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Short Sale: What It Is And How To Complete One To Purchase Real Estate

Molly Grace7-Minute Read
September 22, 2020

Bargain-hunting home shoppers are always looking for ways to get into a great home at a discount. First-timers or other cash-strapped home buyers sometimes turn to short sales in the hope that they can pay as little as possible for the home they want.

Unfortunately, there aren’t really any financial shortcuts to homeownership. Though you might be able to get a deal on a short sale home, it isn’t guaranteed, and the process is complex and lengthy.

If you’re curious about short sales, considering buying one or short selling your home, here’s what you need to know.

What Is A Short Sale?

When a home is sold as a short sale, it means that the amount it was sold for was less than balance on the home’s mortgage.

Short sales offer an out for homeowners who are upside down on their mortgage (meaning they owe more than the home is currently worth) and facing foreclosure due to financial hardship.

With these transactions, the mortgage lender agrees to accept less than what they’re owed and may forgive the remaining debt. In some cases, the borrower may have to contribute some of their own money to help make up some of the shortfall.

Short Sales Occur During Preforeclosure

Short sales are only available under certain circumstances, and the lender will determine whether a borrower meets their criteria to be eligible for one and whether it makes sense from a business standpoint for them to allow a short sale.

In general, borrowers who are considered for short sales are behind on their mortgage payments, facing long-term financial hardship and unable to qualify for other loss mitigation options, such as forbearance or a loan modification. Often, the borrower will already be in preforeclosure when seeking a short sale.

Preforeclosure is the first step in the foreclosure process. It begins when the homeowner has fallen 3 – 6 months behind on their mortgage payments. Once a borrower is notified that they are in preforeclosure, they’ll want to act quickly and work with their lender to avoid losing their home to foreclosure.

Why do a short sale instead of just letting the lender foreclose? Short sales are preferable to foreclosures because rebuilding your life and your credit tends to be a little easier after a short sale than it is after a foreclosure.

While a short sale will also seriously damage your credit score, the length of time you have to wait before you’ll be eligible to purchase a home again is shorter with a short sale than a foreclosure; you may be able to buy a home in as few as two years, while those who have gone through foreclosure typically have to wait seven years to be eligible for a mortgage again. In some cases, homeowners may also be eligible for relocation assistance with a short sale.

The Process Of Short Sales For Homeowners, Buyers And Lenders

Here’s how the short sale process will unfold for each party involved.

Homeowners Must Demonstrate Financial Hardship

When considering whether they’ll allow a short sale to occur, the lender will look at a borrower’s entire financial situation to determine if a short sale is the best option for them.

This means that the homeowner will be required to document the conditions that led to them needing a short sale. This may include writing a hardship letter and proving that you don’t have other assets that could be used to make your payments.

Reasons for hardship could include a reduction or loss of income, divorce, a long-term disability or serious illness of a co-borrower or their dependents, or death of a co-borrower.

Essentially, the homeowner needs to prove to the lender that a short sale is their best and only option to avoid a foreclosure.

Homeowners Must Find A Buyer

Borrowers generally won’t receive full approval for a short sale from their lender until they have a buyer who has submitted an offer.

The seller (a.k.a. the borrower seeking a short sale) should work with a real estate agent who has experience with short sales. Together, they’ll price the property, market it and evaluate offers from potential buyers.

When pricing a short sale property, it’s important to remember that the mortgage lender will want to recoup as much of the remaining mortgage balance as possible. An experienced real estate agent can help sellers’ price the home in line with its estimated market value; however, keep in mind that it’s ultimately up to the lender whether they’ll accept a buyer’s offer or not.

Once a buyer has made an offer that the seller accepts, the seller or their real estate agent will present that offer to the lender to accept, decline or counter.

Working with an experienced real estate professional is vital, as the process of selling a short sale home is complex and finding interested buyers can be difficult, particularly if the property has fallen into disrepair due to the financial hardship of the owner.

The Buyer Must Agree To Purchase The Home “As-Is”

During a standard home sale, it’s normal for the buyer and seller to go through a period of negotiations to come to an agreement that everyone is happy with.

With a short sale, there won’t be any special contingencies or credits paid to the buyer. The home will be sold “as-is,” meaning that what you see is what you get, with no room for negotiation on price due to repairs the home may need.

Buyers who are considering purchasing a short sale home should have the home inspected and get estimates for repairs that need to be completed.

Buyers who plan to finance the purchase should also obtain prequalification or preapproval from a mortgage lender prior to submitting an offer.

The Short Sale Proposal Must Be Presented To The Bank

Depending on the lender’s short sale process, the borrower may submit some information to their lender prior to receiving an offer, or they may wait and submit a full short sale package all at once after a potential buyer has made a written offer on the home.

If you’re submitting a short sale package, your lender will let you know exactly what they expect that package to include. Expect to be asked for documentation of your current financial situation, including pay stubs, tax returns and bank statements, as well as anything that proves your current hardship, such as a termination letter, medical bills, a divorce decree or a death certificate.

Part of documenting your hardship will also include writing a hardship letter. In this letter, you’ll go into detail about the circumstances that led to you needing to short sell your home to avoid foreclosure.

If you’re asking the lender to accept the short sale as payment in full and forgo their right to pursue a deficiency judgement against you – meaning you wouldn’t owe the remaining balance on the mortgage not paid for by the home sale – you’ll include that in the letter. The lender may or may not agree to this.

You’ll also need to provide some information about the buyer: a preapproval letter or proof of funds, a copy of the purchase contract and their earnest money deposit.

The Lender Must Come To A Decision

Once the short sale package is submitted, the buyer and seller will have to wait for the lender’s decision before the process can move forward. This can potentially take several months while the lender reviews the proposal and determines whether it makes sense for them to move forward, make a counteroffer or decline the proposal.

During this time, the lender will see if it makes more sense to allow the short sale or to begin foreclosure proceedings.

Buyers who are shopping for a short sale home must be prepared to wait and be flexible on when they finally can close on their new home.

Short Sale FAQs

Why Do Homeowners Want To Move Forward With A Short Sale?

If you can no longer pay your mortgage and have exhausted all other loss mitigation options, a short sale is a way for you to avoid the long-lasting negative impact that a foreclosure can have on your credit score and history.

While short sales can also significantly hurt your credit, you’ll typically be able to apply for a mortgage again within a couple of years of completing your short sale. With a foreclosure, you’d likely be looking at a seven year wait.

Why Do Lenders Approve Short Sales?

Short sales tend to be more affordable for lenders than foreclosures, so a lender may be willing to allow a short sale even if it means they lose money.

In some cases, a lender may also be able to sue the borrower for the difference between the sale price and what is owed on the mortgage.

Who Buys Properties Owned By Financially Distressed Borrowers?

Anyone who has the means to buy a home can purchase a short sale home or other financially distressed property, such as a foreclosure. However, these types of properties tend to attract real estate investors looking to buy a discounted home, make improvements and then sell the property for more than what they paid for it.

First-time home buyers and other cash-strapped buyers may also try searching for short sale homes to save some money. Keep in mind, that hopeful buyers can end up waiting months to find out if their purchase contract has been approved or rejected by the lender and that they may not even end up saving all that much money if the home is sold at its current market value.

How Do Buyers Identify Short Sale Opportunities?

It’s best to work with a real estate agent who has experience helping buyers purchase short sales or other types of distressed properties.

You might consider looking for a REALTOR® who has earned the National Association of REALTORS’® Short Sales and Foreclosure Resource certification. These agents have received specialized training in these types of sales.

Under What Circumstances Might A Lender Pass On A Short Sale?

A lender will most likely not grant a short sale to a borrower who hasn’t exhausted all their resources to pay their mortgage. This means that if you have money in the bank that could be used for your mortgage payments, you likely won’t be approved for a short sale.

The lender may also determine that the loss they’d incur with foreclosure would be less than the loss from a short sale.

Whether you’re the buyer or seller, one of the best things you can do to improve your chances that the lender approves the short sale is being timely with providing any documentation you’re asked for.

Summary: Short Sales Can End The Foreclosure Nightmare

Though short sales are often complex and stressful in their own right, they can potentially be a helpful, last-chance loss mitigation option to homeowners who are facing foreclosure.

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Molly Grace

Molly Grace is a staff writer focusing on mortgages, personal finance and homeownership. She has a B.A. in journalism from Indiana University. You can follow her on Twitter @themollygrace.