Categories

Short Sale

What Is a Short Sale?

A short sale is when a homeowner sells their home for less than what they owe on their mortgage. With this arrangement, the seller doesn't receive enough money from the sale to pay off their mortgage loan and must make up the difference somehow.

If you're considering selling a home in a short sale, here's everything you need to know about the process and whether it's a good idea.

How Short Sales 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.

Unlike a traditional home-selling scenario, however, the seller will have 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.

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 a short sale is the best solution for both them and the lender.

Required documents can vary by lender. But in general, you should expect to provide income documents, such as pay stubs, W-2 forms, tax returns, bank statements and more. You may also need to provide a hardship letter or affidavit to explain why you can't make your full monthly mortgage payments.

Once you submit your request and documentation, the lender may order an appraisal on the home to determine whether the offer is satisfactory. That doesn't necessarily mean the lender will reject an offer below the home's market value.

In fact, lenders are often willing to approve short sale offers below market value to avoid the foreclosure process, which is costly and time-consuming for both the lender and the borrower.

Short Sale vs. Foreclosure

While both a short sale and a foreclosure will free you of a mortgage you can no longer afford—and come with consequences for doing so—they differ in several fundamental ways. To start, they differ in who initiates the process: 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, on the other hand, 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.

If you're in a situation where you're weighing a short sale vs. a foreclosure, it's important to understand both the benefits and drawbacks of each.

Pros and Cons of a Short Sale

If you're behind on payments and want to be proactive to avoid foreclosure, here's what to expect from the process of a short sale:

Pros

  • It won't impact your credit as negatively as a foreclosure.
  • You may not have to pay a deficiency judgment (a fee for not meeting the terms of the loan) if you live in a state that doesn't allow them, or if you convince the lender to waive it.
  • While the bank must approve the offer, you're still in control of the sale.

Cons

  • It will damage your credit scores.
  • There's no guarantee you'll find a buyer or that your lender will approve the offer.
  • You may still be on the hook for the remaining balance.
  • You may face a large tax bill if your lender forgives the deficiency amount.

Pros and Cons of a Foreclosure

If you'd rather avoid the process of a short sale, here are the pros and cons of going through a foreclosure instead:

Pros

  • Waiting for foreclosure may buy you more time to come up with an alternative living situation.
  • You don't have to worry about repairs or maintenance like you might when you're trying to sell the home yourself.
  • You may be able to stay in the home if you find the money to get current on payments, even after the foreclosure process has begun.

Cons

  • It will have a greater negative impact on your credit scores than a short sale.
  • The lender has total control over the sale of the home.
  • You may have a harder time negotiating over the deficiency judgment.
  • If your lender does forgive the remaining balance, you could end up with a big tax bill.

When Does a Short Sale Make Sense?

For a short sale to work, both the lender and the homeowner must be on board with the process and find the offer from a prospective buyer acceptable. Here's what to consider from both perspectives:

Why Would a Lender Allow a Short Sale?

The longer a lender doesn't receive payments on a loan, the more money it loses. The foreclosure process can take several months—even more than a year—to complete, which can cost the lender thousands of dollars in interest.

In addition to missing out on monthly payments, foreclosing on a home is an expensive legal process. So if going with a short sale allows the lender to recover more money, it makes financial sense.

Why Would a Homeowner Consider a Short Sale?

The primary reason for considering a short sale is if foreclosure is imminent and a short sale could save you from a worst-case scenario.

While a short sale is still not ideal, it'll hurt your credit scores less than a foreclosure and give you a little more leverage to negotiate whether you'll pay the remaining balance after the sale is completed.

Why Would a Buyer Consider a Short Sale?

From a buyer's perspective, a short sale may be a way to get a little more leverage with an offer since short sales tend to draw fewer buyers and, thus, less competition. It may also mean the buyer can purchase a home in the area where they want to live but pay a lower price than what they would have to otherwise.

Buying a short sale is also less risky than buying a foreclosure because the property isn't vacant, and the seller may be less likely to destroy the home because they want to maximize the offers.

What Are the Risks of Short Sales?

Buyers and sellers both take on some risks with a short sale, and it's important to understand what they are before the process begins.

Risks for Sellers

The biggest risks of a short sale for sellers are that you may not find a buyer or that you won't get approval from your bank or mortgage lender. If this occurs, you may not be able to avoid foreclosure.

Depending on the situation, the lender may not approve an offer from a buyer because it's too low or because you don't qualify to go through with a short sale based on your financial situation.

Another major risk is that the lender may sue you for the outstanding mortgage balance, which could serve only to make a challenging situation even more of a struggle. And even if you are able to be forgiven what you owe, you may end up having to pay taxes on it.

Finally, while a short sale won't damage your credit as much as a foreclosure, it'll still show up on your credit report and hurt your credit scores. This decrease may make it difficult to get approved for a loan going forward.

Risks for Buyers

Because the seller's mortgage lender must approve the sale, the process takes longer than a traditional home purchase—up to four months in some cases. If a buyer is in a situation where they need to get into a home quickly, they may not think a short sale is worth the wait.

Also, while a short sale may save a buyer money compared to other properties in the area, the property is purchased "as is," which means costly repairs might have to be covered by the buyer.

Are Short Sale Home Prices Negotiable?

Short sale home prices are negotiable, but not in the same way as the sale price in a traditional purchase is. As the seller, you may be motivated to get rid of the property—but the mortgage lender must ultimately decide whether to accept an offer.

Negotiable items on the home can include the price and closing costs, among other things. A short sale buyer should:

  • Conduct a home inspection to determine the necessity and cost of repairs.
  • Compare prices with comparable homes in the area.
  • Be patient and understand that it can take several months for a lender to approve your offer.
  • Provide a preapproval letter, so the lender knows the deal will go through if approved.
  • Make a sizable earnest money deposit to further convince the lender it's a good offer.

Also, both sellers and buyers should also consider using real estate agents who have experience with short sales. Sometimes real estate market trends can drive down a home's value over time, so having an experienced agent can help manage expectations for an appropriate price.

How Does a Short Sale Affect Your Credit?

Payment history is the most important factor in your credit history, and getting behind on your mortgage payments will have an immediate and severe impact on your credit scores.

While the term "short sale" does not appear on your credit report, the tradeline for your mortgage loan will include a "negotiated settlement" of your mortgage debt for less than originally owed. Anytime an account is reported that way, it will hurt your credit history and credit scores.

This negative item will stay on your credit report for seven years from the original delinquency date of the mortgage. If your payments were never late, the short sale will remain on your credit report seven years from the date it was reported settled or paid.

It's also important to note that a short sale will have a greater impact than other types of settled debts. How much it will affect your credit scores will vary based on your overall credit history. The National Foundation for Credit Counseling is a good resource if you want to seek the guidance of an expert who can help you understand all your options.

Monitor Your Credit After a Short Sale

If you're a homeowner going through the short sale process, it's crucial that you continue to monitor your credit score during and after you close on the home. You may not be able to prevent the damage from the short sale, but you can prevent further damage from other potential negative items and fraud.

With Experian's credit monitoring service, you'll get free access to your FICO® Score and an updated Experian credit report every 30 days. You'll also get real-time alerts about new inquiries and accounts, which can help you stop identity theft before it wreaks havoc on your credit scores.

With the right tools and vigilance, you'll be able to address potential concerns quickly and effectively.

Resources