A short sale is a real estate transaction that occurs when a homeowner sells a property for less than they owe on the mortgage, and the lender approves of the "short" payoff.
Understand what a short sale involves, how it differs from a foreclosure, and its alternatives to decide whether it's the right approach to get out from under your mortgage.
What Is a Short Sale?
A short sale is any property sale where the proceeds of the sale fall "short" of the original loan amount. It occurs when a seller sells a property for less than the balance of their loan, and the lender agrees to accept less than the amount originally due to them after all costs of the sale.
Short sales are commonly initiated by distressed homeowners who are underwater on their mortgages (the loan balance exceeds the home's fair market value) and can't afford or otherwise keep the home but want to avoid foreclosure. But they can also occur if the accepted sale price on a home is higher than the mortgage but not high enough to pay all closing costs and commissions.
In a successful short sale, the lender typically agrees to release the lien on the property in exchange for receiving the loan payoff. It may either forgive the "deficiency" or difference between the original loan balance and payoff or make a plan with the seller to settle the remaining debt. In either case, since the lender will be receiving a short payoff in such a transaction, it must agree to grant a short sale, and will generally only do so if it will benefit the lender's bottom line. If the lender doesn't view the homeowner or property as a good fit for a short sale, it may disapprove of the sale.
How a Short Sale Works
A legitimate short sale must be an arm's length transaction involving an unrelated buyer and seller and a bona fide lender. The following is an example of how the typical short sale unfolds:
- A homeowner has a home that's worth less than what they owe on the mortgage but must sell it as a result of hardship.
- The seller enlists an agent to discuss the short sale proposal (known in short sale terminology as the "short sale package").
- The seller's agent approaches the lender to assess their willingness to entertain the proposal and identify what the lender requires for a short sale.
- The seller works with their agent to price the home and put it up for sale.
- A buyer's agent makes the seller an offer on the property.
- The buyer and seller negotiate the offer through their respective agents.
- The seller's agent accepts the offer on the seller's behalf, and both the buyer and seller sign it, subject to the lender's approval.
- The seller's agent presents the offer to the lender along with the short sale package including the signed purchase contract, a hardship letter explaining why the seller can't keep the home, and a narrative about the local market trends that support the short sale.
- The lender does a "bottom-line" review of the package and eventually responds with approval, refusal, or, in some cases, no response. If the lender refuses the short sale, they'll often state the net proceeds that would be acceptable for approval. In the case of approval, the lender sends a short sale approval letter to the seller in order to demand the loan payoff in return for releasing the lien.
- Escrow closes, and the proceeds are turned over to the lender, not the seller.
To ensure that the short sale is an arm's length transaction, the buyer and seller will generally have to sign affidavits confirming that they aren't related.
Requirements for a Short Sale
There are four essential ingredients for a short sale, which are generally handled by real estate agents who specialize in short sales:
- An underwater home: This means that a home has a fair market value that's less than the remaining balance on the homeowner's mortgage.
- A seller with a hardship: Most lenders view job losses, surprise medical costs, the homeowner's death, natural disasters, and military service as acceptable hardships for a short sale, to name a few examples. Whatever the hardship, it should serve as a clear impetus for the homeowner to sell "short."
- A willing lender: There's no point in proceeding if the lender refuses the possibility of a short sale in no uncertain terms, which happens rarely. The lender should at least be willing to entertain a short sale proposal, but the more proactive and committed they are to the seller's agent's initial approach, the smoother the transaction is likely to be.
- A qualified buyer: Buyers should ideally be prequalified or preapproved, free of excessive contingencies, and flexible with regards to closing.
Lenders generally don't consider the mere fact that you have an underwater mortgage to be a qualifying hardship for a short sale.
Short Sale vs. Foreclosure
Both short sales and foreclosures provide homeowners with a means to dispose of a property they can't keep. However, a short sale is a pre-foreclosure transaction that takes place when you sell a home for less than you owe. A foreclosure occurs when a lender repossesses your home after you fail to make the required payments.
A short sale is generally a voluntary, cooperative undertaking with a lender that allows you to settle debts or have them forgiven in order to avoid the more aggressive, and, in some cases, unwanted, act of repossession by the lender in foreclosure. Borrowers prefer them because they may not damage their credit score as much a foreclosure; moreover, they can get back on their feet faster because they can buy a new home in as little as two years after a short sale compared to seven years after a foreclosure. Short sales also take less time, up to 10 months compared to the foreclosure timeline of as long as one year. Lenders also favor short sales given their lower costs.
|Allows borrowers to settle debts or have them forgiven by lenders||Results in repossession of the borrower's home|
|Takes up to 10 months||Takes up to one year|
|Can have a less negative impact on credit||Can have a more negative impact on credit|
|Allows you to get a new mortgage within two years||Requires you to wait as long as seven years to get a new mortgage|
Alternatives to a Short Sale
If you're underwater on your mortgage and can't keep the home, a short sale may seem like the only way to avoid foreclosure. But other foreclosure alternatives may be available to you.
Discuss your situation with your lender to determine whether you're eligible for a loan modification wherein the lender changes the terms of the existing loan to eliminate the need for a short sale (for example, by reducing the principal), or a mortgage refinancing (replacing it with a new one).
- A short sale occurs when the proceeds from a real estate transaction fall short of the original loan balance.
- It's often used by homeowners who are underwater on their mortgages and can't keep the home but want to avoid foreclosure.
- The short sale must be an arm's length transaction between an unrelated buyer and seller, but it's usually facilitated by real estate agents and must be approved by a lender.
- Short sales are preferable to foreclosures because of their less pronounced impact on credit and shorter timeline, but distressed borrowers should also discuss other foreclosure alternatives with lenders.