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- Mortgage lenders agree to accept less than the amount owed on a property as part of a short sale
- Short sales often take place when a homeowner owes more than the property is worth
- A short sale is different than foreclosure, which involves repossession of a property
Short sales were common from 2008 to 2012, but they are rare in today’s booming housing market. Still, these distressed sales — in which a lender lets the borrower settle their mortgage for less than the total amount of the debt — could become part of the homebuying landscape again. For a buyer, a short sale can yield a good deal on a property, but it generally takes a certain amount of fortitude and patience, plus a lot of luck.
What is a short sale?
A short sale is when a mortgage lender agrees to accept a mortgage payoff that’s less than the outstanding balance, usually in order to facilitate a sale of the property. The lender forgives the owner — typically someone in financial distress — the remaining balance of the loan.
A short sale occurs only with the lender’s permission. Generally, it happens when a home’s value has declined and the mortgage holder owes more than the home is worth, putting them in a state of negative equity.
Short sale vs foreclosure
Buying a home through a short sale is different from buying a property at a foreclosure auction, or one that is actually owned by the bank, known as an REO or real estate owned property.
In a foreclosure, the lender repossesses the property and then tries to sell it for enough to recover its costs. In a short sale, the buyer is purchasing a home from the original owner, who will then repay their mortgage lender. The lender accepts that it won’t recover the full amount of its debt. But accepting the lesser sum is a better option than dealing with the red tape and costs involved with foreclosure and then having to unload the property in a separate transaction.
Short sale process: the seller’s side
1. Submit a hardship letter to your lender
The first step of the short sale process is convincing the lender or mortgage holder that you have come up against a legitimate financial hardship that prevents you from continuing to make mortgage payments on the home. This could involve losing your job, a health-related issue, divorce or even the death of your partner. Your change in circumstances must be communicated to your lender through what’s known as a hardship letter or hardship package. As part of the hardship submission, you may be required to provide significant documentation verifying your hardship, such as bank statements and copies of bills or other expenses.
2. Hire a real estate agent
Unless you plan to go it alone, you’ll need a real estate agent to list your home. It’s a good idea to find a Realtor who has previous experience with the complexities of short sales and can help you navigate the process successfully (some agents may have even completed coursework related to short sales). Interview a handful of agents before making a decision in order to find a professional who understands the process well.
3. List your property for sale
Once you’ve hired an agent, the next step is to list your home like you would with a traditional home sale, holding open houses and waiting for offers to come in. Work with your Realtor to come up with a reasonable price.
4. Submit offer to lender
Once you receive an offer you’re willing to accept, it must still be submitted to the lender for review and approval. The lender review process can be lengthy and the lender may not necessarily accept the initial offer from the prospective buyer. Finalizing a deal may take additional negotiation between the lender, the buyer and you as the seller. And remember, there is no guarantee that the lender will ultimately approve the offer.
5. Finalize the sale
If the lender does approve the offer, the sale can move forward and the proceeds are used to pay off as much as possible of your mortgage balance.
Who benefits from a short sale?
The reality is that short sales are a mixed bag for the buyer, the seller and the lender. Everyone gains something but gives up something too.
For a short sale to close, everyone who is owed money must agree to take less, or possibly no money at all. That makes short sales complex transactions that move slowly and often fall through.
If you’re a seller, a short sale is likely to damage your credit — but not as badly as a foreclosure. You’ll also walk away from your home without a penny from the deal, making it difficult for you to find and pay for another place to live. However, a short sale can forestall foreclosure and its negative impact on your credit. It’s best if homeowner can persuade the lender to report the debt to credit bureaus as “paid in full.”
The buyer gets the property at a reduced price, but the property in all likelihood has its share of problems — think fixer-upper or “as-is” property — and the deal needs to go through considerable red tape to make it happen. Forget about getting any concessions or closing costs paid by the seller: They’re already strapped. A lender might even require that a buyer pays additional closing costs that might be normally assigned to the seller.
For the lender, the proceeds from the transaction are less than the amount the seller needs to pay the mortgage debt and the costs of selling. The lender takes a financial loss, but perhaps not as large a loss as it might if it foreclosed on the property.
For the most part, everyone gets some sort of benefit in a short sale, although everyone gives up a little, too. In the end, a short sale is about staving off worse outcomes.
Common reasons that short sales fall through
Short sales are complex, which means they fall through on a fairly regular basis. There are many different reasons why a short sale may not move forward.
Unable to establish hardship
Your hardship letter should explain why you’re not able to continue making mortgage payments. It should include details that hammer home why you’re truly unable to continue with the loan rather than an explanation of why you’re tired of dealing with financial difficulties. A borrower who could afford their mortgage payment if they cut down spending in other areas, for example, won’t have a compelling letter. A borrower who’s lost their job, is dealing with major illness/medical expenses and is out of savings will have a better chance.
You have too much money
If the seller has money or financial assets, including retirement funds, it is unlikely that the lender will let the debt slide. The proof of income and assets (or lack thereof) must include income tax and bank statements going back at least two years. Sometimes sellers are unwilling to produce these documents because they conflict with information on the original loan application. If that’s the case, the deal is unlikely to close.
Home value has not dropped
Part of a seller’s financial distress can arise from the home being underwater — meaning it’s worth less than the amount owed on it. This situation often occurs if the local real estate market has crashed, drastically lowering property values, and seems unlikely to rebound soon. However, a comparative market analysis (CMA), which takes into account the value of similar properties to estimate the value of the home you’re trying to sell, may show that your home’s value has not dropped enough to justify a short sale.
Too many liens
There might be multiple liens on your property and the proceeds from a short sale may not be enough to resolve all of the outstanding debts.
Short sale process: From the buyer’s side
A typical short sale involves a series of steps, generally in this order, according to Bobbi Dempsey, co-author of “The Complete Idiot’s Guide to Buying Foreclosures.”
- Identify potential short sales: Locate pre-foreclosures in your area by checking online listings, searching courthouse listings, legal ads or using an experienced buyer’s agent. First, try to determine how much is owed on the house in relation to its approximate value. If it seems high, it’s a good candidate because it indicates the seller might have trouble selling it for enough to satisfy the loan.
- View the property: Gauge its condition and come up with a rough estimate of how much it’s going to take to repair or renovate. If it needs work, many “normal” buyers won’t consider it, which is good for you.
- Do your research: What is the property worth? What’s the profit potential? If you’re an investor or even a homeowner planning to live in the home a short time, you’ll want to profit from the deal.
- Find all liens and mortgages: Ask the seller or the agent what liens are on the property, and which lender is the primary lien holder. Confirm this information through a title search before closing the deal to make sure there are no undisclosed liens on the property.
- Figure out the financing: You have to know how you’re going to pay for the property. It’s important to understand that in a short sale you need the ability to move quickly. Once an agreement is worked out, it is common the lender will require closing in as few as 20 days.
- Contact the lender: You or your agent should speak with the lender’s loss mitigation department or resource recovery department. You will need to have the homeowner complete and sign an authorization letter (notarization is usually required), which gives the lender permission to discuss the mortgage situation with you.
- Complete the lender’s short sale application if required: Many lenders have an application specifically for a short sale request. If they don’t have a short sale application, find out what paperwork they need to consider a short sale.
- Assemble the proposal: The proposal generally consists of a package of materials including the application and authorization letter, purchase and sale agreement, hardship letter, statement of the property’s value, a detailed description of the costs and liabilities, and the settlement statement.
- Negotiate the terms: It’s not uncommon for the lender to reject your offer or to come back with a counteroffer. As with any real estate transaction, you should figure out beforehand what your absolute highest limit is, and don’t be afraid to walk away if the lender won’t meet your figure.
- Seal the deal: Once you’ve reached an agreement that all three parties — you, the seller and the lender — can live with, get everything in writing and officially recorded. Make sure the seller understands all of the terms of the deal. Next comes the closing and the property is yours.
Considerations before buying a short sale home
With a short sale, you won’t be able to simply purchase a home for a good price. Here’s an overview on buying a short sale home:
- The lender must agree. For a regular home sale, the seller would use the proceeds to pay off the original loan. In a short sale, the home sells for less than the seller owes, so the lender won’t get all their money back. As a result, the original lender must agree to the sale.
- The seller must prove they have no other option. The seller needs to show some sort of hardship. If they can prove that they can’t keep making mortgage payments and will eventually default, the lender is more likely to agree, especially if the lender doesn’t want to go through the foreclosure process and then sell the home on its own.
- A home’s price must be in line with market value. In many cases, short sales go through because the local market is faltering, and the home’s value has dropped accordingly. The price the buyer is paying must usually be at the current market value.
- Short sales need to be disclosed. Finally, when a home is listed for less than what’s owed on the mortgage, that must be disclosed upfront. Potential buyers should be aware the price is less than the mortgage balance, so they’ll be responsible for negotiating with a lender, as well as dealing with the seller.
Common mistakes short sale buyers make
- Skipping the home inspection – A home inspection helps you identify issues you might otherwise miss, such as necessary repairs or maintenance. If you find a major issue, you might want to back out of the deal. Better yet: Have a contractor or home engineer at the ready in case the inspection uncovers a complex problem — they can provide valuable insight on the cost to remedy, which can help you make a more informed decision about the sale.
- Ignoring legal disclosures – A typical disclosure statement would indicate whether a house is in a flood plain, had any unpermitted renovation or contains notices of any dangerous substances (to the best of the seller’s knowledge). Just because it’s a short sale doesn’t mean the homeowner can overlook or skimp on these disclosures, so be sure to ask for them.
- Leaving too little time for closing – Closing on a home under normal circumstances can take time, and closing on a short sale typically takes longer than that. Make sure to account for this delayed timeline in your plans.
- Falling hard for a bad home – Real estate is an emotional market: It’s easy to fall in love with a home once you start imagining yourself living in it. However, you need to harden your heart, and remember that part of the appeal of this home is (or should be) its bargain nature. Even so, don’t assume you’re getting a great deal, says Connecticut real estate investor Jim Randel, author of “The Skinny on the Housing Crisis.” Consider what you’d need to spend on the home to make it habitable, whether you can afford to rent the home out for less than your mortgage payment and what would happen if the home’s value declines. These tangible factors, rather than emotion, should drive your decision-making.
FAQs about short sales
Short sales can provide a good opportunity for buyers to purchase a home at a bargain price. However, the approval process with the (seller’s) lender can sometimes be lengthy, which can be challenging for buyers who are seeking a quick sales process. Additionally, a home that is being sold via short sale may have issues and may need repairs.
While it is possible to negotiate the purchase price for a home that is being sold via short sale, there is no guarantee that the mortgage lender will approve the price. And because the final price requires approval of the lender, it can be more time consuming to negotiate the price. It’s also unlikely that the seller will be able make concessions or assume additional closing costs.
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. Plus, the original lender needs to review the short sale offer to determine whether they will accept it. If the lender believes they can make more money by going through the foreclosure process, they might not accept the short sale proposal.
You can reduce the time it takes by working with a real estate agent that has experience with short sale transactions and a good track record.. A short sale is one real estate deal where you really need to get help from an experienced agent or attorney. Having a real estate agent on your side who knows how short sales work — and who has negotiated others — will increase the chances of closing the deal.
Whether you should proceed with a short sale depends on your individual situation and what’s likely to work best for you in the long run. If you can’t afford your mortgage, and if home values have dropped in your area, you might not have much of a choice. A short sale might be able to help you preserve your credit to some degree by helping you avoid a foreclosure on your record.
One alternative to a short sale, of course, is simply allowing the mortgage lender to foreclose on your home. A foreclosure on your record, though, can make it hard to get a mortgage in the future, so it should be a last resort, not your first option.
Forbearance is a short-term solution in which the lender agrees to suspend or reduce your monthly mortgage payments for up to one year. Keep in mind that interest will continue to accrue during this period.
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 adjusts the terms of your loan 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 you’re underwater on your home.