Key takeaways

  • A short sale is when a mortgage lender agrees to let a homeowner sell their home for less than what they owe on the mortgage.
  • Short sales often take place when a homeowner owes more than the property is worth.
  • A short sale is different from foreclosure, which involves the repossession of a property.

Short sales were common from 2008 to 2012, but they are less common 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 to facilitate a sale of the property. The lender forgives the owner — typically someone in financial distress — the remaining loan balance.

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

There is a difference between buying a home through a short sale versus a foreclosure. 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.

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.

  • Seller: Through a short sale, the seller can avoid foreclosure. However, they will also experience damage to their credit and walk away from the transaction with no cash for a new place.
  • Buyer: 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.
  • Lender: For the lender, the proceeds from the short sale 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.

The 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. You must communicate your change in circumstances to your lender through what’s known as a hardship letter or hardship package. As part of the hardship submission, your lender might require you 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 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. You’ll hold open houses and wait 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, you must submit it 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 lender uses as much of the proceeds as possible to pay off your mortgage balance.

The short sale process: From the buyer’s side

1. Identify potential short sales

Locate pre-foreclosures in your area by checking online listings, searching courthouse listings or legal ads or using an experienced buyer’s agent. When looking, 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.

2. Do your research

Start by viewing the property. Gauge its condition and estimate how much it will take to repair or renovate. If it needs work, many “normal” buyers won’t consider it, which is good for you. Then, figure out how much you could earn by investing in the property: What’s the property’s worth and profit potential? Finally, 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 ensure there are no undisclosed liens on the property.

3. 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, so get your financing in order.

4. Work with 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. Additionally, 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.

5. Assemble a proposal and negotiate terms

Next, you’ll assemble the proposal, which 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. Once you submit the proposal, the lender may reject your offer or return with a counteroffer. 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. Once you’ve reached an agreement with all parties, get everything in writing and officially recorded. Next comes the closing, and the property is yours.

What to consider when 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 of considerations for 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. 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.
  • Skipping formalities can cause big problems. Foregoing a home inspection or failing to read legal disclosures could cause unwanted issues. 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. In addition, a typical disclosure statement would indicate whether a house is in a flood plain, had any unpermitted renovations or contains notices of any dangerous substances (to the best of the seller’s knowledge).

Common reasons that 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 may not move forward.

Unable to establish hardship

Your hardship letter should explain why you’re truly unable to continue making mortgage payments 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 and is dealing with major illness and medical expenses that have eaten their 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.

FAQ 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 the lender’s approval, it can be more time-consuming to negotiate the price. It’s also unlikely that the seller will be able to 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 it will accept it. If the lender believes it can make more money by going through the foreclosure process, it might not accept the short sale proposal.

    You can reduce the time it takes by working with a real estate agent who 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 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 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 you’re underwater on your home.