What Is a Short Sale? | Arrived - Easily Invest in Real Estate

For homeowners facing foreclosure and unable to afford their homes, a short sale can be a measure to get them out from underwater. In real estate terms, a short sale is when an owner sells the house at a lower price than the outstanding mortgage. The lender, who must approve the sale, receives all proceeds from the sale.

Read on to learn about short sales, how they differ from foreclosures, the process of going through a short sale, and what to keep in mind if you’re a buyer or investor looking to purchase a short-sale home.

Understanding a short sale

A short sale only happens when the owner of the home is under financial stress, behind on mortgage payments, and facing foreclosure. This is why a short sale is sometimes referred to as a pre-foreclosure sale. Once the owner has received a Notice of Default from the mortgage lender, typically a bank, they may be able to sell the home for less than the balance owed on the mortgage loan to settle with the lender and no longer be liable for the home loan.

For a short sale to occur, the following conditions must be met:

• The lender must approve the short sale and any offers on the home.
• The market value of the house must have dropped significantly.
• The homeowner must be unable or ineligible to refinance or modify their mortgage.
• The homeowner must be in default on mortgage payments, with foreclosure proceedings likely if nothing changes.
• The homeowner must prove that they have no income or assets to pay back the outstanding amount on the mortgage.

Once the home sells—as mentioned, for less than the mortgage balance—the lender can either forgive the remaining balance or pursue a deficiency judgment, requiring the borrower to pay all or part of the difference. It is important to note that anti-deficiency laws require the lender to forgive the deficit in some states.

Short sale vs. foreclosure

The primary difference between a short sale and a foreclosure is that while the same problem causes them—a homeowner who has fallen behind on their house payments—they’re two different outcomes. A short sale is an action that is taken to avoid foreclosure. And while in both cases, the homeowner will have to relinquish their home, the foreclosure process, as well as the timeline and consequences, are different from that of a short sale.

• A short sale is initiated by the homeowner, while a foreclosure is a last-resort option for the lender, who must repossess the property and then attempt to sell it.
• A short sale has three parties to the transaction: the homeowner, the potential buyer, and the lender. Even if the homeowner and potential buyer agree, the lender’s approval is necessary for the transaction. With a foreclosure, the homeowner is no longer in the picture, and the property is sold by the lender, most frequently in a foreclosure auction.
• The short sale process is often lengthy and unpredictable and can take up to a full year to process. Foreclosure sales are generally quick. Once the lender has taken possession of the home, they typically want to sell it as soon as possible to liquidate the asset quickly.
• The sale of a short-sale property is much like a traditional sale, where the borrower procures the services of a realtor or real estate agent who will set the sale price, market the property, and facilitate home inspections for the short-sale transaction. Foreclosure sales are quick and often done through an auction, which means they are riskier for investors despite the lower home values.
• While a short sale and the foreclosure process will result in a hit to the homeowner’s credit score, a short sale will have less of a negative impact. Homeowners who go through foreclosure will need to wait between two and seven years before they can purchase another home, while a homeowner who has gone through a short sale may be able to qualify for a house purchase much earlier.

Pros and cons of a short sale

There are many advantages of having a short sale rather than going through a foreclosure, but there can also be some disadvantages.

Pros:

• A short sale can allow borrowers to avoid foreclosure and settle their mortgage debt.
• A short sale does not damage a homeowner’s credit report as much as a foreclosure.
• With a short sale, the borrower can qualify for another home purchase immediately or soon after the sale is complete.
• With a short sale, the lender and not the homeowner incur the fees related to the sale of the property. The closing costs, too, are usually paid out of the proceeds of the sale.
• For homebuyers, one of the most significant benefits of a short sale is the opportunity to buy a home for a discount. While the property will be priced at housing market value, the sellers are highly motivated and willing to offer a better deal.

Cons:

• There is a lot of time and paperwork involved in a short-sale home purchase, and it can take up to a year for a short sale to be finalized.
• For buyers, short sales come with fewer legal disclosures than a typical real estate sale and can be challenging to navigate, especially for first-time buyers.
• There are fewer buyers for a short-sale property since most buyers have little experience with how short sales work.

The process of a short sale

Going through a short sale can be laborious, time-consuming, and unpredictable. Here are the steps for a typical short-sale transaction.

• Step 1: Once the homeowner has decided to opt for a short sale, the first thing to do is talk to their lender and get their approval. For this, they’ll need to submit a short sale package, which includes a hardship letter detailing why they can no longer stay current with their mortgage payments. They’ll also need to show bank statements that prove a lack of income or assets that could allow them to pay off their debt.
• Step 2: The homeowner lists the property and receives an offer along with earnest money, a small deposit showing the buyer is serious. Regardless of the synergy between the homeowner and the potential buyer, the purchase of the property is subject to the lender’s approval.
• Step 3: The lender reviews the buyer’s offer. The lender can accept or reject the offer but outline terms they’d agree to. The lender can also sometimes choose not to respond at all.
• Step 4: The lender’s response is presented to the potential buyer, and terms are negotiated.
• Step 5: If everyone’s happy with the offer, the contract is approved, the short sale is completed, and the home is transferred to the new buyer. All proceeds from the sale of the property are given to the lender, and the borrower is released from their mortgage contract.

Buying a home through the short sale process

Purchasing a short-sale property can be a fantastic deal if you get a home that’s been looked after and is in good condition. However, it is essential to remember that since a short-sale home is sold as-is, without the mandatory seller obligations of a traditional real estate sale, the onus is on you to inspect the property and identify any problems. Some things to consider when opting for a short-sale purchase:

• Subject to lender approval: The homeowner’s mortgage lender will need to approve the sale, which means you’re unlikely to get a 30-day close. Further, if a bank’s market analysis shows a foreclosure proceeding to be more lucrative, they can outright reject your offer.
• Your return on investment: Is the property a good buy? Look beyond the home prices to determine whether a property is right for you. You’ll want to consider how much repairs and renovations will cost, estimate the After Repair Value (ARV), and if you’re planning to use it as a rental, run the relevant numbers to see if it holds up as a profitable rental real estate investment.
• Inspect the property: Make sure to inspect the property thoroughly so there are no nasty surprises once the deal is done.

The bottom line

For homeowners looking at foreclosure, a short sale offer can be a better outcome in terms of credit rating and the ability to purchase a home again.

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Disclosure

The opinions expressed in this article are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. The views reflected in the commentary are subject to change at any time without notice.