What is a short sale?
If you’re facing financial hardship, a short sale can help you avoid foreclosure. Homebuyers and investors may also save money buying a short sale home, but there are challenges.
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Lindsay Frankel has been in personal finance for over eight years. Her work has been featured by MSN, CNN, FinanceBuzz, and The Balance.
Updated October 30, 2024, 4:37 PM EDT
Written by
Senior editor, Credible
Reina Marszalek has over 10 years of experience in personal finance. She is a senior mortgage editor at Credible.
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A short sale allows a borrower to avoid foreclosure. For prospective homebuyers, a short sale may also be a way to save money. But the short sale process is more complicated than a traditional home sale. If you’re curious about how a real estate short sale works, you’ve come to the right place. We’ll cover the benefits and drawbacks, when to consider alternatives, and tips for a successful short sale.
What is a short sale and how does it work?
A short sale is an option for paying off your mortgage through the sale of your home. The lender accepts the sale proceeds as payment for the loan, even if the sale price doesn’t cover your outstanding balance. In most states, the lender can still collect the difference between the sale price and what you owe, but you may be able to avoid additional payments by asking the lender for a written waiver of deficiency.
Your lender must agree to a short sale. If the lender is willing, you’ll be responsible for listing your home with help from a real estate agent. Once you receive and accept an offer from a qualified homebuyer, you’ll submit the offer to the lender for approval, along with a short sale package that includes a hardship letter.
In your hardship letter, you must demonstrate the following to the lender:
- The value of your home has dropped
- You are experiencing financial hardship
- You are in danger of defaulting on your mortgage payments
- You don’t have assets that would help with repayment
If the lender accepts the offer, you’ll proceed to closing. The lender will pay for real estate commissions and most other closing costs. The proceeds from the sale go directly to the lender.
What are the benefits and drawbacks of a short sale?
For the seller
A short sale may be a good solution if you have negative equity in your home, which means you owe your lender more than your home is worth. A mortgage with negative equity may also be called an underwater mortgage or an upside-down mortgage. But there are also some drawbacks to selling your home in a short sale.
Pros
- May cause less damage to your credit than a foreclosure, especially if you’re up-to-date on your mortgage payments
- Costs less than a traditional sale because the lender covers most of the fees at closing
- If your lender agrees to a waiver of deficiency, you may get out of debt without paying the full amount you owe
- The waiting period for a new mortgage is shorter following a short sale than after foreclosure
Cons
- Requires you to leave your home without receiving any money from the sale
- You won’t be able to negotiate with buyers, and the lender needs to approve the purchase offer
- If the lender doesn’t agree to a waiver of deficiency and later gets a deficiency judgment, you could face wage garnishment
- If the lender waives the deficiency, you may owe taxes on some of the forgiven debt if it exceeds a threshold or if your mortgage was a cash-out refinance
For the buyer
Homebuying is expensive, especially with today’s high mortgage rates, and it can be tough to find a home in competitive markets. Purchasing a short sale house has some benefits in that regard, but there are also a few challenges to consider. Because the process can be complicated, a short sale may not be the best option for a first-time homebuyer.
Pros
- You may get a better deal on the sale price when compared to a traditional purchase
- May provide an opportunity to build equity quickly through home renovation
- There may be less competition due to a smaller pool of prospective buyers
Cons
- Discounts on short sale properties aren’t typically as steep as foreclosures
- To qualify for a short sale, sellers must be experiencing financial hardship. As a result, they may not be up-to-date with home maintenance
- Real estate agents may be hesitant to work with short sale buyers due to a greater risk the deal will fall through
How to buy a short sale home: 8 steps to follow
- Find a real estate agent who works with short sales: Interview a few real estate agents and ask them about their experience with short sales. You might want to find a Realtor who has the Short Sale and Foreclosure Resource (SFR) certification.
- Search for short sale homes: Your real estate agent can help you find properties labeled as short sales or pre-foreclosures on the Multiple Listing Service. You can also find listings on real estate websites or search county public records.
- Determine the value of the property: Your real estate agent will use comparable sales data to determine a reasonable offer for the property.
- Apply for mortgage pre-approval: Unless you’re paying all cash, you’ll want to get a letter of mortgage pre-approval from a lender to submit with your offer. This will require a hard credit check, which will cause a dip in your credit score. Pre-approval letters expire, so you’ll want to be ready to make an offer in the next month.
- Tour the home: If the seller allows, view the home to get a sense of its condition and ensure that it meets your needs.
- Make an offer: Work with your real estate agent to submit a written offer. For the best chances of approval, the offer should be reasonable based on the value of the home and have flexible terms and few contingencies.
- Get a home inspection: You’ll want to get a home inspection to ensure there aren’t any major issues with the house that would be unaffordable to repair. However, it’s unlikely that the seller will agree to make repairs or offer credits based on the results. The seller’s lender may also deny an agreement that includes these conditions.
- Close on the home: Once the seller’s lender has accepted the offer, the closing process is very similar to a regular real estate transaction.
5 common reasons short sales fall through
- The seller doesn’t qualify: If the seller doesn’t qualify or can’t demonstrate that they qualify, the lender won’t agree to a short sale. For example, an appraisal that doesn’t show price decline could interrupt a short sale.
- The paperwork is incomplete: Short sales require a lot of paperwork. Working with a professional real estate agent will ensure everything gets filed properly.
- The buyer’s offer price is too low: An offer on “the low side of reasonable” may still be accepted, according to the National Association of Realtors, but the seller’s lender is unlikely to accept an offer way below fair-market value. The lender may also refuse the offer if it has too many contingencies.
- The buyer’s financing falls through: If the buyer is unable to qualify for a mortgage, which may occur even after the buyer is pre-approved, the short sale will fall through, unless the buyer has the funds to pay cash.
- There are additional lienholders: Even if the primary mortgage lender approves the short sale, a junior lienholder may not. For example, if the seller has an outstanding home equity loan, that lender may not approve the short sale without receiving at least a partial payment.
What is the difference between a short sale and foreclosure?
A short sale may be a better option than a foreclosure, but that’s not necessarily the case. Here’s what you need to know about a short sale vs. foreclosure.
Alternative options to consider
If you don’t qualify for a short sale or want to stay in your home, you have other options. If you’re not sure which option is best, you may want to get help from a housing counselor.
- Forbearance: If your hardship is temporary, you can request forbearance from your loan servicer, which allows you to temporarily pause or reduce your mortgage payments.
- Loan modification: Permanent loan modification can reduce your monthly payment through a lower interest rate or a longer term.
- Loan assumption: Some mortgages are assumable, which means you can sell your home to a buyer who takes over the mortgage. Ask your loan servicer if this is an option for you. The buyer must qualify and agree to cover any default. If your mortgage is upside-down, it might be difficult to find a buyer unless your mortgage rate is particularly attractive.
- Deed in lieu of foreclosure: A deed in lieu of foreclosure is a voluntary agreement to transfer ownership of your home to the lender. This is typically preferable to a foreclosure.
- Bankruptcy: Bankruptcy is a legal process that can help discharge certain debts, including mortgage debt. Bankruptcy allows you to avoid foreclosure and stay in your home. You may still need to catch up on any late payments or enter into a repayment plan, depending on your loan status and the type of bankruptcy filing.
What is a short sale FAQ
Why do sellers choose a short sale?
Most sellers choose a short sale because it offers certain benefits when compared to foreclosure. For example, it may be less damaging to your credit and allow you to qualify for a new mortgage sooner. A short sale is best for homeowners who have negative equity and are experiencing financial hardship.
Does a short sale hurt your credit?
Yes, a short sale hurts your credit. However, it may hurt your credit less than foreclosure if you are current on your mortgage payments and your lender agrees to a waiver of deficiency.
Can you negotiate the price on a short sale?
As a seller, you can’t negotiate with a buyer on the sale price during a short sale. Your lender may negotiate with the buyer, however.
How long can a short sale last?
A short sale requires a lot of paperwork, and three parties must agree to the sale, so it can take a long time to complete. After you accept an offer from a buyer, it can take four to six months or longer to close.