Can’t Afford Your Mortgage Payments
Short Sale vs. Foreclosure
Short sales and foreclosures are processes that can happen when a homeowner can’t keep up with their mortgage payments, are underwater on their home loan, or both. With either process, the homeowner loses their home, but the circumstances and outcomes are different.
- Short sale: Short sales are initiated by the homeowner to get out of a mortgage and avoid foreclosure. This typically occurs when they’ve missed payments and owe more than the home is worth.
- Foreclosure: This is a legal process initiated by the lender when the borrower has defaulted on their mortgage loan. Regardless of how much the home is worth, lenders foreclose on homes to recoup the amount owed by taking control of the property and selling it.
Learn more >> How to Stop a Foreclosure
Benefits and Drawbacks of a Short Sale
Listing your home as a short sale could help you avoid a foreclosure and deliver other benefits as well. A short sale may present an opportunity to sell your home for less than what you owe, but it also poses certain risks you should consider.
Benefits for Sellers
- Limits impact on your credit: A short sale won’t impact your credit as negatively as a foreclosure, which is considered the second most damaging event to your credit history after a bankruptcy.
- May avoid a deficiency judgment: You may not have to pay a deficiency judgment if you live in a state that doesn’t allow them or if you persuade the lender to waive the deficiency amount. However, you could owe taxes on the forgiven amount.
- Manage the sale: While the bank must approve the offer, you’re still in control of the sale. By contrast, you would have no control over the sale process in a foreclosure.
Drawbacks for Sellers
- Damages your credit: A short sale could remain on your credit report and negatively affect your credit score for up to seven years (in addition to any late payments leading to the short sale.
- May not reach a deal: There’s no guarantee you’ll find a buyer or that your lender will approve the offer.
- Could still owe the lender: You may still be on the hook for the remaining deficiency balance if your lender pursues a deficiency judgment. Lenders in some states may sue to collect the deficiency amount after a short sale.
- Could incur tax liability: You may have to pay taxes on the forgiven deficiency balance.
Buying a home listed as a short sale could deliver substantial benefits compared to a traditional or foreclosure home sale. Of course, short sales aren’t for everyone and there are some factors that make a short sale unappealing for many.
Benefits for Buyers
- Work with motivated sellers: Negotiations may go more smoothly with a short seller motivated to get out from underneath their mortgage to avoid foreclosure, compared to a traditional seller looking to fetch the highest offer for their home.
- Saves money on the home purchase: Although lenders prefer sales offers to be near market value, they often approve below-market offers.
- Builds equity faster: Once an offer is approved, a short sale can take several months to complete. If the market continues to rise during that time, you could start gaining equity before you even get the keys. And since short sale homes are typically sold as-is, you can also build sweat equity by updating the property yourself.
- Compete with fewer buyers: Generally, there’s less competition for short sale homes because many buyers don’t want to deal with the extra hassle and longer timeframe to complete the deal.
Drawbacks for Buyers
- May result in minimal savings: While short sales are often less expensive to spur more offers, your offer may need to be closer to the property’s market value to get approved by the lender.
- Must purchase as-is: When viewing a short sale home, bear in mind that you’ll be responsible for completing any repairs or updates you see. Unlike the traditional sales process, you can’t ask the seller to make repairs or grant seller concessions.
- Can last several months: Be prepared for the short sale process to take several months to complete, which may not work if you need to get into a home quickly. In a hot real estate market, the longer wait could result in added equity if home prices rise before you complete the deal. On the other hand, if the deal falls through, you could re-enter the real estate market facing higher prices than before.
- Could be harder to find short sale opportunities: Fewer short sale listings may be available when home prices are rising or stable, as homeowners are less likely to be underwater on their mortgages. However, short sale opportunities tend to rise when the housing market is distressed, such as during the subprime mortgage crisis from 2007 to 2010.
Short Sale Process for Sellers
If you think your situation calls for a short sale, you may take the following steps to initiate one.
1. Consult Your Tax Accountant
Before listing your home, it’s wise to speak with your tax accountant about the potential tax liability. For example, if the sales proceeds fall $75,000 short of the total amount due on your mortgage and your lender waives the difference, it’s considered taxable income by the IRS, and you should expect a 1099-C for it. Your tax accountant can guide you on whether or not you must pay taxes on the forgiven amount or how to mitigate paying taxes on it.
2. Submit a Short Sale Package to Your Lender
You can talk with a decision-maker in your lender’s loss mitigation department about selling your house as a short sale. Your lender will likely want a hardship letter explaining the reason you’re unable to make your monthly mortgage payments, such as a loss of income, divorce or other financial hardship.
Your lender will also want to know if you have assets that would help you catch up on payments. To that end, be prepared to provide proof of income and bank statements and other financial documents to verify your claim.
3. List Your Home For Sale
It’s wise to enlist the help of a real estate agent with experience in short sales to help you navigate the process more smoothly. The agent should be able to help you price your home in line with recent comparable home sales in your area. While your agent might list your home below market value to attract multiple offers, your lender is less likely to approve the agreed-upon price if it’s too low.
4. Submit the Sales Offer to the Bank
Once you agree to an offer with a buyer, submit the sales contract to your lender for approval. Remember, it could take several months for the lender to review your financial information and sales proposal before they reach a decision. The lender could reject the offer, accept it as-is or suggest an offer they would agree to. If the lender offers new terms, it’s up to the buyer to accept them or not. If all parties agree to a short sale, ownership is transferred to the buyer, and the lender receives all sales proceeds.
Lenders often forgive the loan deficiency, but they could take legal action by pursuing a deficiency judgment against you for the outstanding balance that wasn’t covered by the short sale. If you can, get a waiver of deficiency in writing before completing a short sale.
Alternatives to a Short Sale
A short sale can be an effective way of selling your home to avoid foreclosure, but it’s not your only option. One of the simplest solutions may be a phone call away. Consider contacting your lender to discuss other options, such as:
- Loan modification
- Forbearance
- A revised repayment plan
These options could be particularly helpful if you anticipate your financial situation will improve in the near future and help you get back on track with your mortgage in the meantime.
A deed in lieu of foreclosure is another option that could help you save off foreclosure. With this arrangement, your lender agrees to release you from your mortgage if you voluntarily transfer your property title to them. As with a short sale, you’ll need to submit an application and supporting documents detailing your income and expenses. Your lender may require you to attempt to sell your home before agreeing to a deed in lieu.
How to Buy a Short Sale Home
Follow these steps to purchase a short sale property.
1. Find a Home for Sale
As with the seller, it’s a good idea to work with a real estate agent experienced in completing short sale deals. You can also find homes for sale by searching a multiple listing service (MLS) if you have access to it, or request a list of short sale listings from your agent. Your agent should dig into the details, like checking the title to make sure it’s clean, verifying if the home is already in foreclosure and figuring out how much is owed to the lender so you can formulate a competitive offer.
Tip: If you’re an investor or house flipper, you’ll also need to consider the cost to make repairs and what the estimated after-repair value (ARV) of the home would be to determine if you’ll make a sufficient profit.
2. Get Preapproved
Before submitting an offer on a short sale, it’s imperative to get preapproved for a mortgage. There’s a good chance the lender won’t consider your offer without a preapproval. Fortunately, the preapproval process is typically quick, and many lenders can review your credit and financials and issue a preapproval letter in one day.
Learn more >> How to Get Preapproved for a Mortgage
3. Submit Your Offer
Once you find a home you want to purchase and the seller agrees with your price, submit a proposal to the seller’s lender or bank. Your proposal should include your preapproval letter, purchase contract signed by you and the seller, recent “comps” in your area and proof of funds. You might also put down an earnest money deposit to show the seller and bank that you’re genuinely serious about buying the property.
Your offer should include contingencies that allow you to back out of a deal if they aren’t met. With a short sale, you might consider making your offer contingent on the deal being approved by the lender. Similarly, you might want to include contingencies like setting a specific time frame for the deal to close and another that allows you to cancel the offer if the home inspection reveals major issues.
4. Negotiate and Close the Deal
The lender may accept your initial offer or counter it with specific terms. Being flexible and quick to respond during negotiations could help the process go smoothly. Otherwise, if the bank accepts your offer, all that’s left to do is finalize things with your own lender to process your loan and close the sale.
What to Consider When Buying a Short Sale Home
Buying a short sale property could be a smart move if you proceed with caution. Consider these short sale factors before submitting an offer.
- You’ll likely have to buy the house as is. Lenders are generally unlikely to pay for repairs and renovations, so you’ll have to do them yourself. For this reason, it’s smart to get an inspection so you know what your repair costs could be before you buy the house.
- Short sales take time. The timeline for the lender’s decision on your offer could range from a few weeks to several months. If you need to purchase a home quickly, a short sale may not be in your best interest.
- You may get a deal, but not a steal. While the seller may be willing to accept lower offers to facilitate a sale, the lender will want a price close to market value.
Reasons Why a Short Sale Might Not Work Out
Here are the most common reasons a short sale falls through before closing:
- The seller doesn’t qualify. Sellers have to meet a lender’s specifications for demonstrating hardship to qualify for a short sale. A seller’s assets could disqualify them, for instance. Also, lenders won’t approve short sales when the seller is current on their mortgage payments.
- The buyer’s offer is too low. Buyers should be aware that a seller may list a home for less than its market value in an effort to trigger multiple bids. The lender may reject an underpriced offer.
- The buyer’s mortgage application is rejected. A buyer could be disqualified for a mortgage based on their credit, debt-to-income ratio or lack of funds for a down payment. Also, if the buyer isn’t preapproved for a mortgage, the seller’s lender may not approve the short sale.
- The lender decides to proceed differently. A lender may choose to foreclose on a home rather than accept a short sale offer if they believe they’d recover more money through foreclosure.
Frequently Asked Questions
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Yes, a short sale may hurt your credit score because you’re paying less than the full amount owed. While the term “short sale” does not appear on your credit report, the tradeline for your mortgage loan may show as “settled” or “account paid in full for less than the full balance.”
This negative item will stay on your credit report for seven years from the original delinquency date of the mortgage. Also, any missed mortgage payments leading to the short sale could severely damage your credit, since your payment history is the most important factor in your credit score.
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A short sale can take three to six months to process, depending on your lender, the sales offer and other factors. Submitting requested documents promptly may help to avoid delays. A short sale may not make sense if you need to move sooner.
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You can find short sale homes by working with a buyer’s agent experienced in purchasing short sales. You can also call a brokerage and request a list of short sales in your area. The multiple listing service (MLS) shows short sale homes for sale, but you typically have to have a real estate license to view the database.
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Whether or not it makes sense to sell your home through a short sale depends on your personal financial situation.
Generally, a short sale may benefit you if you can’t keep up with monthly payments and your lender has denied a loan modification, forbearance or a revised repayment plan. In that case, a short sale could help you avoid foreclosure.
On the other hand, the negative impact on your credit, lengthy timeline and your lender’s ability to reject the offer could be risks that might not be worth taking.
Rebuilding Your Credit After a Short Sale
Missed payments and a short sale could impact your credit, though their effects on your credit score could decrease over time. If you’re going through a short sale, take steps to begin rebuilding your credit immediately. Check your credit score and report for free with Experian to see where you stand and resolve any potential issues on your credit report, such as inaccurate or fraudulent information. Also, consider signing up for free credit monitoring to better understand factors impacting your credit score and to track your credit rebuilding efforts.
The post What Is a Short Sale on a House? appeared first on Experian’s Official Credit Advice Blog.
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