What Is a Short Sale in Real Estate?CASAPLORERTrusted & Transparent
What You Should Know
- A short sale is an alternative to foreclosure, and is when the lender agrees to the home being sold for less than the amount still owed on the mortgage loan
- Short sales can happen if the homeowner can’t keep up with their mortgage payments, or if the home value has fallen well under the remaining mortgage balance
- Homeowners can still be responsible for unrecovered amounts remaining after the home sale if the lender goes forward with a deficiency judgement
- Buying a short sale home might come at a discount, but it can be a lengthy process and the home may require repairs out of pocket
What Is a Short Sale?
A short sale is when a home is sold for less than the homeowner still owes on the home’s mortgage. The mortgage loan lender will receive all of the proceeds from the short sale of the home to partially cover the amount still owed. The remaining amount still outstanding will either be forgiven and cancelled, or the homeowner can still be responsible for repaying the leftover amount. The bank or mortgage loan lender will need to approve any short sales.Why Do Short Sales Happen?
When a homeowner is in financial distress and can’t keep up with their mortgage payments, their mortgage lender will take action to try to recover the money that they lent out. This is especially so for underwater mortgages, which is when the amount owed on a mortgage is more than the market value of the home. Lenders will try to limit their losses and recover money once a homeowner has defaulted on their mortgage loan. Foreclosures allow the lender to take ownership of the home and then sell it to recover money that they lent out. However, the foreclosure process takes a very long time.
Short sales are an alternative to foreclosures. Instead of needing to go through the process of taking possession of the home in order to sell it, short sales do not transfer ownership of the home from the homeowner to the lender. Instead, the homeowner themselves will sell the home with permission from the lender. Short sales are faster than foreclosures by skipping straight to the sale of the home.
States with Anti-Deficiency Laws
With a short sale, there will be a difference between the amount owed on the mortgage and the amount that the home is sold for. When the home is sold for less than the remaining mortgage balance, this difference is called a deficiency, which is the amount that the lender loses. Most states allow lenders to go after borrowers to recover this deficiency through a deficiency judgement. In these states, lenders can sue the homeowner for the remaining amount of the mortgage that is leftover after the short sale. If your state allows deficiency judgments, you will need to negotiate with your lender to allow for loan forgiveness in your short sale agreement in order to avoid a deficiency judgement.
Some states have laws that limit the amount of the deficiency that can be recovered. Some states also have anti-deficiency laws that protect borrowers from being sued for any deficiencies in real estate under certain conditions. States that have anti-deficiency laws include:
- New Mexico
- North Carolina
- North Dakota
Short Sale vs Foreclosure
Foreclosure is usually used as a measure of last-resort due to its time-consuming and disruptive process. With a foreclosure, the lender will take possession of the borrower’s home. This can be through the courts, such as with a judicial foreclosure, or without going to court through a nonjudicial foreclosure. In either case, a foreclosure can take months, and in the case of a judicial foreclosure, it may even take years. Foreclosing on your home can also have devastating impacts on your credit score, which can prevent you from getting another mortgage in the near future. While there are ways to get a mortgage with bad credit, a foreclosure will stay on your credit history for seven years, leaving a red flag that future mortgage lenders may see.
Short sale agreements can be initiated by the borrower, while foreclosures are usually initiated by the lender. A short sale is a mutually agreed upon decision between you and your mortgage lender, and is generally not as harsh as a foreclosure. Instead of being forced out of your home in a foreclosure, a short sale means that you agree to sell your home. You still lose your home, but agreeing to leave the home can be a more agreeable experience compared to being evicted from your home in a foreclosure.
Can I Get a Home Loan After a Short Sale?
Going through with a short sale can also allow you to qualify for a mortgage loan earlier, rather than the years it can take to repair your credit after a foreclosure. With a short sale, you can qualify for a FHA loan immediately after your short sale if you weren’t late on your mortgage payments. If you missed or defaulted on any mortgage payments, then you will need to wait three years before you are able to apply for a new FHA home loan. If you had extenuating circumstances, you can qualify after just one year.
For conventional mortgage loans, the minimum waiting period is four years, but it can be two years if there were extenuating circumstances. This is also true for conforming loans, such as those by Fannie Mae. USDA loans have a wait of three years, while VA loans have a two year wait.
Waiting Periods After a Short Sale
|Loan Type||Waiting Period||Waiting Period with No Late Payments||Waiting Period with Extenuating Circumstances|
|Conventional Loan||4 Years||4 Years||2 Years|
|FHA Loan||3 Years||No Wait||1 Years|
|USDA Loan||3 Years||3 Years||3 Years|
|VA Loan||2 Years||No Wait||2 Years|
The Short Sale Process
The first step to a short sale is getting the lender to agree to it in the first place. You will need to prove that you can’t afford to make your mortgage loan payments and that you have already tried other avenues to try to fix your financial situation. Mortgage lenders might not readily accept a short sale if you aren’t already in financial distress. That’s because agreeing to a short sale means that the lender will be agreeing to get less money back than they lent out to you. If your lender feels that you can keep up with your loan payments, then they might feel that they will recoup less money through a short sale compared to having you continue making payments.
Once the lender approves your short sale proposal, you will then need to sell your home. While you are responsible for selling your home, such as getting in touch with a real estate agent, it is your lender that will ultimately approve or decline buyer offers. Your lender will be the one that receives the money, and so they will handle the negotiating. Even if your lender has agreed to a short sale, they may still decide to start foreclosure proceedings if they think they can get more money with a foreclosure compared to a short sale.
The basics steps to a short sale for a borrower under financial distress are:
- The homeowner determines that they can’t afford to make their mortgage payments and that their situation can only be resolved by defaulting on their mortgage
- A short sale proposal is agreed upon between the homeowner and their lender
- The home is listed for sale
- Once the home is sold, all of the proceeds will go to the lender. If the homeowner still owes money to the lender, it can be forgiven if there was a deficiency balance waiver agreed upon in the proposal
- The homeowner is free of the mortgage, but they now no longer own a home
The selling part of the short sale process can take some time. This can be the case if the lender is in no hurry to get rid of the home, since they’re looking to recoup as much of their investment as possible. This can be in stark contrast to a foreclosure, where a bank will try to sell the home as quickly as possible.
A benefit to a short sale is that while the home is being sold, the homeowner can still remain in the home. With a foreclosure, the bank may evict you from the home once ownership of the home is transferred to them. Since the bank will be the one who will receive the proceeds from the sale, that also means that the bank will be the one that will need to pay for real estate commissions. If you were to try to sell your home by yourself ahead of time to avoid a short sale or foreclosure, then you will be the one paying for real estate commissions. However, you may still be responsible for paying real estate commissions even if you don’t receive any money from the sale depending on your short sale agreement with your lender.
How Long Does a Short Sale Take?
A short sale can take months. Homeowners may still be able to live in the home during this time, with them still being responsible for the home until the home has been sold. Buyers of a short sale home should be flexible in their closing dates.
Short Sale for Buyers - Pros and Cons
If you’re a buyer, you might be looking to purchase foreclosed homes or short sales in order to get a good deal. While prices might be lower, there are things that you will also need to consider when buying a short sale home.
The two main things to account for when buying a short sale home is the time that it takes and the condition of the home. Buying a short sale home can be a lengthy process when compared to a regular home transaction. That's because the homeowner's lender will need to approve offers, and they will also be the one negotiating with you. This can take time, which can even be months, before a short sale is finalized.
The home's condition is another thing to look out for. The homeowner is in financial distress, which means that they might not be able to afford maintenance or home repairs. The homeowner’s lender might not be willing to make any repairs to the home either, since they are already trying to cut their losses and can be unwilling to pour more money into the home. In other words, short sale homes are often sold “as-is”.
When buying a short sale home, it's important to have a home inspection so that you know what repairs will need to be made, and how much it will cost. This will add onto the cost of purchasing the home, and may eat away at any possible savings from purchasing the short sale. One thing to remember is that a short sale does not always mean that you will be able to buy a home for well under market value. The lender has time to try to get as much money as they can from the sale, so short sales can be priced at market value.
Example of a Short Sale
To see how the short sale process works, let’s take a look at a home that was bought five years ago for $500,000. The homeowner currently has a mortgage balance of $400,000. However, the local real estate market has performed poorly, and the home’s market value today is only $300,000. Currently, the homeowner owes $100,000 more on the loan than the home is worth. This means that the mortgage is underwater. A declining economy has also resulted in the homeowner losing their job. Home prices are still falling, and so the homeowner wants to walk away from the mortgage before they lose even more money.
In order to pay off the mortgage, the homeowner will need to come up with $100,000. They can’t sell the home for $400,000, since that’s well over what the home is worth, and they don’t have enough money for it either. They also lost their job, so they can’t afford to continue making mortgage payments. They meet with their mortgage lender and propose a short sale on their home.
The lender agrees, and the homeowner gets in touch with a listing agent to sell their home. The homeowner hasn’t been keeping up with maintenance, and it’s estimated that repairs would cost around $20,000. The lender agrees to list the home for $280,000. A buyer submits an offer for $280,000, which the lender accepts. Once the home has been sold to the buyer, the homeowner, or former homeowner, will need to move out of the home. They will get nothing from the sale of the home. Instead, their $400,000 mortgage debt will be forgiven. The $120,000 deficiency balance, which is the difference between the outstanding mortgage principal balance and the proceeds from the home sale, can be forgiven.
- $400,000 mortgage balance
- $280,000 home sold price
- $120,000 deficiency
If the homeowner lives in a state that doesn’t have anti-deficiency laws, and if the lender did not agree to waive deficiencies in the short sale proposal or agreement, then the homeowner is still on the hook for $120,000 to be repaid to the lender. The lender might collect this amount by suing the homeowner with a deficiency judgement. However, if the lender knows that this amount will be hard to collect, such as if the homeowner no longer has any assets left, then they may avoid the costs of a deficiency judgement by forgiving the balance. If the lender does go through with a deficiency judgement and the homeowner is unable to pay, then the homeowner may need to declare bankruptcy.
History of Short Sales in the United States
Short sales were prevalent in the US after the housing crisis and the Great Recession. In 2010, there were 273,000 short sales in the US, while in 2011, there were 306,000 short sales in the US. A 2013 report by CNN found that short sales made up 32% of all home sales in the United States in 2012, with the number of short sales being triple that of foreclosures.
Average Discount of Short Sale Homes
According to the same 2013 CNN report, the average discount for a short sale in 2012 was 23%. That's less than the average discount of a foreclosure of 39%.
For example, if the market value of a home was $300,000, then it would on average sell for $231,000 in a short sale, or $183,000 in a foreclosure.
Short Sale Alternatives
While it might feel like the only alternative to a short sale is foreclosure and bankruptcy, there are other alternatives to a short sale. During the pre-foreclosure process, you might be able to negotiate with your lender to work out an agreement. This might involve lowering your monthly mortgage payments by extending your mortgage term. A deed in lieu of foreclosure is also an alternative that lets you avoid foreclosure.