During the Great Recession of 2008, many homeowners owed more on their mortgage loans than the value of their homes. Being "underwater" led to an increase in foreclosures, as well as a type of sale known as a pre-foreclosure or "short sale." The real estate industry recovered, but the Covid Pandemic has again shaken up the real estate industry. For those struggling and fearful of a foreclosure, a short sale may be a way out.
In this guide, we discuss what a short sale is and how it works.
What is a short sale?
A short sale is also known as a pre-foreclosure sale. It allows the homeowners who cannot make the mortgage payment to work with lenders to sell the home when they can no longer make the payment. While borrowers can get out of debt without a foreclosure
, it is a way for lenders to recoup some of the remaining debt on a mortgage. The property gets sold at a lower price, making it attractive to home buyers and those who want to rent or flip a property.
How do short sales work?
To sell your home in a short sale you need to prepare a hardship letter for your lender and explain why you cannot fully repay the mortgage. You will also have to include tax returns and pay stubs to prove your point. A lender will only agree to the short sale if the homeowner has fallen under hard times. Events like a medical emergency or downturn in the business can convince the lender.
Your lender will agree to the sale only if you prove that you have recently fallen into financial trouble. It could be a sudden downturn in financial standing, such as a job loss during the Pandemic, or a health crisis like a serious illness.
Once the lender approves, your property will listed as short sale and offers made on the property will go directly to your lender. You will not have a say in the process; the lender will accept, reject, or counter offers. In most cases, the home is sold for lower than the remaining balance of your mortgage loan in order to sell it quickly. However, receiving some of the remaining loan balance is better than a foreclosure that could cost the lender 100% of the balance so the lender might forgive the difference in the outstanding debt. Alternatively, the lender may get a deficiency judgment against you. In this case, you will have to pay for the difference between the original mortgage and the home's sale price, which will still be less than your full mortgage and possibly more affordable to you.
Step-by-step short sale process
If you are behind on the mortgage and are thinking about a short sale, you need to consider how likely the lender will agree to it. The lender is not under any obligation to do so. Here is a step-by-step process you need to follow.
Consider your present financial situation
Whenever you request a short sale, your financial condition will make a difference to the lender. If you cannot make payments because of something like a medical emergency or loss of income, the lender will be sympathetic to the situation. But if the financial troubles have been around for a long time and you did not disclose them in the application, then the lender might not accept the short sale. In such an event, the lender could opt for foreclosure.
Request short sale approval
It is advisable to never approach the lender with a request for a short sale until the mortgage payments have gone into default. The lender will not consider a short sale if you can make some of your payments on time. They could also decide that a foreclosure is a good chance at recouping the losses. If you are proceeding with a request for a short sale, speak to the lender's loss mitigation department. They will offer the best solution to your problem.
Get ready for the short sale
After getting the lender's approval for the short sale, you need to create a proposal and start looking for buyers. It is advisable to consult a real estate agent, an attorney, and a tax professional for advice.
Price the sale
Setting a price on the short sale is not as easy as selecting a regular home sale. You might want to sell your property at the market value but remember why you chose a short sale in the first place. Ensure that you ask for a price high enough to stabilize your finances and get you out of your mortgage.
Find the buyer
You will have to create a short sale proposal and include documents that prove your financial hardship. It could be anything that proves your current financial situation. Do not dramatize or exaggerate the circumstances, as it can put you in trouble. Only state the reality.
Submit your proposal
After you have the proposal in place and have found a buyer, you need to submit the buyer's offer to the lender. The lender will consider your financial information and can also deny the proposal. Everything lies in the hands of the lender. If the sale is approved, you will need to wait for the lender to accept the buyer's offer. It may take a few weeks.
Short sale vs. foreclosure
The foreclosure and short sale processes occur when homebuyers cannot keep up on the mortgage payments. In both events, the homeowner will lose possession of the property, but the repercussions are different. In a short sale, you decide to show your financial hardship through the proposal and seek the approval of the lender to sell the property for a lower amount they owe on it.
You will enter this process voluntarily, but this is not the case for foreclosures. After the lender approves the short sale, a seller will be in charge of selling the property. But only the lender will be responsible for the negotiations, and the lender will decide if the buyer's offer should be accepted or rejected.
A foreclosure is a legal action that the lender takes to seize the seller's property after they fall far behind on the monthly payments. In both events, there will be a negative impact on your credit. However, a foreclosure can have a more damaging effect on the credit score. It is also an expensive process and has also forced sellers to file for bankruptcy in many cases.
There is an advantage of a short sale for the seller. It allows you to qualify for another home right away. There is a 3-year waiting period for getting an FHA loan
after a short sale. However, you can get one any time after the closure of the short sale if your mortgage or installment payments were more than 30 days late in the year before filing for a new mortgage.
Pros & cons of short sales
Sellers can gain from a short sale, but it also has a few cons to consider.
- Recovers credit score. Many borrowers who opt for a short sale process find it easier to buy another property without waiting for long. However, the mortgage could be challenging. If you are current on the mortgage payments when you decide to short sell the house and the year before you make an application, the FHA will allow you to apply for a mortgage instantly and re-enter the housing market. In contrast, a foreclosure will hurt your credit report for around 7 years.
- Less stress. By choosing a short sale, you can avoid the emotional trouble of foreclosure, and you can also stay in your home while it is on the market.
- Save on fees. The seller has to bear the closing costs and commission for the real estate. But in the case of a short sale, this amount will be paid by the lender.
- Debt absorption. The home buyer will pay off the seller's debt.
- Prevent foreclosure. With a short sale, you can prevent the home from going into foreclosure, which could long-term impact the credit score.
- Debt forgiveness. The lender might accept the short sale proceeds and choose to write off the remaining balance as a loss. You will not be held accountable for paying off anything that remains after the short sale.
- You need your lender's approval. When you want to go ahead with a short sale, you will need approval from the lender. This can slow the process or could end it in no time. The approval is not easy to obtain even if you have a genuine reason for the non-ability to make the outstanding payments on the mortgage. If the lender decides not to approve the proposal, you may have to opt for foreclosure.
- It could be a loss for you. The seller will get the proceeds in a regular property sale, but a short sale is different as the proceeds will go towards the lender for debt recovery. There is also a chance that the mortgage balance will not be paid off entirely by the short sale, and you may have to pay the difference amount.
- It will damage your credit score. This might not be long-lasting, but there is an impact on your credit score after a short sale. It could knock off about 160 points from your credit report.
- You have no negotiation power. You will play an active role in the sale of the property, but only the lender will decide whether to accept the proposal or not. The seller has no negotiation power.
- It may take time to get another mortgage. You will have to complete the waiting period before you qualify for another mortgage. This period could be anywhere from 2 years to 7 years.
- Deficiency judgment. There are many cases where the lender has sued the seller to recover the outstanding dues after the short sale. In this case, the credit score will have a huge impact similar to that of a foreclosure. But this process is not legal in all states.
The bottom line
Whether you proceed with a short sale or not is a personal decision. The home will only go into a short sale when you realize that you cannot keep up with the mortgage payments under any circumstances. So, instead of waiting for a foreclosure, you initiate the short sale process. Your home should be worth less than what you owe on it, and you should be able to prove financial hardship. If you have the assets or income to pay back the mortgage balance, the lender will not accept your proposal.
During the financial recession, short sale transactions and foreclosures were common in 2008 but have become less commonplace lately. They are still an option for individuals who are unable to make the mortgage payment on time. However, it is best to consider the pros and cons before moving forward with a short sale transaction. It is not always a win-win.