Short sale

Short sales help homeowners in a challenging financial situation. Bankrate explains.

What is a short sale?

In real estate, a short sale is transaction where a property sells for less than the amount owed on the property. Short sales usually take place instead of more drastic, expensive measures, such as bankruptcy or foreclosure, when the creditor anticipates that the homeowner will no longer be able to make mortgage payments. It is usually more profitable for the creditor than foreclosure and allows the homeowner to repair his or her finances.

Deeper definition

Creditors hold a lien against a home when its owner owes money on a mortgage, for services rendered on the home (mechanic’s lien), or when the home’s equity has been used as collateral on a loan. The Internal Revenue Service (IRS) may also assert a lien when the homeowner has unpaid taxes.

If the homeowner falls behind on her payments, or if it becomes otherwise impossible for her to pay, she may consider a short sale. All parties to the lien or liens must agree to accept a sale price for less than the value of what they are owed before the sale can proceed. They do so when it makes sense for a creditor to sell the property for as much money as possible.

Short sales are also beneficial for the homeowner because they don’t impact his credit score as severely as bankruptcy or foreclosure. Since the home was sold rather than foreclosed on or seized, the homeowner can receive a new home loan more quickly because creditors consider the homeowner to have acted more responsibly. Homeowners do not profit from a short sale: all proceeds are owed to the creditor.

The buyer of a home purchased in a short sale stands to get a good deal, but she faces a more complex route to closing the sale than she would through conventional real estate. For one, the lien holder approves a short sale only after it sees what kind of offers the seller gets, so any price the buyer agrees to pay the homeowner is subject to approval by the creditor. It’s possible that the creditor will find no price acceptable (it may prefer foreclosing on the property or decide that the homeowner’s financial distress isn’t bad enough), in which case the buyer has wasted her time. In some cases, this could take months.

Before considering a short sale, it might make sense to refinance your home. Bankrate allows you to compare rates.

Short sale example

Hansel lost his job and has fallen on hard times. He takes a look at his budget and realizes he won’t be able to make any mortgage payments for the foreseeable future. He lists his home as a short sale with a realtor, and a buyer named Gretel makes him an offer. His bank, which owns the mortgage, considers Gretel’s offer for a few weeks, and proposes a higher amount before it will approval the sale. After hearing Gretel’s counteroffer, the bank decides that it can recoup more from the sale than from Hansel’s mortgage, and allows the purchase to proceed. After a year, Hansel is approved for a loan to buy a smaller, more manageable home, although his credit takes much longer to recover.

More From Bankrate