A guide to the short sale process

You can avoid foreclosure with a short sale, but you’ll need the mortgage lender’s approval.

Elissa

Elissa Suh

Published February 11, 2020

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KEY TAKEAWAYS

  • Homeowners facing foreclosure might opt for a short sale instead

  • Short sale approval depends wholly on the mortgage lender

  • Short sale approval depends wholly on the mortgage lender

  • Short sale process can take a long time, so buyers of short sale homes should be prepared to wait

If you fail to pay your mortgage, then you could be facing foreclosure. Once the bank repossesses your house, you will have to leave and will be evicted if you don’t do so on your own. Foreclosure carries negative financial consequences, especially regarding your credit history.

One way for homeowners to avoid foreclosure is by voluntarily selling their homes and giving the proceeds to their mortgage lender. In this transaction, known as a short sale, the loan servicer gets the money from the sale and the homeowner receives mortgage debt forgiveness for any remaining balance. Short sales can affect your credit, but not as badly as a foreclosure would. Not all homeowners facing foreclosure will qualify for a short sale. Short sale approval is completely up to the lender. Typically, the home sells for less than the value of the mortgage. (That’s why it’s called a short sale — the lender ends up short of the original loan money.)

Short sale homes are often listed at a discounted price, making them an alluring real estate investment. However, buying a short sale isn’t always a good idea since it can be a lengthy and complicated process. This is because in order for a short sale to happen, the lender must give their approval. They have the final say and usually aren’t in a rush to accept a short sale offer.

We’ll discuss how a short sale works, how it compares to foreclosure, and buying short sale homes.

In this article:

How does a short sale work

A short sale is when the homeowner who is facing foreclosure sells the property for less than what they owe on the mortgage, thus avoiding foreclosure and the severe negative consequences that come with it. The mortgage lender must give their approval in order for the short sale to take place.

A short sale happens when:

  • a homeowner cannot make mortgage payments
  • the market value of the property has declined
  • the amount of money owed (mortgage loan balance) is greater than the market value

Instead of being foreclosed on, the homeowner approaches their mortgage lender to tell them they’re considering a short sale. You’ll need to present a short sale package , which is a collection of your financial documents (like bank statements and tax returns) that prove financial hardship. The lender wants to know that you really don’t have the money to repay your mortgage loan and that you’re not just trying to get out of it.

Next contact a local real estate agent who will use comparative market analysis (CMA) to list the property at the right price. The short sale process can be complicated so you’ll need the help of a good real estate agent throughout it.

When you find an interested buyer, you’ll show a signed sales contract to the lender and wait for their approval.

If the lender approves, then the buyer gets the house and the bank gets the money, and the homeowner avoids foreclosure. But the lender can also deny the contract or counter and ask for more money.

Make sure you have written agreement from the lender agreeing to forgive your remaining mortgage debt once the sale has completed. This is sometimes called a waiver of deficiency.

Also keep in mind that forgiven debt is considered a form of income, which you must report on your tax return.

HAFA

In the past, the government sponsored the Home Affordable Foreclosure Alternatives (HAFA) program, which provided extra help — like relocation assistance money — to homeowners facing foreclosure who did not opt for loan modification. The HAFA program ended in 2017.

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Short sale vs foreclosure

At the end of either short sale or foreclosure, the homeowner leaves the house and relinquishes ownership of it. While this end result is the same, how it is reached and the consequences are very different.

Once a house has been foreclosed, it will be sold at a public auction. The process is typically fast, so the mortgage lender can quickly recoup the money. A short sale is a pre-foreclosure sale. The lender typically does not feel as pressed to make a quick sale, favoring instead a better sale. Short sales allow the homeowner a more graceful exit during a difficult situation.

Foreclosure has a severe negative impact on your credit history. Your credit report will carry the derogatory mark of foreclosure for seven years, making it difficult to get a loan, open a credit card, or buy a house in the future. Homeowners facing foreclosure suffer from a drop in their credit score as well, since they’re not making their monthly payments.

A successful short sale, on the other hand, avoids foreclosure. You may not have to wait as long (two years instead of seven) to take out a mortgage for a new home in the future. However, your credit score may still take a hit — depending on how far into the foreclosure process you were in when you stopped making mortgage payments you’ve missed and how far into the foreclosure process you started.

Buying a short sale property

If you are interested in buying a short sale home, talk to the listing agent who will communicate with the seller and the bank, which is really in charge of the sale.

Whether or not buying a short sale can be a good idea for you depends on your circumstances and situation. Buying a short sale might be appealing to someone who wants to make a quick real estate investment — but profiting from distressed properties via short sale might not be as easy as you think. Here are a few things to consider:

Short sale buyers are not in control

The main thing to remember is that negotiating a short sale ultimately happens between you and the bank or loan servicer of the current homeowner’s mortgage.

Short-sale properties may be listed at low, below-market prices, but the lender may likely push for a higher price to recoup more of its losses. In fact, if you want to buy a short sale, you should be prepared to shell out more money.

Plus, if the price is so low, it may entice other interested buyers who are willing to pay more.

Short sales have high closing costs

Purchasing a home comes with extra closing costs. Often, you can negotiate these costs with the seller, but don’t expect any such help in a short sale. The bank will rarely give you money for standard costs, like a pest inspection or repairs for any major damages, since they just want to recoup money they lent for the initial mortgage loan.

You buy the property in “as is” condition

Buying a short sale property means buying it “as is”. However, if you’re interested in a short sale property you can and should try to get permission to conduct a home inspection (which you’ll have to pay for). This way you’ll at least be aware of the property’s condition.

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