Selling Your Home with a Short Sale
Stability and rising value are two of the most important reasons people purchase homes. Investing in real estate is, for the most part, a reliable way of building equity and working towards a larger or nicer homes. But sometimes life events or market conditions make it harder to keep up with the payments.
Instead of facing foreclosure, some sellers will explore a short sale, a strategy that helps sellers get as much as possible from their home even if the value is less than what’s owed on the mortgage. While less than ideal, they can often be the best option for both the seller and the lender of the original loan.
What Is a Short Sale?
A short sale is essentially a real estate transaction with an offer that’s less than what the seller still owes on their mortgage. Normally, the buyer would take on all of the remaining portion of the mortgage, but a short sale acknowledges that market conditions have negatively impacted the home’s value and that the seller can no longer keep up with the mortgage. The current value no longer aligns with what buyers will offer.
Because a short sale starts with market downturns and falling behind on bills, they usually happen after:
- Losing a job, divorce, high medical bills, or other sudden financial hardship
- An unexpected decline in property values after the home was purchased
- Adjustable-rate loan terms coming into effect, making payments unaffordable
How to Start a Short Sale
Lenders have to approve the short sale, and while it sounds unlikely that they would accept less money than what the house is worth, short sales are often better than going through foreclosure because of holding and marketing costs. This is true even when there are multiple lenders involved; each lender would have to agree to receiving less than what they are owed.
There are a couple other contingencies that must be met for a lender to accept a short sale. For one, the seller must prove their financial hardship. Documentation of a job loss, divorce or medical concerns would be used to show lenders that defaulting is a high possibility. Second, the deal must be between two individuals who are not related or connected in any way. Otherwise, buyers and sellers could try and manipulate the price or hide messy financials.
Once hardship is proven and the mortgage is considered underwater, sellers can advertise their home as a short sale opportunity. Buyers will bring their offers forward, and the seller takes that price to the lender. The timeline is usually much longer (as much as 3-4 months vs. 30-45 days) than in routine sales because the lender has to carefully consider their risk and expected losses before approving the short sale amount.
Backup Offers Are Expected
Short sales are the best option for situations that are already tenuous, so it’s common practice to allow backup offers. If the deal were to fall apart because the seller became insolvent or one of the lenders doesn’t approve, a backup offer could be quickly accepted to keep the process moving.
Things You Should Know Before a Short Sale
Some lenders face straw buyers/flopping fraud: When the buyer has a connection to the seller, they can intentionally put up a low offer, with a goal of reselling short after more closely aligned with the real market price. The lender won’t know about the difference in value because the appraisal was faked, or other offers were hidden from them. This is why lenders require that the buyer and seller have no connection to one another before they’ll approve a short sale.
Properties are sold as-is: Short sales happen in the first place because the seller is dealing with financial hardship. That also usually means the home’s condition has declined to some degree, and the seller isn’t interested in or capable of hiring someone to catch up on deferred maintenance. Buyers and lenders expect this, so you probably won’t need to worry about hiring contractors.
Some agents specialize in short sales: With the seller in hardship and the lender overwhelmed, it helps to bring in other real estate professionals experienced with short sales. Short Sales and Foreclosure Resource (SSFR) certification is offered by the National Association of Realtors, and teaches these agents how to manage short sales. They can help you navigate the process and structure the short-sale packages to bring to lenders for approval.
Things You Should Know After a Short Sale
Different states enforce what are called deficiency judgements: Would you as the seller still owe the shortfall difference? Some states allow lenders to recoup the money that makes up the difference between the short sale and the original mortgage terms through deficiency judgements. The lender could sue you for the amount, garnishing wages or placing liens on other property. Sometimes, however, they’ll agree to forgive the remaining debt to avoid the risk of higher costs associated with foreclosure.
There are tax implications and an impact to credit scores: Even if the lender agrees to forgiving the sale shortfall, that amount may potentially be counted as taxable income. While this tax was excluded from sales of a primary residence in the past, this is no longer the case. And regardless of whether that money was taxed, the short sale as a whole will impact your credit score, although not as much as foreclosure would.
You’ll need to wait a period of time before you can buy another home with lender funding: Sellers initiating a short sale often do so because they can’t make the mortgage payments. To protect themselves from the same risk in the future, most major lenders will require the seller to wait as much as 4 years before they’ll approve a new mortgage, though this period can be shortened.
Sometimes, It’s in the Lender’s Best Interest to Say No
In most cases, lenders prefer short sales because they’ll get more of their investment back than if they’d pursued foreclosure, as legal fees, property maintenance, taxes, and marketing efforts to find a new buyer all further eat into the lender’s money. But there are certain situations where the lender won’t approve the short sale:
The loan is supported by insurance, so the lender will get paid regardless of what method the property is sold with.
The offer’s too low, so the lender believes they could get more money by starting foreclosure proceedings.
The lender has reason to suspect that the buyer and seller know each other, and are trying to get a lower offer accepted to resell the home later for more.
Short Sales Are Helpful for Sellers with Few Options
Short sales aren’t a reflection of the seller, as many of the situations that could lead to them are outside of their control, like a sudden medical emergency or drop in market prices. Instead, they’re a way for distressed homeowners to streamline the path to selling, and for lenders to ensure they get as much of their investment back as possible.
To avoid the slower process and extra paperwork, consider looking for an agent or investor with SSFR certification. They have enough experience with the unique moving parts in a short sale that you won’t have to worry about missing a step.