What Is A Short Sale? How It Works And Pros And Cons To Consider

When you buy a home, you always assume you’ll be able to afford it now and forever. But life happens and occasionally there are curveballs. If you can’t stay in your home and also can’t sell it for what you owe, you might work with your servicer on a short sale. But what is a short sale? What do sellers and the buyers of these properties need to know?

What Is A Short Sale In Real Estate?

In real estate, the term “short sale” is the process in which a servicer allows a homeowner to sell their property for less than the amount owed on their mortgage. The homeowner often initiates the short sale to avoid foreclosing on the home and inflicting further damage to their credit score.

Your mortgage servicer is the entity you make your mortgage payments to. This may or may not be the same company that closed your mortgage loan.

In addition to collecting the money and passing it on to mortgage investors, your servicer is the first source you should contact if you’re falling behind on mortgage payments. They’ll go over options you have to help you get back on track and stay in your home.

After going over all the options, there may be no way for you to afford your house payment in the future. Perhaps you need to move quickly due to job relocation or you can’t keep the house after a death or divorce. Your servicer will next work with you to identify a way to gracefully exit your home and may provide some assistance. A short sale is one option.

What Is A Short Sale Vs. Foreclosure?

Both a short sale and foreclosure require a homeowner to part with their home. A short sale is a voluntary process that gives a homeowner the opportunity to avoid the more damaging consequences of foreclosure. With a foreclosure, a lender involuntarily takes ownership of a property and sells it to recover the amount owed.

Short sales and some foreclosures both come from negative equity situations. Negative equity occurs when you owe more on your home than it’s worth. This can occur because of a downturn in your local market after you buy a home. In all situations, a short sale is going to be a preferable alternative to a foreclosure.

Although the two have a similar impact on your credit score, a short sale may mean a shorter waiting period before you can get your next home loan. Of course, you’ll need to use these waiting periods to rebuild your credit, as your score will have to recover. Here are the timelines from our friends at Rocket Mortgage^® for your comparison:

In certain circumstances, there is no waiting period to get a new mortgage after a short sale on an FHA loan. To qualify though, you need to meet the following conditions:

• No mortgage or installment payments 30 days late in the year prior to the short sale.
• No mortgage or installment payments 30 days late for a year prior to the application date.

How A Homeowner Can Benefit From A Short Sale

The main benefit for a homeowner of going through with a short sale as opposed to a forced foreclosure is that the timeline is shorter for getting a new home loan should they choose down the line. A servicer might also provide some relocation assistance to help them find their next place.

There’s also the emotional benefit that you still have some agency over the process. You’re helping list the property and take care of it throughout the process. The servicer approves the offer, but you still sign off on the sale. The process is also shorter compared to a drawn-out foreclosure, so you could be free of the burden of the home sooner.

Why A Servicer Might Approve A Short Sale

There’s a misconception that exists among buyers that a short sale is a good way to get a sweetheart deal on a home. The reality is the home is still being sold for fair market value or close to it. It’s just less than what the homeowner owes on the mortgage.

If a homeowner is struggling with the payments, but is willing to assist with the sale, that’s better than the servicer having to maintain the property, complete a foreclosure and find a buyer. If your home is no longer affordable and you do not have equity to sell it for a full payoff then pursuing a short sale is a good option.

How Does A Short Sale Work?

If you’re considering a short sale, you should talk to your servicer and make sure that’s truly the best option for your circumstances. We’ll go over several other options that may be available to you a little later on. For now, let’s take a look at what it’s like to use a short sale to sell a house with a mortgage.

Receive Servicer’s Approval

Before you can move forward with a short sale, you’ll need to get approval from your servicer. Your servicer will make their decision based on the guidelines of the investor in your mortgage. This approval is important because the lender has to agree in advance to take less than the outstanding mortgage balance.

As part of the approval process, your servicer and investor may require you to show a hardship. They’ll want to know about your financial situation and what led to your need to move on via a short sale. In certain circumstances, there may be a negotiated cash contribution toward your outstanding balance as a condition of approval.

Hire A Professional Real Estate Agent

If you’re approved to move forward, the next step is to hire a real estate agent. You’ll want to find someone experienced in dealing with short sales because the process is a little different than normal. Offers have to go to the lender for approval and there are conditions around what’s included in your purchase agreement.

If you don’t have a budget, that’s okay. Agents are paid up to 6% commission out of the proceeds of the sale.

The Sale Price

Setting the sales price is just like dealing with any other transaction. You want to set the price as close to fair market value as you can. If potential buyers see it as the right value for the money, you could attract a bidding war. Even though it’s a short sale, everyone involved in the transaction is better off if you get as much money for the property as possible.

Get The Offer Approved

The next step is to get the offer approved. In cases where the servicer is also the lender, they may have authority to approve the agreement on their own. Otherwise, it may have to go to the lender and even the mortgage investor (Fannie Mae, Freddie Mac, FHA, VA, etc.).

As part of this process, an appraiser will be sent out to make sure that the property is given an appraisal. In many cases, the amount of the purchase has to be worth at least the “as-is” home value, meaning the value of the home if no changes are made.

Close On The Sale

This is a nontraditional selling process, but you still have to close on the sale. In most circumstances, sellers are required to sign the paperwork on closing day. There are limited circumstances in which someone may not need to be there if they’ve already signed a quitclaim deed.

Dealing With The Deficiency

Because you’re selling the property for less than your remaining mortgage balance, there’s a deficiency after the sale. Depending on applicable local laws and lender policies, you may or may not be required to pay back this deficiency. If the amount you’re short isn’t waived, the investor in your loan may try to collect themselves or refer you to collections.

If the deficiency is waived and the debt is forgiven, the forgiveness is often taxable as income at the federal level. State and local treatment of forgiven debt may vary. Consult with a tax advisor about your situation.

The Pros And Cons Of Short Sale Homes For Sellers

A short sale has both its benefits and downsides for sellers. Here are the things you need to consider:

Pros

If you have to sell through a short sale, there are several things that make this process more beneficial than some other resolutions if you can’t stay in your home.

• Get approved for another mortgage faster: If you make all mortgage and installment payments for the year leading up to the short sale and the year prior to your application, there is no waiting period to get an FHA loan. On a conventional loan, the waiting period is 4 years as opposed to 7 for a foreclosure.
• Lender may forgive the remaining mortgage loan: Although they may not be legally obligated, mortgage investors will sometimes waive the remaining debt on a mortgage loan.
• Chance of lower closing costs: Lenders often pay the closing costs on the seller’s end of a short sale transaction. This could be important in a situation where the budget might be tight.
• Possible relocation assistance: If you’re still living in your home at the time the review is done, your servicer may provide you with some amount of money to help you find other living accommodations.
• Short sale may be faster than foreclosure: A short sale can allow you to get out of the home and move on faster if you’re just ready to move forward.

Cons

Although not as bad as a foreclosure, there are still several downsides to doing a short sale.

• Major credit impact: Although there are ways to get another home loan faster by going through a short sale as opposed to a foreclosure, a short sale still has a comparable credit impact to the foreclosure. This could have a significant impact on your ability to apply for other loans and credit.
• Can still take time: Though in some instances, it can be faster than a foreclosure, if you’re ready to just move on from the house, you should know this isn’t a lightning-quick process. This is something to keep in mind as you still deal with payments and maintenance until the sale.
• House is sold as-is: Sellers likely don’t have the money for home improvements if they’re doing a short sale. Lenders aren’t in the repair business either. At the same time, short sales are based on a property being sold as is, so this limits the market to people who can deal with any necessary work.

How To Buy A Short Sale Home

If you’re looking to buy a home that’s a short sale, there are several steps you should take to ensure the process goes smoothly.

Have Your Financing In Order

Once they accept an offer, lenders want to make sure that the loan is going to close. Because of this, you need to show that you have rock-solid financing. If you’re buying with a mortgage, you want to be able to show a strong preapproval.

Our friends at Rocket Mortgage offer a Verified Approval.¹ In a Verified Approval, they check your credit, but they also collect documentation on your income and assets so you know exactly how much you can afford. It’s also something that can be trusted by every seller and their real estate agents, so it’s going to help whether you’re buying a short sale property or anything else.

Work With An Experienced Real Estate Agent

It’s just as important that you find a good real estate agent as a buyer. Short sales aren’t a typical transaction and you’ll want someone with experience to guide you through the process.

Homes that are short sales are usually sold as is, so someone with a good eye can tell you what work might need to be done on the house before you go too far.

Research The Property

Because the home is being sold as is, it’s important to know exactly what you’re getting going into the process, so be sure to do your research. Although properties sold under a short sale are usually in better condition than distressed properties – because someone has been living in the home and keeping up with certain maintenance tasks – the property may still need some work.

Get A Home Inspection

It’s probable that in most situations, you’ll have had your offer accepted prior to being able to order a home inspection. Because the home is being sold as is, the lender probably won’t accept offers with an inspection contingency. However, that doesn’t mean you should skip the inspection altogether.

Whether the home is in pretty good condition or a fixer-upper, you’ll want to know exactly what you’re buying before you move in so you can be prepared. The only way to know that for sure is to get a professional inspection done.

Head To Closing

Once you get past the inspection and appraisal stage, it’s time to head to closing. One thing that’s important to note for buyers here is that because you’re dealing with lender negotiations, you’ll likely be unable to get seller concessions. You can expect closing costs to typically be in the range of 3% – 6% of the purchase price.

Short Sale Alternatives

If you’re even considering a short sale, it’s important to be mindful of all the options that may be available to you before going down that path. Contacting your servicer is going to be your best bet because they’ll be able to fully discuss the options that are available to help you straighten out your mortgage situation. Rocket Mortgage clients can fill out their Application for Success.

It should be noted that outside of very specific circumstances, such as a natural disaster, these will all have some impact on your credit score. However, most of these workout options will have a more modest impact on your credit than foreclosure.

Sell At Or Above Your Balance

Before going so far as to even consider a short sale or anything else, you should make sure you really have a solid idea of the value of your property. If there’s any chance that you can sell your home for at least the amount of your mortgage balance, that’s the most desirable option because there’s no negative impact to your credit.

Forbearance

If you have trouble with your mortgage payment, the first thing a servicer is likely to be able to offer is forbearance. Forbearance involves a temporary pause in your mortgage payment. It can last anywhere between 3 – 6 months depending on your circumstance and what led to the hardship.

Of course, you’ll need to make up those payments once the forbearance is over, but this buys you time to get your finances back in order and before resuming your payments.

Reinstatement

The most desirable option after forbearance is to do what’s called a reinstatement because it brings your loan current right away. Coming out of the forbearance, you would cut one lump-sum check for all of your back payments.

Understandably, this isn’t feasible for many, but it could work if you have been working for a while with the promise of back pay and your employer comes through.

Repayment Plan

A repayment plan involves adding a fixed amount to your mortgage payment each month until the loan is brought current. Typically, repayment plans last no more than 6 months, but depending on the investor in your mortgage and the circumstances, they could last a year or more with approval.

Payment Deferral

Depending on the number of months of missed payments you have and the investor in your mortgage, you may be able to defer the missed payments to the end of your loan, meaning you would owe them when the loan is paid off. Your servicer will evaluate you for this option.

Loan Modification

The goal of a loan modification is for you to be able to stay in your home by changing the term and interest rate of your mortgage. These are often referred to as cap and extend modifications.

The first thing that happens is any missed payments are recapitalized, meaning they are put back into your outstanding mortgage balance. Then your term is extended so the payment is more affordable. Your rate will change as well, although the rate used depends on the investor in your mortgage. Whether the rate goes up or down depends on market conditions at the time.

It should be noted that if you’re trying to get a new mortgage, you cannot be in a trial modification period. Before executing a full modification agreement, a servicer will do several months of trial modification with you to make sure you can handle the payments.

Deed-In-Lieu Of Foreclosure

A deed-in-lieu of foreclosure occurs when someone just signs the deed over to the mortgage lender. This functions a lot like a regular foreclosure, but the lender doesn’t physically come and repossess the property. In addition to avoiding the hassle of a foreclosure, a lender might give you some assistance toward getting your next place if you sign the property over.

Foreclosure

In a foreclosure, a lender takes possession of your property. This is usually for nonpayment, although they can foreclose for other reasons as well. The lender is exercising their rights under the lien. A buyer owns the property, but the mortgage company has a lien on it which gives them the right to take it back if you don’t satisfy your obligations.

A foreclosure has the longest waiting period to obtain a new mortgage and the most substantial negative impact on your credit, so it’s something your servicer and lender will typically only go to as a last resort. You want to try to avoid this at all costs.

FAQs On Short Sale Homes

Now that we’ve gone over the sale and purchase of short sales and the alternatives in detail, let’s touch on a few other questions you might have.

How long does a short sale take?

The timeline can vary. What is important to note is that they may take considerably longer to negotiate than a typical home sale because, in addition to the buyer and seller negotiating, the lender has to ultimately approve the offer.

What is the best way to find short sale homes?

People don’t generally go out of their way to look for short sale homes. You’re looking for the best value for your money. However, you should know going in whether you’re dealing with a short sale situation because it will affect your ability to negotiate. You can talk to your agent and it may be in the multiple listing service description.

Can I finance the purchase of a short sale house?

There are no restrictions in terms of how you pay for the home. The one problem you might run into is that these homes are usually sold “as is.” That means that depending on the condition of the house, it may not be considered move-in ready and could fail an appraisal or pass subject to conditions. You may have to pay for repairs before or after you move in or walk away from the sale.

The Bottom Line: Short Sales Can Help Homeowners, Lenders And Buyers Resolve A Financial Challenge

A short sale involves working with your servicer and lender to sell a property for less than your outstanding mortgage balance. This is typically utilized when you’re having trouble making your mortgage payment and property values have fallen to the point that you can’t pay off your existing mortgage balance in a sale. It has to be approved by the lender.

A short sale is better than some other alternatives in a default situation because the waiting period to get a new loan may be much shorter and lenders may also provide you with relocation assistance. On the downside, the credit impact of this is almost as bad as a foreclosure. You’ll have to rebuild your credit profile quite a bit before applying for another mortgage.

If you’re considering a short sale, you should be aware that there may be other options which would allow you to stay in your home. It’s very important that you speak with your mortgage servicer if you ever run into payment trouble. Rocket Mortgage clients can fill out the Application for Success.

If you do decide to go down the short sale path and receive lender approval, you’ll need to work with an experienced real estate agent because of the complexities involved in buying and selling short sale properties. Rocket Homes^SM can connect you with one of our Verified Partner Agents.

¹Participation in the Verified Approval program is based on an underwriter’s comprehensive analysis of your credit, income, employment status, assets and debt. If new information materially changes the underwriting decision resulting in a denial of your credit request, if the loan fails to close for a reason outside of Rocket Mortgage’s control, including, but not limited to satisfactory insurance, appraisal and title report/search, or if you no longer want to proceed with the loan, your participation in the program will be discontinued. If your eligibility in the program does not change and your mortgage loan does not close due to a Rocket Mortgage error, you will receive the $1,000. This offer does not apply to new purchase loans submitted to Rocket Mortgage through a mortgage broker. Rocket Mortgage reserves the right to cancel this offer at any time. Acceptance of this offer constitutes the acceptance of these terms and conditions, which are subject to change at the sole discretion of Rocket Mortgage. Additional conditions or exclusions may apply.