What Is a Short Sale?

Maybe someone has told you to steer clear of short sales, or maybe you’ve heard they’re a great deal!

No matter what you’ve heard, the bottom line is this: Buying a short sale home is a complicated process. In fact, very few short sales are completed within 30 days. Knowing whether or not it’s worth all the extra effort depends on your specific situation.

Before you jump on a house with a “too good to be true” price, you need to understand how the short sale process works and connect with your real estate agent for more details.

 

What Is a Short Sale on a House?

A short sale happens when a homeowner sells their house or other piece of real estate for less than they owe on their mortgage to avoid foreclosure. A short sale must be approved by the lender that holds the mortgage.

For a sale to be considered a short sale, these two things must be true:

1. The homeowner must be so far behind on mortgage payments that they can’t catch up. Or they must have a hardship (like a job loss, divorce, natural disaster or death in the family) that will keep them from making future payments. Homes on the brink of foreclosure are called distressed properties.
2. The house is worth less than the remaining balance on the mortgage.

A short sale is usually a homeowner’s last-ditch effort to avoid foreclosure. But since lenders aren’t in the business of losing money, they normally aren’t in a hurry to get rid of a property at a loss.

A lender will take their time to recover as much of their loss as they can. Here’s the thing: Just because a property is listed as a short sale does not mean the lender has to accept your offer, even if the seller accepts it.

This is what makes the short sale process so tricky.

Short Sale vs. Foreclosure

Short sales and foreclosures are both painful ways to get out of a home mortgage. But a short sale might be a little less painful.

Short Sale

In a short sale, a homeowner (who is usually behind on their payments) lists their home for sale for less than they owe on their mortgage.

Potential buyers and their agents deal with the seller’s real estate agent during the short sale process, but all offers and other terms must be approved by the lender. The short sale cannot happen unless the lender approves it.

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Because everything is dependent on the lender, the short sale process can be lengthy and unpredictable—even if the homeowner and the potential buyer agree on terms. Short sales often fall through because the lender doesn’t approve the terms—or the buyer finds another home while waiting to hear back from the lender.

Foreclosure

On the other hand, a foreclosure is a legal process a lender initiates to take ownership of the home after the buyer has stopped making payments for at least several months.

Most foreclosed homes have already been abandoned, but if the homeowners are still living in the house, the lender will evict them. The lender then sells the home through an auction or a real estate agent to try to recover as much of the loan amount as possible.

The foreclosure process typically takes less time than a short sale because the lender wants to liquidate the home (aka, turn it into cash) as quickly as possible.

Which Is Better?

For homeowners, a short sale is typically preferable to a foreclosure for two reasons. First, a short sale is voluntary (while a foreclosure is forced). Secondly, after a foreclosure, most people are required to wait seven years before getting another mortgage loan (while a short sale may cause you to wait for at least two years).¹

Most lenders would prefer a short sale to a foreclosure because it allows them to recoup as much of the original loan as possible without a costly legal process. In fact, in most cases a lender will only pursue a foreclosure after attempting to sell the home through a short sale.

But sometimes, a lender thinks it can get more of its money back by foreclosing on a home, so it’ll reject the possibility of a short sale.

How Does a Short Sale Work?

If you’re wondering what happens as part of the short sale process, these are the standard steps:

Step 1: The homeowner starts by talking to their lender and a real estate agent about selling their house as a short sale. At this point, they may submit a short sale package to their lender. This is a set of documents—like W-2s and bank statements—that proves they’re no longer capable of making their mortgage payments and have no assets that would allow them to catch up on payments.

Step 2: The homeowner works with a real estate agent to list the property. They’ll execute a sales contract for the purchase of the property once a buyer is interested. But the lender must approve the contract, and it’s not final until then—even if both the seller and the buyer agree on the terms.

Step 3: The lender reviews the contract and could respond in a variety of ways. They could choose not to respond at all, they could reject the offer, they could reject the offer but outline which terms they would agree to, or they just might approve the offer.

Step 4: When the lender’s response is presented to the potential buyer, the contract will either stay the same or the buyer will choose to accept or reject the lender’s terms. So, at this point, the ball is in the buyer’s court.

Step 5: If the contract is approved, the short sale property closes, and ownership of the home is transferred to the new buyer. The lender receives all proceeds from the sale of the property and typically pays commissions and other sellers closing costs.

Most of the time, the lender forgives the loan balance as part of the short sell agreement. But it could pursue a deficiency judgment against the borrower. This means the lender takes legal action to have the borrower repay the remainder of their mortgage that wasn’t covered by the sale of the house.

Alternatives to a Short Sale for a Homeowner

If you find yourself in a tough spot where you can’t make your mortgage payment and are facing foreclosure, a short sale isn’t your only option.

Your first thought might be to avoid your lender’s calls and overdue notices and hope the situation magically resolves on its own. But you really need to be proactive. Talk to your lender and explain your situation. They might be able to modify your loan or revise your payment plan to give you some time to catch up.

If you pay private mortgage insurance (PMI) because you put less than 20% down when you purchased your home, your PMI company might be able to help get your mortgage up to date. Keep in mind, you’ll eventually have to repay the PMI company.   

How to Buy a Short Sale Property

If you’re thinking about buying a short sale property, here are some good tips:

1. Do your research.

Before making an offer on a short sale property, work with your real estate agent to do investigative work on it. Your agent can check public records to see how much money the homeowner still owes on the mortgage. Between that and the comparable properties in the area, your agent should be able to give you good advice about how much (or if) you should offer.

2. Understand the lender is calling the shots.

You may be working with the seller and their agent to submit an offer, but ultimately, the lender is in control of the short sale process.

3. Always do a home inspection.

Don’t be tempted to waive the home inspection when buying a short sale to speed up the process. You should always hire a professional home inspector to evaluate the home to spot any potential big-ticket problems with the property. Buying a house without a proper inspection can be disastrous.

4. Partner with an expert real estate agent.

Whether you’re selling or buying in the short sale process, you need an expert real estate agent who has specific experience with short sale properties.

Because short sales are so complex, you’ll need an agent you can trust to walk you through the process and answer any questions you have along the way.

Why Lenders Do Short Sales

The only reason a lender would want to do a short sale is because they believe it’s their best chance to recoup as much of the mortgage loan balance as possible.

Because of that, a lender usually won’t consider a short sale if:

• The loan is current. If the homeowner is making regular payments and doesn’t have any hardships, the lender has no reason to think they can’t continue making them. Usually, the homeowner must be issued a notice of default in order for the lender to even consider a short sale request.
• The homeowner declares bankruptcy. Negotiating a short sale is considered a collection activity, which is not allowed in bankruptcy.

So basically, the lender will hold off on a short sale until it looks like the only other option is a foreclosure. In that case, the short sale makes sense for them because a foreclosure is more of a legal hassle and more expensive.

Why Homeowners Do Short Sales

If a homeowner is considering a short sale, things have gotten bad. For them, a short sale means selling their home at a loss. Plus, they have to endure the emotional stress of convincing the lender to allow them to do it. Selling a house through the short sale process is never ideal—the only reason a homeowner would want to do it is to avoid foreclosure.

Throughout the process, the homeowner’s focus is convincing the lender that a short sale is the best option. The homeowner must:

• Prove they won’t be able to bring the mortgage current and that they have no assets—cash, savings, etc.—that can be used to catch up on payments
• Confirm local home values have dropped so low that the home won’t sell for enough to pay off the current mortgage balance
• Provide most lenders a signed contract with a buyer to consider a short sale
• Make sure the short sale agreement includes a waiver of the lender’s right to pursue the homeowner for the remaining balance of the loan

For a short sale to happen, both the lender and the homeowner have to be willing to sell the house at a loss. The homeowner will make no profit, and the lender will actually lose money for selling the house for less than the amount owed.

A short sale is not a do-it-yourself deal. A real estate agent who’s experienced in short sales is absolutely essential.

3 Things to Consider Before Buying a Short Sale

There’s not a cut-and-dry answer to whether or not you should purchase a short sale home. Deciding if a short sale property is right for you depends on your specific situation and the details of the property.

One thing is certain, though: If you want to buy a short sale property, you need to be prepared for a lengthy, complicated process.

Here are three things you should know before submitting an offer for a short sale property:

1. The timeline will be slow and unpredictable.

Because the lender has to approve the short sale contract, it can take weeks or months before you know if your offer has even been accepted. There’s no way to know exactly how long the process will take since it’s completely up to the lender and their willingness to sell the home at that price.

2. You’ll probably have to buy the house as is.

Because the lender is in the driver’s seat, it’s also unlikely they’ll agree to pay for any extras, like buyer’s closing costs or repairs. You may not be able to ask for repairs, but you should always get an inspection so you know exactly what you’re signing up for before you purchase the home.

3. You may not be getting a great deal.

When a short sell listing hits the market, it may be listed for less than it’s worth to draw buyers in. But that doesn’t mean that’s the price it will sell for. In the short sale process, the lender typically doesn’t evaluate the price until there’s a proposed contract and an appraisal—because they’ll want to get a price as close to market value as possible.

A seller might be ready to accept an offer lower than the list price—maybe because they have a rushed timeline. However, the lender’s goal is to lose as little money as possible in a short sale. While there may be instances where a short sale property really is a great deal, that won’t always be true—so be careful.

Find a Short Sale Expert!

Before you consider buying a short sale home, you need to talk to a real estate agent who has experience with the short sale process.

Need help finding a pro? Our RamseyTrusted real estate program can help you find top-rated agents in your area. As you interview them to find the best fit for you, make sure to ask about their experience with short sales. With the right real estate pro, you can navigate the short sale process with confidence!

Find a RamseyTrusted agent today.