Short sales were a common sight in the housing recession around 2009 but they have since faded from the headlines as homeowners typically find buyers before facing financial doom.
What is a short sale? It can happen when a mortgage lender agrees to accept less than the amount owed against the home because there is not enough equity to sell and pay all costs of the sale.
A short sale applies to a home transaction before ever reaching foreclosure. There is still an opportunity to come to some arrangement with the original creditors to satisfy a considerable chunk of the borrowed amount – but not all of it.
It can be a good solution for homeowners who need to sell quickly and get out of financial challenges when they owe more than the property is worth. Banks and lenders have become more agreeable when it comes to these transactions – after all, financial institutions do not wish to be saddled with unwanted real estate.
How does a short sale work? The owner will list his/her home with a skilled real estate broker for the current market value and the lender will take less for the home than the amount of the borrower’s loan. For homeowners to qualify for a short sale, they must fall into these circumstances:
- Financial hardship – This is when an owner faces cash-flow challenges after taking possession of the home.
- Monthly income shortfall – The lender will want to see that the owner cannot afford, or soon will not be able to afford, to live on his/her budget.
- Insolvency – The lender will also want to see that the owner does not have significant liquid assets that would allow him/her to continue paying the mortgage.
Financial hardship can happen to anyone, and the lender will want to see proof of these difficulties. The cause of these challenges can be many – typically they are either from a job loss, changes in family dynamics, rising debt and/or business failure.
The process of listing and marketing the property is much the same as with any other.
Once an offer is received in a short sale, the seller must review and accept it before it can be submitted to the lender. During the review process, the lender may request additional paperwork from both parties and it may accept a second offer if it is financially beneficial to the institution. (The first buyer can raise his/her bid to beat other offers.)
Generally, the lender will require a hardship letter that provides proof that the seller cannot afford to remain in the home or pay the mortgage debt. The lender will also require a pre-approval letter from the buyer’s lender or other proof that the funds to purchase are available.
The owner’s lender can either accept the offer and approve the sale, reject the offer or attempt to negotiate more favorable terms. When a final agreement is reached, a date is scheduled to close on the deal.
Short sales can involve significant legal and tax consequences, which is why all sellers considering a short sale should be advised to first meet with a legal and tax professional to determine whether this step is their best option.
The big downside of a short sale is that it typically does not provide owners with extra money as a normal transaction. Most – if not all – of the funds from the sale will go towards paying off the mortgage and closing costs.
After the sale, owners might find it difficult to find another place to live unless they have thought ahead. And yet, short sales are often preferred over another option – foreclosure – which will severely damage the owners’ financial status.
Even if owners in a short sale experience a lower credit score, it should still be good enough to allow them to get an apartment or open a bank account.
In addition to the homeowner, only licensed lawyers, loan officers and real estate brokers can conduct a short-sale negotiation. It benefits the owner to work with only those skilled in this complex area.
Short-sale transactions can take much longer to complete than traditional deals – three months or more – and are noted for falling apart, typically when the buyer or seller becomes discouraged by the process. For example, a lender will sometimes accept the initial offer only to then seek time to find an improved bid.
If they pack their patience, buyers can often acquire a home at a steep discount and essentially purchase a home worth more than its assessed value.
While short sales are unlikely to re-emerge as they did during the Great Recession, it’s a valuable piece of knowledge to store away if buyers encounter one.
Resources
For assistance, speak to a real estate attorney or the U.S. Housing and Urban Development (HUD) team of counselors.
Find a HUD counselor today.
Washington state guide to short sales