Short Sales 101

Many homeowners are at risk of losing their homes through a foreclosure sale. Missed payments can lead to foreclosure proceedings initiated against the borrower. Late fees, interest, and default-related fees are often added to the mortgage balance at this point. The mortgage debt then continues to grow until it is paid off. Sometimes, the mortgage balance ends up being greater than the home value. When that’s the case, the mortgage is considered underwater.

If you’re facing a foreclosure action with an underwater mortgage, what can you do? One option may be to consider a short sale. A short sale occurs when the homeowner sells their house for less than the payoff amount on the mortgage loan. It's different from a short payoff. The lender will have to approve the short sale transaction before it can proceed. The primary benefit to pursuing a short sale is that this process allows a borrower to avoid foreclosure. But, there are some downsides.

This article discusses short sales, the steps involved in a short sale, and the pros and cons of short sales. 

What Is a Short Sale?

When a homeowner fails to make several mortgage payments, the mortgage lender can foreclose on the house. The mortgage lender will likely move to sell the house at a foreclosure sale to pay off the loan. The foreclosure process differs from state to state. Some states require the mortgage lender to file a lawsuit against the borrower before a foreclosure action can be formally initiated. This is called judicial foreclosure. Other states allow the foreclosure process to take place out of court. These processes are referred to as nonjudicial foreclosures.

To avoid foreclosure, you may want to sell your home. Mortgage lenders have a lien on your property for the amount due on the mortgage loan. When you sell the property, you’ll pay the lienholders with the sale proceeds and the liens will then be removed. In a short sale, the sale price is not enough to pay off the balance due on the loan. So, you’ll need to have the short sale approved before you can sell the house and remove the lien. 

After a short sale, there will be a remaining balance due on the mortgage. The lender may or may not forgive the balance. A short sale can occur pre-foreclosure or during the foreclosure process. Why would the mortgage lender agree to a short sale? It may be less expensive for the mortgage lender to allow you to sell the property than for the mortgage lender to go through the foreclosure process. 

Short Sale vs. Deed-in-Lieu

A short sale is different than a deed-in-lieu of foreclosure. A homeowner negotiates a deed-in-lieu when they return the property to the lender instead of undergoing the foreclosure process. Short sales are also different from REO sales. REO stands for real estate owned by the bank. An REO sale is when the property does not sell to a third party at a foreclosure sale. Instead, the mortgage lender becomes the owner and hires an experienced real estate agent to sell the property.

Short Sales vs. Foreclosure

Short sales and foreclosures both occur when a homeowner can’t pay their mortgage payments. In both situations, the affected house is sold to pay off the mortgage balance due to the mortgage lender. One of the primary differences between these two processes is who controls the sale.

In a short sale, the homeowner will be selling the property. Since the sale price is less than the mortgage debt, you’ll need the lender’s approval before you can proceed. Lenders have different criteria for who is eligible for a short sale. You must contact your mortgage servicer or lender to make a short sale request. Most borrowers work with a qualified real estate agent to help find potential buyers through the short sale process.

In a foreclosure, a homeowner has no control over the sale of their home. The house will be sold at a foreclosure sale if the homeowner cannot work out an alternative arrangement with their lender.

Short Sale Checklist and Timeline

It can be helpful to know what steps to take and how long the short sale process will take. Here's a checklist and timeline.

1. Get lender approval.

You’ll need to apply for short sale approval with the loss mitigation department of your mortgage lender. Short sale approval is dependent on two factors:

• You must show that the home is worth less than the mortgage balance. The lender will base the market value of your house on the housing market. They will look at the sale prices of the homes in your area. 

• You will have to show financial hardship. You will have to prove that you don’t have assets or income to pay the remaining outstanding balance due after the short sale. Some lenders will only consider short sales if you are 30-90+ days delinquent on your mortgage payments. 

2. Find a real estate agent in your area.

A qualified real estate agent in your area with short sales experience can help you with the short sale process. You will need to show the mortgage lender that your house is worth less than the mortgage balance. You can do this with a comparative market analysis that values your home based upon comparable home sales in your area. A lawyer that has experience with short sales can also help you navigate this process. Talk to different attorneys to find the one that you believe will best represent you. 

3. Put your house up for sale and find potential buyers.

After you hire a real estate agent, put your house on the market to see what offers you can get. The timeline can vary depending on the market. Watch out for short sale scams.

4. Prepare your application.

You might want to start preparing the loss mitigation application while you are looking for a buyer. But, you won’t submit the application until you find a potential buyer. Applying for short sale approval requires a lot of information. Generally, you’ll need to submit a hardship letter that explains why you can’t pay your mortgage. You will probably be required to show proof of income and assets. This may be done by submitting tax returns, pay stubs, and bank statements. In addition, you’ll probably need a comparative market analysis to show the value of your home. The lender won’t approve a short sale if they believe that they could break even if they sold the home. 

5. Let the bank respond to your application. 

The timeline will vary concerning when you may hear back from the loss mitigation department. You can receive a decision on a short sale request within 30 days, but it can take up to 6 months. The lender may require the potential buyer of the property to agree to cover closing costs, etc. 

6. Finalize the sale.

If the lender approves of the short sale offer, then you can move toward finalizing the sale. The potential buyer will have to put a down payment on the purchase. Short sale properties are typically sold “as is.” The potential buyer may get a home inspection to understand what they are getting into. 

Typically, a short sale property is sold at a reduced price because the process is time-consuming. At the closing, ownership of the property is transferred to the new home buyer. The lienholders will be paid out of the money received from the sale. Because it is a short sale, the sale funds won’t be enough to pay the mortgage debt. You will still owe what has not been paid to the lender (commonly referred to as a deficiency balance) unless the lender has agreed to waive that amount. 

Pros and Cons of a Short Sale

Short sales can be a great way to avoid foreclosure and the damage it can cause to your credit. But there are also some drawbacks to be aware of.

Advantages of a Short Sale

• You will not have to go through the stress of a foreclosure sale. You will also have some control over the sale of your home.

• A foreclosure will have a serious negative impact on your credit score. If the lender agrees to accept the proceeds of the short sale and write off the remaining balance, this won’t have as much of an impact on your credit score as a foreclosure would. 

• If you can get the lender to agree to waive or write off the remaining balance that you owe, then you won’t have to worry about the lender trying to recover the deficiency from you.

• Fannie Mae, Freddie Mac, FHA, USDA, and/or VA have special policies that may eliminate deficiency debt from a short sale.

• The lender may agree to pay some of the costs involved in the sale of a home such as the broker’s fees. This will come from the proceeds of the sale.

• Short sales benefit lenders because they don’t have to go through a time-consuming and costly foreclosure. 

• Homebuyers can purchase a short-sale home at a reduced price.

Disadvantages of a Short Sale

• You are losing their home and this is a stressful event. 

• It is a time-consuming and long process. You may lose a potential buyer if the loss mitigation department does not respond to your short sale request for a while. A buyer who has an agent familiar with short sale transactions may help to get short sale approval.

• The lender may not write off the remaining balance due on the loan after the short sale transaction is completed. The lender may seek a deficiency judgment against you.

• If the lender forgives the deficiency, you may have to pay taxes on this debt forgiveness. 

Alternatives to a Short Sale

If you want to save your home, there are options available such as a refinance, loan modification, deed in lieu, or bankruptcy.

Refinance

Refinancing is a pre-foreclosure alternative that usually requires a borrower to be current on their mortgage payments. Refinancing will replace the old loan with a new loan that may have a lower interest rate or be for a longer term, which can make monthly payments more affordable. 

Loan Modification

A loan modification modifies the terms of the loan document. It may lower the interest rate or extend the term of the loan. Missed mortgage payments may be added to the total amount that you owe. Unlike refinancing, you can seek a loan modification if you aren’t current with your payments. A loan modification can help you make up your missed payments and keep your home. 

Bankruptcy

In most cases, filing for bankruptcy will stop a foreclosure. Filing for Chapter 13 can help a homeowner save their home from foreclosure. A homeowner can keep their house and pay their missed mortgage payments over time through a plan. The homeowner will also have to keep up with their regular mortgage payments to the lender. A homeowner in Chapter 13 can also apply for a loan modification if the bankruptcy court has adopted a loss mitigation program. 

If your house is sold at foreclosure and the sale of the house does not cover the mortgage balance, the lender can sue you for the remaining amount due and get a deficiency judgment against you. Filing for Chapter 7 bankruptcy will help you eliminate a deficiency judgment that the bank may have against you after a foreclosure sale. 

Deed in Lieu 

When the lender agrees to allow you to transfer your ownership of the property to them to satisfy a loan that is in foreclosure, this is a deed in lieu. The lender will not proceed with foreclosure. In this case, borrowers will still lose their home but they have more control over the process and it won’t affect their credit scores as negatively as a foreclosure would.

Let’s Summarize...

A short sale is a good option in some situations. You can control the sale of your home and reduce the mortgage debt. But there are also downsides. Short sales are time-consuming and require approval from the lender. You may also be liable for a deficiency or owe taxes if the remaining debt is forgiven. If you choose to pursue a short sale, the process may go more smoothly if you have a skilled team like an experienced real estate agent and lawyer helping you. Consider the pros and cons of a short sale to see if it is the right option for your circumstances.