What is a short sale? Let's break it down. Say you're selling your home; however, the offer you get is so low, it won't cover the total amount you owe your lender on your mortgage balance. But you need to unload it, so you'll take it. This is a short sale—simply put, you end up “short” on paying back your lender, and your lender agrees to accept less than what's owed on the loan.
Short sales aren't the norm, but they aren't all that uncommon, either. According to recent data from real estate information company RealtyTrac, about 5% of all single-family home and condo sales are short sales.
Often homeowners are pushed into a short sale by personal financial troubles that make it impossible to pay their monthly mortgage to their lender. At the same time, they find it hard to sell at a price that would enable them to pay off their entire loan—especially if local real estate market trends have driven down their home's market value. This happened in many communities across the nation when real estate market values fell during the housing bust of 2011.
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Foreclosure vs. short sale: What's the difference?
While selling a home as a short sale is hardly ideal, many experts argue it's smarter than pursuing more drastic measures like foreclosure. Foreclosure is when a homeowner falls so behind on the mortgage payments, the lender repossesses the house, often against the homeowner's will, then tries to sell it. If the amount the mortgage company receives from the sale is less than the mortgage debt owed, depending on state laws, the homeowner may have a deficiency judgment. In other words, the now-former homeowner may still owe money on the home loan.
Foreclosures are less common than short sales. Even during economic downturns like the housing crisis of 2011, the rates rose up to only 3.6%. Right now, the rate hovers under 1%.
People often confuse foreclosures with short sales, and while they share some similarities in that both typically happen to homeowners in distress, the process and consequences are very different. For one, the foreclosure process typically happens very quickly, since lenders are eager to recoup the costs incurred by the unpaid mortgage.
Foreclosure also negatively affects an individual's credit score and credit report. As a result, individuals who undergo it typically have to wait at least five years before they can qualify for a new home loan.
Bottom line: Foreclosure is scary for good reason. People facing it will want to approach their lender and discuss their options—one of which might be to do a short sale instead.
How sellers benefit from short sales
Here are a few of the benefits of a short sale for distressed home sellers, and why they might want to consider it over foreclosure:
- A short sale does way less damage to a homeowner's credit report and credit score than a foreclosure. This means the homeowner will be in better shape to apply for a mortgage and buy a new home down the road.
- Homeowners have the dignity of being able to sell their own home. This is no small thing.
- A short sale enables homeowners to stay in the home until the sale is completed. A foreclosure forces homeowners to vacate.
- While a seller typically pays all real estate agent commissions and other closing costs, in a short sale the seller pays nothing; the lender or bank foots the bill.
The short sale process
A short sale process starts off like any other home sale: You contact a real estate agent (ideally one who specializes in short sales), list your home (mentioning that it's a “short sale/subject to lender”), then wait for an offer to come in. But once you accept an offer, things get tricky. You'll need to get the blessing of your lender—and since lenders lose money with short sales, they're rarely eager to hop on board.
“Some banks may even prefer to pursue a foreclosure, since they not only assume ownership of the property but may receive bailout money from the homeowner's mortgage insurance policy," says Marlene Waterhouse, a real estate agent and the owner of Short Sale Solutions.
On the other hand, a short sale may appeal to a lender, since owning and selling real estate are hassles lenders may prefer to avoid.
To assess whether to approve your short sale, your lender will require you to submit some paperwork, including your offer letter as well as a “hardship letter” explaining why you can no longer make your mortgage payments, along with financial documents such as income statements or medical bills to back that up. At that point, the lender will most likely have your home appraised to determine if the offer you've received is fair. If it is, the lender may allow the deal to go through, although it may have some stipulations (more on that next).
How buyers benefit from short sales
Short sales can be bargains for home buyers, but prepare to jump through many more short-sale-buying hoops than you'd find in a foreclosure or even a typical home sale.
“I wouldn't recommend short sales for first-time buyers, who may get frustrated with the extra paperwork and long waits,” says Waterhouse. “A traditional sale takes 30 to 45 days to close after the offer is accepted. A short sale typically takes 90 to 120 days, or even longer.”
The reason for these holdups is that the mortgage lenders—which are stuck paying for closing costs that a seller would typically cover—will often counter with their own demands in an effort to raise their bottom line. So, short-sale buyers might hear, “We'll accept your offer, but you're responsible for all repairs, wire transfers, and notary fees.”
Our advice: Go ahead and negotiate, or walk away if you aren't satisfied with the terms of the deal. Ultimately it's up to you to decide whether it's worth it to absorb these extra costs. When in doubt, ask your real estate agent to help you crunch the short-sale-buying numbers.
Should buyers buy foreclosures instead?
While foreclosures can also be bargains, buyers should know that they come with a lot more risk than a short sale. For one, keep in mind that a foreclosure home is sold at a courthouse, sight unseen. So, there's no time for a buyer to inspect the house for structural problems; you also inherit all liens tied to a foreclosure. In this sense, a short sale might be a safer transaction.
Bottom line: When a short sale is done right, sellers, buyers, and the lender can all walk away happy.