What Is A Short Sale

What Is A Short Sale And How Does It Work?

November 27, 2023

Produced by:
Richard Stevens

Richard Stevens is an active real estate investor with over 8 years of industry experience. He specializes in researching topics that appeal to real estate investors and building calculators that can help property investors understand the expected costs and returns when executing real estate deals.

A short sale occurs when a house is sold for less than the value of the outstanding mortgage, due to unexpected financial difficulties of the homeowner. It is an alternative to foreclosure that is generally less damaging to a borrower’s credit score.

Importantly, there are three things that can happen in order to cover the short fall on the mortgage:

  1. The borrower is forgiven by the lender, which means they don’t have to pay back the shortfall
  2. The borrower is required to pay back part of the short fall
  3. The borrower is required to pay back the entirety of the short fall

In order for the lender to recover the short fall amount (either partially or in full), it must apply for a deficiency judgement, whereby a lien is placed on the property owner for the outstanding amount. It is worth noting that a deficiency judgement is illegal in certain states, which effectively forces lenders to forgive the borrower for the short fall, if they agree to the short sale.

Table of Contents

Basic Overview Of How The Short Sale Process Works

Step 1: The property owner informs the bank of their financial difficulties, and formally requests to initiate a short sale

Step 2: The bank reviews the property owner’s request and either agrees or disagrees to the short sale proposal  

Step 3: If the bank agrees, the difference between the sale price and the mortgage may be forgiven entirely. Alternatively, a new arrangement may be formed, where the property owner is obliged to pay back the short fall, either partially or in full.

Benefits of A Short Sale For The Seller

A short sale is less damaging to the seller's credit score than a foreclosure

While neither option is ideal for the homeowner, a short sale can be considered the lesser of two evils, because of the reduced impact on credit score.  With that being said, both options will hurt the seller’s credit history. A short sale just does less damage than a full-blown foreclosure.

Short Sales Offer A Financial Escape Plan For The Property Owner

Most homeowners have no intention of initiating a short sale when they originally take ownership of the house. However, the simple reality is that no one is immune to financial difficulties which can set the stage for a short sale to occur.

For instance, millions of people in America have lost their jobs as result of the covid 19 pandemic, and plenty of entrepreneurs have seen their company’s crumble. As a result, they could easily end up with a mortgage payment that is no longer affordable to them.

In this scenario, a short sale can ease the financial difficulties of the homeowner, while still making it possible for the bank to recover most of the capital that was borrowed.

Increases The Likelihood of Owning A Home In Future

A homeowner who has gone through a short sale should be eligible to apply for a new home loan relatively soon after the short sale concludes. The timeline ranges from a few months to several years, depending on the circumstances and financial recovery of the property owner. 

Conversely homeowners who experience foreclosure can expect to wait three to seven years before they are able to purchase another home.

No Need To Pay The Seller’s Realtor Commissions

In America, the total cost of realtor commissions is usually in the region of 6%. The 6% is usually split between the buyer’s agent and the seller’s agent.

With a short sale however, the bank effectively takes on the responsibilities that the seller’s agent normally would. This is a big benefit to the seller, because they can save a sizeable sum of money by avoiding realtor fees and commissions.

Benefits of A Short Sale For The Buyer

Who Benefits From A Short Sale

Favorable Financing Terms from The Bank

One of the main reasons banks and other lending institutions may agree to a short sale is because it can be cheaper and less risky than a foreclosure.

Instead of difficult legal proceedings, the possibility of forced eviction, and the likelihood of fetching a lowball price at auction, short sales present some attractive alternatives. Notably, the ability to sell the house to a new buyer, while skipping the auction altogether. In this scenario, the bank may offer the new buyer favorable financing terms in order to solidify the sale and alleviate most of the risks associated with the house.

Discounted Home Price

The primary reason buyers will consider a short sale is the reduced price of the home. When the original homeowner proposes a short sale to the bank, it’s pretty clear to all parties involved that the financial foundations of the mortgage are under threat. In other words, short sales are not really about maximizing profit for the seller. Instead, a short sale effectively acts as a legally viable way for the homeowner and the bank to cut their losses and minimize the damage.

This is good news for the new buyer, because there is a strong possibility of purchasing the home for less than the true market value of the house. A deeply discounted price might not be guaranteed, but there is a high probability getting good value for money when you successfully purchase a short sale home.

Risks Of Buying A Short Sale Home

Risks Of Buying A Short Sale Home

It can take much longer than a normal house sale

According to Zillow, the average house in the US spends around 30 days on the market before being sold, with another 30-45 days needed to officially close the sale. All in all, it is typical to complete the process in 8-10 weeks.

When purchasing a short sale, there is no guarantee that the process will move swiftly. There are a large number of legal proceedings and agreements with the bank that need to be completed before the house is even eligible to be sold.

While the average short sale takes around 90 to 120 days, it’s not unusual for the process to take up to 12 months.  The final timeline depends on the complexity of the financial situation, the efficiencies of the bank, and the administrative skills of the homeowner. For many real estate investors, this timeline is simply too long and too frustrating to deal with. If you’re serious about pursuing a short sale, you need to be extremely patient and simply accept that the process will take considerably longer than a traditional home sale.

The deal might fall through completely

Even though a short sale is preferable to a foreclosure to the seller, that doesn’t necessarily prevent a foreclosure from occurring. If the borrower’s relationship and financial standing with the bank deteriorates after a short sale has been initiated, it is still entirely possible for the bank to force a foreclosure option instead.

As a potential buyer, this is literally the worst thing that can happen. You might spend months waiting to conclude the deal, only for the house to be forced into foreclosure and sold at an auction. It’s pretty clear that this outcome would be both disappointing and frustrating for a motivated buyer. Unfortunately, this is a risk that you can’t truly eliminate from the equation.

The House Might Be Badly Maintained

In almost all scenarios, the owners of short sale houses tend to be cash-strapped. Instead of prioritizing important repairs and footing the bill for important maintenance tasks, it is far more likely for the owner to defer any cost that they possibly can, including their mortgage payment. This can lead to a poorly maintained home that will need a significant repair budget to be restored to an optimal state.

Unexpected Unpaid Liens

It is reasonably common for homeowners to take out more than one mortgage on a property, which translates to multiple liens on a single home. As the new homeowner, you could become legally obliged to pay back one of the outstanding liens, if you fail to identify it during the due diligence process. While this situation might not be that common, it does happen. Fortunately, you can avoid this risk by initiating a preliminary title search.

Short Sale vs Foreclosure - What's The Difference

Key Characteristics of a Short Sale

Key Characteristics of a Foreclosure

How To Find Short Sale Houses?

Use A Real Estate Agent: A real estate agent can be a massive ally in your search for short sale houses. Real estate agents are often the first to know when a short sale becomes publicly available. In addition, estate agents have direct access to the MLS, which has the biggest database of properties in the US. More importantly, experienced agents will be able to find short sale properties on the MLS, using their expert know

Directly From the Courthouse: Believe it or not, it is possible to access lists of people that have defaulted on their mortgage payment at your local courthouse. These homeowners are often open to the possibility of a short sale, although there is no guarantee. Nevertheless, the accessing lists of loan defaulters at your local courthouse can be a fertile hunting ground for short sale proposals.

Using Online Portals: Another great way to find short sales is using foreclosure.com. On this site, they literally have a category for both pre-foreclosures and short sales. The only catch is that foreclosure.com is a premium site, which means there is a monthly fee required to access all their listings. Although the membership fee may serve as a minor obstacle to some investors, if it can accelerate your search for a short sale house, it’s a fee worth paying.

Should You Buy A Short Sale House?

If you are aiming to become a first-time homeowner or you are a relatively inexperienced real estate investor, it is probably best to steer clear of short sales entirely. The time, energy and administrative skills needed to close a short sale could ultimately hinder your goal of successfully purchasing a home.

However, if you are an experienced real estate investor with time on your hands or a house flipper looking for a home with extra mark-up built into the deal, investing in short sale homes could definitely be worth your while.

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