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What Is A Short Sale In Real Estate?

6-Minute Read
Published on December 21, 2023
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Homeowners struggling to keep up with their mortgage payments have several options. One is what’s known as a “short sale,” and it’s an alternative to foreclosure – the ultimate worst-case scenario if you can’t pay your mortgage.

Let’s take a close look at what a short sale is, how it works, and the pros and cons for both the seller and buyer.

How Does A Short Sale Work?

A short sale in real estate happens when the borrower can’t cover their mortgage payments and has to sell their home for less than what they owe. The creditor will have to approve the sale, and the proceeds from the short sale go to their mortgage lender. The borrower will have to pay any outstanding debt the sale doesn’t cover if the lender wins a deficiency judgment against them.

A short sale is a more favorable outcome than foreclosure, which damages the borrower’s credit more and provides no repayment to the lender.

Because homes usually deteriorate under an owner in financial trouble, real estate sold in a short sale has a reduced price. As a result, investors and first-time buyers can benefit by purchasing property at a lower cost than usual.

Why Do Short Sales Happen?

A short sale occurs because the homeowner can’t afford their mortgage payments. This financial inability can arise from various factors, such as job loss, unexpected medical bills or a pay cut.

Additionally, the homeowner must owe more than the home is worth for a short sale to occur. For example, if a homeowner’s mortgage balance is $225,000 and their home is worth $200,000, the lender could grant permission for a short sale.

The seller must submit a hardship letter stating that they can’t afford their mortgage. The letter must provide proof of their financial inability, and a list of liens showing how many parties have a financial interest in the property.

In addition, the seller’s lender will perform a comparative market analysis to determine an acceptable sale price.

How To Purchase A Short-Sale Home

You can purchase a short-sale property through the easy steps outlined next.

1. Seek Preapproval

Preapproval from your mortgage lender is crucial because it states how much you can borrow to purchase a home. Without initial approval, you might look at homes outside your price range. Sellers generally hesitate to accept offers that don’t have preapproval for a loan, because the absence of this suggests a lack of financial backing. Waiting for lender approval after an offer is accepted costs the buyer and seller time, and there’s no guarantee the approval will come through.

When thinking about buying a home, obtaining a preapproval (sometimes known as an initial approval) first can strengthen your position as a buyer.

2. Find A Real Estate Agent

Working with a real estate agent to find a short sale is an excellent idea. Real estate professionals have multiple listing service (MLS) access and can help locate short-sale properties. Plus, their knowledge of local housing markets can help you find valuable homes at discounted prices.

3. Make An Offer

When you find a short sale home you’d like to purchase, it’s best to make an offer quickly – but don’t lowball it. Although a short sale often means a lower purchase price, the mortgage lender wants to recover as much money as possible. Therefore, the seller is more likely to accept a competitive offer.

The home’s market value, neighborhood and broad economic trends contribute to what price makes sense.

4. Get A Home Inspection

Short-sale properties are sold as-is, diminishing the buyer’s ability to negotiate. Even so, it’s a good idea to get a home inspection so you’re aware of necessary repairs or renovations. Also, a home inspection can indicate when it’s better to walk away from a home than commit to a property riddled with issues.

You may not be able to request a lower price when the home inspection reveals problems, but you can look for other short sales if the home’s damage is overwhelming.

5. Wait For Lender Approval

Although initial approval makes the home buying process more efficient, waiting for lender approval on the seller’s end still takes time. Usually, receiving approval from the seller’s lender takes longer than any other step in the short-sale process. 

6. Close On The Home

Once the seller’s lender approves the sale, you can close and move into your new home.

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The Pros And Cons Of Short-Sale Homes

Short-sale homes come with advantages and disadvantages for both buyers and sellers. Let’s consider a few.

Short-Sale Pros

A short sale can benefit buyers and sellers in the ways we’ll describe below.

Pros For Buyers

With a short sale, buyers get a home at a discounted price because the seller and mortgage lender are eager to sell. Also, the volatile elements of short sales – such as the varied conditions of homes for sale and fluctuating time frames – drive away buyers and reduce competition.

Pros For Sellers

Short sales allow sellers to avoid foreclosure and have an easier time buying another home. Specifically, homeowners who were on time for every mortgage payment in the year before their home sale can qualify for an FHA mortgage loan. Plus, a short sale allows the seller to live in the house until it sells, and the lender pays the closing costs and real estate commission instead of the seller.

Sellers can also rid themselves of debt through the proceeds of the short sale that lead to debt forgiveness from their lender after the transaction.

Short-Sale Cons

Buyers and sellers also face specific challenges with a short sale.

Cons For Buyers

For buyers, a short sale requires more time because the seller’s lender and involved lienholders confer with each other whenever they receive an offer. Communication over a short sale can become drawn out as the lender determines if they’ll make enough money back from a specific buyer. The short-sale process can take even more time if the seller is slow filing the required hardship letter and financial documentation.

Lack of negotiating power and challenges defining a home’s value can also be obstacles. As a result, buyers interested in a short sale usually research properties extensively and risk unforeseen lienholders delaying or canceling a sale.

Finally, because the seller doesn’t have sufficient resources to pay the mortgage, the home could be in poor condition and need repairs. This factor can reduce home value and make the home more of a liability than an asset.

Cons For Sellers

A short sale can hurt a seller’s credit score because the lender can sue the seller for the difference between the short-sale price and the outstanding mortgage balance, decimating the seller’s credit.

A short sale also doesn’t provide a financial return for the seller because the lender decides the home price and collects the proceeds.

Lastly, after a short sale, the seller usually must wait 2 – 7 years to obtain a mortgage if they don’t get an FHA loan.

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Short-Sale FAQs

Here are frequently asked questions that emerge when buyers and sellers pursue a short sale.

What are the alternatives to a short sale?

Alternatives to a short sale include foreclosure, a loan modification, a payment plan from your lender, and refinancing your mortgage or renting out part of your home to afford your mortgage.

What’s the difference between a short sale and foreclosure?

A short sale means the seller retains ownership and residency of their home while working with their lender to sell the home at a reduced price. A foreclosure means the lender takes ownership of the home after the homeowner fails to pay the mortgage for 90 days. The lender also sells the home and evicts the homeowner.

Should I buy a short-sale home?

A short-sale home can be an excellent investment if you thoroughly research short-sale properties, obtain lender approval, and find a home that doesn’t require extensive repairs or renovations. However, short sales can take more time than traditional home sales and present buyers with a home in desperate need of fixing.

How long does the short-sale process take?

A short sale can be a long transaction between the buyer and seller. That said, it’s vital to make an offer right away on a home you’re interested in, even if it takes a while to close.

The Bottom Line

Short sales can provide relief to sellers in a financially challenging situation and create opportunities for buyers. However, they also take longer to transact than conventional home sales.

Sellers considering a short sale should discuss options with their lender before absorbing the credit implications of such a move. Similarly, it’s recommended that buyers do their homework and work with a real estate agent to ensure that the short sale they’re interested in would be a smart purchase.

If you’re looking to buy a short-sale home, start the mortgage approval process today and connect with one of our Home Loan Experts to discuss your financing options.

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Headshot Ashley Kilroy

Ashley Kilroy

Ashley Kilroy is an experienced financial writer. In addition to being a contributing writer at Rocket Homes, she writes for solo entrepreneurs as well as for Fortune 500 companies. Ashley is a finance graduate of the University of Cincinnati. When she isn’t helping people understand their finances, you may find Ashley cage diving with great whites or on safari in South Africa.