A short sale in real estate refers to the sale of a property for less than the outstanding balance on the mortgage. Essentially, the homeowner is “short” of the funds needed to pay off the loan entirely after the sale. Short sales typically happen when a homeowner is in financial distress and unable to keep up with mortgage payments, which may lead to foreclosure if no action is taken. While the lender must approve a short sale, it is often viewed as a mutually beneficial alternative to foreclosure for both the borrower and the lender.
In this article, we’ll explore what a short sale is, how it works, the process involved, and the potential benefits and risks associated with it. We’ll also look at the difference between short sales and foreclosures, as they are often confused, but have distinct differences that can significantly impact homeowners.
How a Short Sale Works
A short sale begins when a homeowner who can no longer afford their mortgage payments approaches the lender to request approval for selling the home for less than what is owed. If the lender agrees, the home is then listed for sale. However, unlike a traditional home sale, the final approval to sell the home must come from the lender. This is because the lender takes a loss on the outstanding balance of the mortgage and must agree to accept less money than the full loan balance.
Steps in the Short Sale Process
Financial Distress
The homeowner faces financial difficulties, such as a job loss, reduced income, or unexpected medical expenses, making it challenging to continue mortgage payments.
Approval from Lender
The homeowner submits a short sale proposal to the lender, demonstrating financial hardship and explaining why a short sale is the best option compared to foreclosure. The lender will review the homeowner’s financial documents, including tax returns, pay stubs, and bank statements, to determine eligibility.
Finding a Buyer
Once the lender gives preliminary approval, the home is listed on the market like any other property. However, potential buyers need to know the sale is contingent upon lender approval.
Negotiating the Sale
When an offer is made, it is submitted to the lender for approval. The lender can either accept, reject, or counter the offer. This step can take several weeks or even months, as lenders carefully review each offer.
Finalizing the Sale
If the lender approves the offer, the sale moves forward. The proceeds of the sale go directly to the lender, who will then forgive the remaining loan balance, although in some cases, the lender may ask the homeowner to pay a portion of the remaining balance.
Short Sale vs. Foreclosure
A short sale is often confused with foreclosure, but the two processes are quite different.
Short Sale
Voluntary
A short sale is initiated by the homeowner who is experiencing financial hardship but wants to avoid foreclosure.
Credit Impact
While a short sale does negatively impact the homeowner’s credit score, the damage is typically less severe than a foreclosure.
Future Home Buying
Homeowners who go through a short sale may be eligible to purchase another home in a few years, depending on their financial recovery.
Lender Approval
A short sale requires the lender’s approval since they will receive less than what’s owed on the mortgage.
Foreclosure
Involuntary
Foreclosure occurs when a homeowner defaults on their mortgage payments, and the lender takes legal action to repossess the property.
Credit Impact
Foreclosure has a more significant impact on a homeowner’s credit score, often lasting for seven years or more.
Future Home Buying
After a foreclosure, it may take several years for a homeowner to qualify for another mortgage, often between five to seven years.
Legal Process
In a foreclosure, the lender does not need the homeowner’s consent to sell the home, and the home is often sold at auction.
Benefits of a Short Sale
For homeowners and lenders alike, a short sale offers several benefits
Avoiding Foreclosure
A short sale helps homeowners avoid the lengthy and costly foreclosure process, which can be emotionally and financially draining. Avoiding foreclosure also mitigates the long-term damage to the homeowner’s credit.
Less Impact on Credit
While a short sale will still negatively affect a homeowner’s credit, it generally does less damage than a foreclosure. Homeowners may be able to rebuild their credit faster after a short sale compared to a foreclosure.
Lender Recoups Some Losses
For the lender, a short sale allows them to recover a portion of the mortgage balance, often more than they would through foreclosure.
Homeownership Possibilities
After a short sale, homeowners may be able to purchase a new home more quickly than if they had gone through foreclosure.
Control Over Sale
Homeowners have more control during a short sale since they can still participate in the sale process and negotiate offers with potential buyers.
Risks and Drawbacks of a Short Sale
Despite the potential benefits, a short sale comes with risks that homeowners should consider
Prolonged Process
Short sales are not quick. The process can take months, as lenders review each offer carefully, leading to uncertainty for both the buyer and seller.
Tax Implications
Depending on state laws and IRS regulations, the forgiven mortgage balance in a short sale may be considered taxable income, which can create additional financial burdens for the homeowner.
Deficiency Judgments
In some cases, lenders may seek a deficiency judgment, which requires the homeowner to pay the difference between the sale price and the remaining mortgage balance, though this varies by state.
No Guaranteed Approval
Lenders are not obligated to approve a short sale, and if they believe foreclosure is a better option, they may decline the homeowner’s request.
Credit Impact
While the impact is less severe than foreclosure, a short sale still damages the homeowner’s credit score, making it harder to secure loans or credit in the future.
Who Qualifies for a Short Sale?
Not all homeowners qualify for a short sale. Lenders typically require homeowners to demonstrate financial hardship before they will consider approving a short sale. This can include
Job Loss
Homeowners who have lost their job or experienced a significant reduction in income may qualify for a short sale if they can prove they are unable to make mortgage payments.
Medical Expenses
High medical costs that cause financial strain may be considered a valid reason for a short sale.
Divorce or Death
Divorce or the death of a spouse can lead to financial hardship, making it difficult to continue paying the mortgage.
Declining Property Values
Homeowners whose property values have significantly declined, resulting in an underwater mortgage (owing more than the home is worth), may also qualify for a short sale.
Conclusion
A short sale in real estate offers a way for homeowners facing financial hardship to avoid foreclosure and minimize the damage to their credit. By working with the lender and finding a buyer willing to purchase the home for less than the mortgage balance, homeowners can potentially move on from their financial struggles more quickly than if they let the home go into foreclosure. However, a short sale is not without its risks, including potential tax consequences and a lengthy approval process. Homeowners considering a short sale should carefully weigh the pros and cons and consult with a real estate professional or financial advisor to ensure it’s the right decision for their situation.
