What Is a Short Sale?
A short sale in real estate is an offer of a property at an asking price that is less than the amount due on the current owner’s mortgage.
A short sale is usually a sign of a financially distressed homeowner who needs to sell the property before the lender seizes it in a foreclosure.
All of the proceeds of a short sale go to the lender. The lender then has two options—to forgive the remaining balance or to pursue a deficiency judgment that requires the former homeowner to pay the lender all or part of the difference. In some states, this difference in price must be forgiven.
A short sale usually indicates a homeowner in financial distress, a real estate market in the doldrums, or both.
The short sale must be approved in advance by the mortgage lender.
The former owner may be required to pay the shortfall or the debt may be forgiven.
The financial consequences of a short sale may be less severe than a foreclosure for both the seller and the lender.
For a home buyer, a short sale can be a good opportunity if approached cautiously.
Understanding a Short Sale
Short sales usually occur when a homeowner is in financial distress and has missed one or more mortgage payments. Foreclosure proceedings may be looming ahead. They also are more likely to occur when the housing market is in a down period, such as the 2007-2009 financial crisis which caused home prices to plummet and sales to slow in many regions.
For example, if real estate values drop, a homeowner may end up selling a house for $150,000 when there is still $175,000 remaining to be paid on the mortgage. The difference of $25,000 (less any closing and other selling costs) is called the deficiency.
Before the process can begin, the mortgage lender must sign off on a decision to execute a short sale, sometimes termed a pre-foreclosure sale.
The lender, typically a bank, requires that the mortgage holder submit documentation explaining why a short sale makes sense. No short sale can occur without the lender’s prior approval.
Short sales tend to be lengthy and paperwork-intensive transactions, taking up to a full year to process. They are not as detrimental to a homeowner’s credit rating as a foreclosure.
A short sale hurts a person’s credit score less than a foreclosure but it is still a negative credit mark.2 Any type of property sale that is denoted by a credit company as not paid as agreed is a ding on the score. Short sales, foreclosures, and deeds-in-lieu of foreclosure all hurt an individual’s credit rating to some degree.
Short sales don’t always negate the remaining mortgage debt. There are two parts to a mortgage. The first is the lien against the property that is used to secure the loan. The lien protects the lender in case a borrower can’t repay the loan. It gives the lending institution the right to sell the property for repayment. This part of the mortgage is waived in a short sale.
The second part of the mortgage is the promise to repay. Lenders can still enforce this portion either through a new note or the collection of the deficiency. In any case, the lender must approve the short sale, which means borrowers are sometimes at their whim.