How to Navigate the Complexity of a Short Sale

For many who are experiencing financial hardship, a short sale is a better option than allowing their home to go into foreclosure. 

A short sale typically occurs when a homeowner sells their home or property for less than the amount owed on the mortgage. It requires approval from the mortgage lender and is an option for homeowners who are in financial distress and unable to afford their mortgage. 

A short sale is possible when a homeowner experiences financial hardship, and the sale of their home would not provide enough equity to pay off the existing mortgage. The lender must approve a short sale, and buyers initiate a short sale instead of waiting for the lender to begin the foreclosure process. 

Consider a scenario where a homeowner has a remaining mortgage balance of $400,000, but they can only sell their property for $350,000. The homeowner may choose to pursue a short sale, allowing them to avoid their obligation to the $50,000 difference, known as a deficiency balance. 

The lender may forgive the deficiency balance or pursue legal action (a deficiency judgment) to recover it.

You could get a great deal as a homebuyer, but purchasing a short sale isn’t without risk. 

As a buyer, the biggest benefit is that a short sale may allow you to purchase a home for less than market value. “The buyers can go in with instant equity into a property,” says Amber Pleiss, a real estate agent with Berkshire Hathaway in San Diego, California.

Short-sale properties are often in better condition than foreclosed homes, too. “A short sale keeps the homeowner from destroying the property because they’re angry they’re being foreclosed on,” Pleiss explains. “Short sale homeowners are more cooperative. They know they won’t get evicted. They know when their move-out date is going to be.” 

• Buying a short sale can be a lengthy process. In some cases, it can take several months or even longer. The lender’s process and the seller’s approval to complete a short sale can cause delays. A short sale could also face delays if the home has multiple liens.  
• A short sale requires lender approval. Normal home sales do not require approval from the seller’s lender, but a short sale does. This is because the homeowner is trying to sell for less than the mortgage balance. 
• You’ll negotiate your offer with the lender. If a seller is approved for a short sale, the lender will be part of the negotiations when you submit an offer. A lender might reject your offer or submit a counteroffer. In some cases, they might not even respond. Further, if multiple liens exist on the property, all lien holders must agree to the sale.
• A short-sale property is sold “as-is.” As the buyer, you must be ready to purchase the property as-is. This means that the lender will not provide a seller concession for any issues on a home inspection, and they will also not make any repairs. This can be a noticeable concern with a short sale since the seller may not have the funds to maintain their property.  
• You must make sure that the short sale is approved. A property advertised as a short sale might still be waiting for lender approval. When reviewing a property, verify that the lender agreed to the short sale early to avoid wasted time. 
• Cash offers and large down payments are preferred. Lenders are more likely to prioritize buyers who can pay cash or make a substantial down payment. This can reduce your competitiveness if a bidding war occurs with buyers who will purchase a short sale with more money upfront. 

“A short sale makes sense when a homeowner does not want to face foreclosure,” says Pleiss. “It allows them more control over the property, including how and when they exit rather than face an eviction.”

Short sales generally damage a homeowner’s credit history and purchasing power, but less so than a foreclosure. 

Avoiding foreclosure is The greatest benefit of selling your home through a short sale. 

“Within one year, as long as they keep their credit intact, they can usually purchase another home,” Pleiss says. “Foreclosures stay on their record.” 

Another benefit is that some lenders may be willing to pay the homeowner when they complete the short sale. “If the seller can show hardship and prove they have to relocate out of state, that’s when the lender typically gives more money,” Pleiss says. “They want them to get out of the property.”

The homeowner’s lender must approve a short sale. A lender can reject a short sale from the beginning or come back after approval and decide to terminate the deal. In these cases, a homeowner has no choice but to go through with a foreclosure. 

Additionally, a short sale can be time-consuming if the seller does not have all their paperwork together. 

“If a seller gives me everything up front, I can immediately submit the paperwork to the bank and get approval within seven to 10 days,” Pleiss says. “But if the lender doesn’t have the full short sale package, I’ve seen between six to eight months just to get a short sale approved.”

When a short sale goes through, the mortgage lender writes off the forgiven deficiency balance as a loss on their investment. 

Let’s say a short-sale property closes for $50,000 less than what was owed on the mortgage. The mortgage lender will report a $50,000 cancellation of debt on a 1099-C tax form. However, this monetary “gift” is reported under a short sale, and since cash was never received, the homeowner will not be taxed on that income. They will still have to include that 1099-C in their annual tax filing. 

• Find a real estate agent with short sale experience.
• Get your home market-ready.
• Prepare your documents.
• Send your short sale package to your lender for approval. 

Short sales are a bit more complicated than typical home sales because you have to get approval from your mortgage lender. For this reason, having a real estate agent with short sale experience will help the process go a lot smoother. Rather than trying to figure it out independently, start the process with a professional on your side. 

Documents required to initiate a short sale may vary from state to state, but as a seller, you will typically need to submit the following:

• A hardship letter explaining financial constraints. 
• Proof of income and assets. 
• Home appraisal documents.
• Documentation from the buyer that demonstrates loan preapproval. 

You will also need all the documents included in a typical home sale, such as the title, purchase agreement and closing disclosure. 

To begin the short sale process, a seller needs to send their lender a comprehensive short sale package. “If you don’t give a full package over to the lender and feed things over little by little, a processor may put the file at the back,” Pleiss explains.  

Rebuilding your credit is one of the most important steps you can take to improve your financial health after the sale. 

“Once a homeowner is in default, their credit has already gone far down,” Pleiss says. On top of that, the short sale will hurt the homeowner’s credit because they are settling on a loan for less than is owed rather than paying the balance in full. 

Here are a few steps you can take to improve your credit score after a short sale: 

• Make debt and credit card payments on time
• Keep credit card balances below 30% of your limit
• Pay your credit card balance in full every month 

It’s best not to rush into homeownership until after your finances have recovered and you can once again afford monthly mortgage payments. It may also be a good idea to wait until your credit score has increased, as a higher score typically helps you qualify for a lower interest rate. 

Short sales are more complicated than typical real estate transactions for both buyers and sellers. Both parties will benefit from the guidance of a knowledgeable real estate agent who knows how to navigate the process. 

As a buyer, a short sale can allow you to purchase a home for less than fair market value, but the process is not without potential delays and risks. A seller benefits from a short sale when they are in financial distress, allowing them to avoid foreclosure when they can no longer afford their mortgage payments. 

Can you negotiate a short sale price? Everything in real estate is negotiable, including short sales. However, your offer is subject to lender approval with a short sale. The seller’s mortgage lender can reject, counter, or choose not to respond to your offer. 

How long does a short sale take? A lender can approve a short sale in as little as seven days, and the seller can close in 30 days. However, a short sale is dependent on the lender and the seller completing the steps for lender approval. In a worst-case scenario, it could take several months, and the process can become more complicated if the home has multiple liens. 

Why do sellers choose a short sale? A seller may choose a short sale to avoid foreclosure if they are behind on their mortgage payments and their loan balance exceeds the equity in the home. 

Who benefits from a short sale? A short sale can benefit both the buyer and seller. The seller can avoid foreclosure, and the buyer may be able to purchase the property for less than market value. The lender can also benefit by selling the home without waiting for it to go into foreclosure.