What Is a Short Sale in Real Estate?

Falling behind on your mortgage payments is frightening, especially if foreclosure is on the table. Not only could you lose your home, but you’ll generally suffer major damage to your credit score.

Fortunately, foreclosure may not be your only option if you can't make mortgage payments. A short sale sometimes allows you to avoid foreclosure by selling your home for less than what you owe. But there are several drawbacks to consider before selling your home this way.

What is a short sale?

A short sale involves selling your home for less than what you owe on the loan. It can be an option to avoid foreclosure when you can no longer afford mortgage payments and are underwater on the loan, which means you owe more than the home is worth. 

Your lender must agree to a short sale, and, in some cases, you will still owe money to the lender when the short sale is complete. However, credit damage from a short sale can be less severe than from a foreclosure. 

Short sale vs. foreclosure

Both short sales and foreclosures are possible outcomes when you can no longer afford your mortgage payment. Both have long-term consequences, but, in many cases, a short sale is the “less damaging option,” according to Seini.

“Generally, a short sale gives owners more control over the process while also reducing the long-term impact on credit compared to a foreclosure,” Seini explains. “Depending on the circumstance, a future lender may look more favorably on a borrower who proactively worked through a short sale.”

Proactive is the key term here. A short sale is a proactive step that you can take when you know you can’t keep up with your mortgage. A foreclosure is an action the lender takes when you stop making payments. 

While a short sale still has a lot of downsides, taking the initiative to sell your home can be far better than waiting for a foreclosure, which can result in longer-term credit score damage and a longer period before you can buy another home.

How does a short sale work?

Selling your home via a short sale is more complicated than selling it the traditional way. The biggest hurdle is that you must get lender approval.

Here’s how the process works:

Find a qualified real estate agent

Short sales are less common than traditional sales, and many real estate agents lack the resources to process them. Find an agent with experience in short sales who's familiar with timelines, documentation, and procedure.

Submit a hardship letter

Your lender must approve a short sale before you can move forward. To get approval, submit a hardship letter that clearly demonstrates the financial challenges preventing you from affording your mortgage payment. 

Negotiate a deficiency waiver

When you sell your home for less than what you owe on the mortgage, the difference is called a deficiency balance. In some states, called non-recourse states, lenders are generally prohibited from pursuing a deficiency judgment against you. In recourse states, however, your lender could sue you unless the short-sale agreement has a deficiency waiver. 

Consult a real estate attorney to understand whether your lender could pursue a deficiency under your state’s laws and whether you should request a written deficiency waiver. If your lender is unwilling to provide a waiver, make sure you have a plan to pay the remainder of what you owe after the sale.

Read More: Recourse Loan: What Is It? How Does It Work?

List your home

If your lender approves a short sale, list your home for sale. Your agent can help you find a competitive price that your lender is likely to approve.

Submit the offer for review

Once you get an offer, you can’t accept it without your lender’s approval. Submit the offer for their review and the review of any other lienholders if there are multiple liens on your home. Once you get approval, you can accept the offer.

Turn over the keys

Follow all the normal steps to selling your home, leading up to closing day, when you’ll transfer ownership.

Once the process is complete, your lender may try to collect the deficiency balance if allowed by state law.

Qualifications to do a short sale

To get approved for a short sale, you must demonstrate financial hardship. This may require providing documents, including bank statements and copies of bills. But what actually qualifies as financial hardship varies by lender. 

“The most common hardships typically involve job loss, divorce, major medical expenses, or some other indicator of a significant drop in income,” explains Suzanne Seini, real estate agent and founder/CEO of Innovate Realty. “In some situations, rising adjustable mortgage payments or mounting debt can leave homeowners in financial distress and thus force lenders to consider a short sale.”

But if you have access to cash reserves or assets that would help you cover the cost of the mortgage, you might not qualify.

“Lenders may deny a request if they believe the homeowner still has the financial means to make payments, has substantial assets available to leverage, or if the lender believes they have a stronger path to recover the outstanding balance,” adds Seini.

Pros and cons of short sales for sellers

As a seller, a short sale is likely a better option than a foreclosure, but it’s still a last resort if you have other options to catch up on your loan or remain in your home. Here are some pros and cons of short sales to consider before choosing this option.

Details on the pros

• Less damaging alternative to foreclosure: A short sale will lower your credit score and likely affect your ability to buy a home for 2 or more years. However, the impact of a foreclosure is usually far more extreme.
• Potential for relocation assistance and leasebacks: “With a short sale, a lot of times, you can get a relocation fee,” when an investor purchases your home, says Bob Thompson, a real estate agent and growth coach at Legacy Group International. He adds, “Investors will sometimes purchase items to help out and coordinate with the sellers on move-out date and time. Sometimes, investors will even allow a rent-back,” meaning you may be able to stay in your own home as a renter. Don’t count on these arrangements, though. They’re not guaranteed.
• Possible debt elimination: If your lender agrees to settle the debt with the sale, you can walk away from the short sale with no outstanding mortgage debt to repay.

Details on the cons

• Damage to your credit: A short sale could lower your credit score significantly, depending on your overall credit profile and payment history. However, a short sale may still do less damage than a foreclosure if you haven't missed payments and the sale appears on your credit report as a settled account.
• Inability to buy a new home: After a short sale, you might not be able to get a mortgage for a new home for up to two years, according to Thompson. The interval can depend on the type of loan, how much your credit has recovered, and other factors.
• Possible tax implications: If the lender waives the deficiency, the IRS may treat the forgiven debt as taxable income. Exclusions may apply, so consult an accountant or tax professional.
• No guarantee of approval: If your lender denies your application for a short sale, you won’t be able to move forward. And even if you are approved, your lender gets the final say on the sale, not you.

Read More: The Tax Benefits of Owning a Home

How to buy a short-sale home

Sellers aren't the only ones who must understand how a short sale works or the pros and cons. If you are thinking about buying a short-sale home, here's what you need to know. 

Pros and cons of short sales for buyers

Buying a short-sale home could save you a lot of money, but you’ll need to find a good real estate agent and thoroughly weigh all the risks to make the best choice. Consider these pros and cons before moving forward.

Details on the pros

• Affordable homes: Short-sale homes are generally priced lower than similar homes because the owner and the lender are trying to get out of an unfortunate situation. Your money can go further.
• Often in better condition than foreclosed homes: When a homeowner knows they’ll lose their home to foreclosure, they may have no motivation to keep up with maintenance. This can lead to major problems. But homeowners pursuing a short sale may be more motivated to make their homes desirable, so you may experience fewer issues.
• Less competition: Buying a short-sale home isn’t an easy process, and many homeowners are unwilling to do the extra work and take on the additional risk. Plus, many real estate agents have never done short sales before, so there may be fewer agents representing other buyers. While there’s never a guarantee, you're less likely to get caught in a bidding war with multiple buyers.

Details on the cons

• Slow process: “Short sales require patience,” says Seini. “Approval timelines are often loose, and even though it’s labeled as a short sale, unpredictability on timing means there’s more back-and-forth with lenders than in a traditional transaction.”
• Multiple lenders may be involved: When buying a short-sale home, your lender isn't the only one who must approve the sale. The seller’s lender must also review and agree to the deal. If there are any other liens on the property, even more parties must review and approve the sale. The involvement of multiple lenders creates added complications and a greater risk of the sale not going through.
• Less negotiating power: Short-sale homes are often sold as-is. While you should get a home inspection to learn about any major issues, you typically shouldn’t expect the seller to fix any issues or lower the asking price as a result of the inspection.
• Increased risk: Because short-sale houses are often sold as-is (and sometimes with minimal seller disclosures), homes may be more likely to have aging systems and appliances in need of repair or replacement. “Many short-sale homes have deferred maintenance because the seller was already under financial stress and couldn’t accommodate the cost of needed repairs,” Seini explains. “Incomplete repairs can become major (and often costly) problems if overlooked.” 

If the financial savings outweigh the risks for you, here’s how to find and buy homes listed for short sale:

1. Find short-sale homes

Start by hiring a real estate agent who is experienced in short sales. The National Association of Realtors warns that many agents aren’t familiar with this type of sale, so it's important to work with someone who knows how to navigate this complex process.

A real estate agent can help you find homes listed for short sale. You can also search for short sales on sites like Zillow and Realtor.com or look for pre-foreclosure homes using a database like RealtyTrac.

2. Research the property

When you find a home you’re interested in, gather as much information as you can. Your real estate agent should be able to help with key tasks, including:

• Putting together a comparative market analysis so you can see what similar properties are selling for
• Contacting the listing agent to understand how many liens there currently are on the property. If there are multiple liens from different lenders, each lienholder must approve the short sale, which often leads to delays in the closing process.
• Asking the listing agent for basic info, like the age and condition of the roof, HVAC, and other core systems and appliances. You'll also want to confirm the condition of these systems in a home inspection.

3. Secure financing

Before you make an offer, you should obtain mortgage pre-approval, unless you plan to pay with cash. Find a lender specializing in short sales.

When you apply for financing, be ready with the documents needed for mortgage pre-approval. Making an offer with a pre-approval letter shows the seller that you’re a serious buyer whose funding is likely to be approved.

4. Make an offer

Once you’ve gotten approval from your lender, you can make an offer on the house. 

Your real estate agent can help you decide how much to offer. You'll need to walk a fine line, as the seller's lender is motivated to sell but still wants to recoup as much of their investment as possible. That said, you should be able to make an offer under market value.

Hearing back from the seller might take longer than a typical offer process since one or more lenders are involved in the approval process.

5. Get a home inspection

Typically, short-sale homes are being sold as is, so you won’t be able to negotiate after a home inspection for any repairs or price reductions. That doesn't mean you should skip the inspection.

A home inspection is your opportunity to identify hidden issues, including neglected maintenance and aging systems. When buying a short-sale home, you should anticipate issues and must decide how much you’re willing to spend to address any problems after buying the house.

Your initial offer should include a home inspection contingency clause that allows you to back out of the sale if you discover safety hazards or major issues you’re not comfortable with.

6. Close on the home

Your real estate agent will review the closing timeline and process with you. Expect a short sale to take longer to close than a traditional sale, due to the back-and-forth with multiple lenders.

You should receive a closing disclosure a few days before the actual scheduled closing. Review it carefully with your agent to ensure there are no errors. You should also have a final walk-through scheduled shortly before closing.

Before closing, you’ll typically need to wire your down payment and closing funds to the closing agent or escrow/title company. Your agent and loan officer can help. On the actual day of closing, be prepared to sign a lot of paperwork before the home is yours.

Is a short-sale home right for you as a buyer?

A short-sale home could be right for you if:

• You’re not in a rush to move: Short sales often take longer than traditional sales. If you need to move fast, this might not be the right fit.
• You want a more affordable home: Short-sale homes are often priced more competitively than comparable homes.
• You’re willing to buy a fixer-upper: Short-sale homes may have some maintenance issues to address. This can reduce the savings from the home’s lower price.
• You’re not picky: If you have a long list of must-haves for your home, a short sale might not be a good fit. Short sales are few and far between, so your options are more limited.