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. 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
Requirements for a Short Sale
• 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.
While selling a home as a short sale is hardly ideal, many experts argue it’s smarter than pursuing more drastic measures like foreclosure. Foreclosure is when a homeowner falls so behind on the mortgage payments; the lender repossesses the house, often against the homeowner’s will, then tries to sell it. If the amount the mortgage company receives from the sale is less than the mortgage debt owed, depending on state laws, the homeowner may have a deficiency judgment. In other words, the now-former homeowner may still owe money on the home loan. Foreclosures are less common than short sales. Even during economic downturns like the housing crisis of 2011, the rates rose up to only 3.6%. Right now, the rate hovers under 1%. People often confuse foreclosures with short sales, and while they share some similarities in that both typically happen to homeowners in distress, the process and consequences are very different. For one, the foreclosure process typically happens very quickly, since lenders are eager to recoup the costs incurred by the unpaid mortgage. Foreclosure also negatively affects an individual’s credit score and credit report. As a result, individuals who undergo it typically have to wait at least five years before they can qualify for a new home loan.
How Sellers Benefit From Short Sales
• A short sale does way less damage to a homeowner’s credit report and credit score than a foreclosure. This means the homeowner will be in better shape to apply for a mortgage and buy a new home down the road.
• Homeowners have the dignity of being able to sell their own home. This is no small thing.
• A short sale enables homeowners to stay in the home until the sale is completed. A foreclosure forces homeowners to vacate.
• While a seller typically pays all real estate agent commissions and other closing costs, in a short sale the seller pays nothing; the lender or bank foots the bill.
The Short Sale Process
A short sale process starts off like any other home sale: You contact a real estate agent (here’s how to find a real estate agent in your area), list your home (mentioning that it’s a “short sale/subject to lender”), then wait for an offer to come in. But once you accept an offer, things get tricky. You’ll need to get the blessing of your lender and since lenders lose money with short sales, they’re rarely eager to hop on board. “Some banks may even prefer to pursue a foreclosure, since they not only assume ownership of the property but may receive bailout money from the homeowner’s mortgage insurance policy.” On the other hand, a short sale may appeal to a lender, since owning and selling real estate are hassles lenders may prefer to avoid. To assess whether to approve your short sale, your lender will require you to submit some paperwork, including your offer letter as well as a “hardship letter” explaining why you can no longer make your mortgage payments, along with financial documents such as income statements or medical bills to back that up. At that point, the lender will most likely have your home appraised to determine if the offer you’ve received is fair. If it is, the lender may allow the deal to go through, although it may have some stipulations.
How Buyers Benefit From Short Sales
Short sales can be bargains for home buyers, but prepare to jump through many more short-sale-buying hoops than you’d find in a foreclosure or even a typical home sale. The reason for these holdups is that the mortgage lenders which are stuck paying for closing costs that a seller would typically cover will often counter with their own demands in an effort to raise their bottom line. So, short-sale buyers might hear, “We’ll accept your offer, but you’re responsible for all repairs, wire transfers, and notary fees.” While foreclosures can also be bargains, buyers should know that they come with a lot more risk than a short sale. For one, keep in mind that a foreclosure home is sold at a courthouse, sight unseen. So, there’s no time for a buyer to inspect the house for structural problems; you also inherit all liens tied to a foreclosure. In this sense, a short sale might be a safer transaction.
Selling your house for less than you owe on your mortgage is a scary financial situation to be in. With all the uncertainty that goes along with a short sale, it’s tempting to reach out for help from a familiar face. But that may be a mistake. If that favorite agent of yours doesn’t specialize in short sales, you won’t have the right help. A short sale has multiple parties involved, numerous regulations that must be met, and requires several rounds of negotiations. Only an agent well-versed in short sales can successfully navigate this complex transaction. So the minute you decide that a short sale is the right way to sell your home that is the moment you need to start looking for an expert short sale agent. On the surface, the short sale process shares some similarities with a traditional one—you find an agent, list your home, find a buyer and negotiate the sale. But that’s where the similarities stop. Your agent must also negotiate with the lender holding the current mortgage on the property over the amount of money they’re willing to lose on the short sale. These negotiations start before your home even goes on the market. They begin the first time your agent approaches your lender about allowing a short sale. You need an expert in place to handle these initial negotiations because some lenders would rather foreclose on a property than allow a short sale. If the bank will make more money between the private mortgage insurance payout and selling your foreclosed home themselves (typically for less than your short sale offer), you’re out of luck. An experienced agent will have worked with your lender on previous short sales. This gives them insider knowledge on how best to convince your mortgage company that short selling the home is in their best interest. A major part of these initial negotiations is the short sale package you’ll need to put together to convince the bank that you are financially unable to pay your mortgage. Along with a hardship letter, you’ll need to share all of your financial records with your agent including all of those overdue notices and other uncomfortable collection documents. Since your short sale agent is going to see all of the nitty-gritty details of your difficult financial situation, you need to find one that you trust and feel comfortable with. The trouble is that short sales aren’t so common these days, so finding an expert isn’t always easy.
Things to Know Before You Buy a Short Sale House
Comparable Sales for a Short Sale House
Some short sales are priced extremely low. So low that the sellers’ bank will never accept them. These types of listings receive multiple offers. But all is not lost. It will need to be priced near market value to get your offer accepted. If you’re not prepared to pay above a superficial price on a lowball short-sale listing, then pass.
Mortgage Amounts, Number of Loans, and Lenders
Ask your agent to research how much is owed against the home and find out the number of loans that are recorded. A second or third mortgage lender will receive peanuts as compared to the amount a senior lender in first position will get. Moreover, some lenders, deserving or not, get a reputation for being difficult to work with. If your agent is an experienced short sale agent, he or she will know who these lenders are and can advise you of the difficulty you may encounter. If your offer is 20% or 30% of the mortgaged amount, it probably won’t see the light of day on the negotiator’s desk.
The Short Sale Listing Agent’s Track Record
A listing agent who is advertising a short sale but has never closed a short sale is a risky proposition for you. That’s because it’s up to the listing agent to submit the short sale package to the lender and negotiate. Your buyer’s agent can’t talk to the bank. Some listing agents hire outside companies to do their job, and the results of those negotiations are often sketchy at best. Ask yourself, do you want to risk rejection of your short sale purchase because the listing agent has no experience?
Short Sale Seller Qualifications
Find out if the listing agent has received a completed short sale package from the seller, and ask about the contents of that package. A complete short sale package consists, at a minimum, of the following:
• Sellers’ hardship letter
• Tax returns
• Payroll stubs
• Financial statement
• Bank statements
Some sellers do not want to cooperate and are slow to return these documents. Others have never been told by their agent that these documents are mandatory. You don’t want your short sale purchase delayed because the listing agent doesn’t have the required documents.
Number of Short Sale Offers Received
Homes priced under market value will receive multiple offers. An agent is not required to disclose the terms of those offers, but you do want to know how many offers you are up against.
Here’s how it generally works:
• When a short sale home comes on the market, the first offer will most likely be a tad below list price.
• The second, at list price.
• The third offer will be slightly higher, maybe by $1,000 or $2,000.
• The fourth offer will be significantly more.
The Listing Agent’s Short Sale Procedures
Although realtors are required by the Realtor Code of Ethics to treat everybody fairly, not every agent is a realtor. This means the short sale listing agent may decide to submit only one offer to the seller and withhold other offers. Withholding other offers could be considered to be a violation of the fiduciary relationship formed between the listing agent and the seller. The seller is entitled to receive the highest and best price, including all offers. Realize that even if your offer is submitted to the bank, as time marches by while waiting for short sale approval, another buyer could outbid you. Let the seller know if you are willing to raise your price if necessary.