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What Is A Short Sale In Real Estate? A Guide To The Process

Miranda Crace13-minute read

January 27, 2021

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If you’re interested in buying a house at a discount, short sales can be an appealing option. Short sales are a safer alternative to foreclosures for both sellers and their lenders, which is why you often can find them priced just below market value. They’re also often in better condition than distressed properties. However, these transactions are far more complex than your average sale and can involve a lot more risk.

Before you decide to purchase a short sale, you must know precisely what you’re getting yourself into. Reading this guide will arm you with the knowledge you need to navigate a short sale and determine if it’s the right choice for your circumstances.

What Is A Short Sale? Definition And Explanation

A short sale occurs when a homeowner in dire financial trouble sells their home for less than they owe on the mortgage. The lender of the original mortgage gets all of the proceeds of the sale, and either forgives the difference or gets a deficiency judgment, which requires the original borrower to pay what’s left over.

Although this seems like a less-than-ideal arrangement for the lender, especially if the difference is forgiven, it’s often a preferable alternative to foreclosure. A short sale is a way for a homeowner and their lender to get out of a difficult financial situation by taking a loss, so it’s often possible for a buyer to profit by this transaction. However, buyers should be aware that these transactions are not always good investments.

When Does A Home Go Into Short Sale?

A home goes into short sale when the homeowner realizes that they can no longer afford to keep up with their mortgage payments. Instead of waiting for the bank to foreclose on the home, the homeowner initiates the short sale process by submitting an application to the lender.

There are two critical factors that the lender will consider when deciding whether to approve a short sale:

  • The home has to be worth less than what the homeowner owes on it. The lender will want to review recent sales of comparable properties to make sure this is the case.
  • The seller must be able to prove financial hardship. They have to show that they don’t have the income or assets to pay back the rest of the mortgage.

Short sales and foreclosures were much more common during the financial recession of 2008. As the economy has improved and the housing market has recovered, short sales have become less commonplace. However, they’re still an option.

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Short Sale Vs. Foreclosure

Short sales and foreclosures are both processes that occur when homeowners are struggling to keep up on their mortgage payments or find that their mortgage is underwater. (Underwater mortgages occur when a borrower owes more money than the home is worth.) In both cases, the homeowner loses possession of their property, though the circumstances and repercussions are different.

The extent of the seller’s control is a significant difference between these two processes. In a short sale, a seller will decide to submit a financial package, seeking a lender’s approval to sell the property for less than the amount they owe on it. Therefore, the seller enters into this process voluntarily, which is not the case for foreclosures. Once a lender approves a short sale, a seller is in charge of selling the property. However, the lender is responsible for the negotiations and determines whether to accept or reject buyers’ offers – as it is the lender who is trying to recoup costs.

On the other hand, a foreclosure is a legal action taken by a lender to seize a seller’s property after they fall too far behind on their monthly payments. Although both processes can negatively impact a seller’s credit, a foreclosure can have a far more damaging impact on a seller’s FICO® Score and how long they have to wait to get a mortgage again. Furthermore, the foreclosure process can be expensive for the seller (and lender) and ultimately force them to have to file for bankruptcy in some cases.

The big advantage of a short sale from the seller’s side is that you may be able to qualify for another home right away. The normal waiting period for getting an FHA loan after a short sale is 3 years, but you can get one at any time after the short sale closes if you have no mortgage or installment payments that were 30 or more days late in the year prior to applying for the new mortgage. Additionally, you can’t have any 30-day late mortgage or installment payments in the year before the short sale.

The waiting period for a new VA loan is 2 years. Meanwhile, conventional loans have a 4-year waiting period and jumbo loans require a 7-year wait.

The Short Sale Process For Buyers: 6 Steps

Although the steps involved in a short sale are very similar to a traditional deal, the process is more complicated because of the lender's involvement. The typical homebuying process merely requires the seller to transfer their equity to the buyer in exchange for the agreed-upon purchasing price. However, in a short sale, the transaction is in the hands of the lender, so the process tends to be more time-consuming and convoluted. The following six steps illustrate the primary differences between a short sale and a traditional sale:

Step 1: Get Approved For Financing

As with any home purchase, the first step is getting approved. While it’s always beneficial for buyers to obtain preapproval before making an offer, it’s even more important in a short sale as the lender will want to ensure that the new buyer is actually capable of purchasing the property.

With Rocket Mortgage®, the process of securing approval is fast and convenient. It can be done online by filling out an application and providing us with permission to check your credit score and sharing information regarding existing income and assets. Based on your financials, we’ll recommend mortgage options and tell you how much you’re approved to borrow. After you've shared documentation around income and assets, see your options. We’ll give you a Verified Approval1 that will demonstrate that you’re a qualified, serious buyer.

Step 2: Get A Real Estate Agent And Find A Home

Finding any home can take time, but it’s more challenging when your heart is set on scoring a short sale. Instead of searching through all the listings available in your desired area, focus on preforeclosure property listings online. You can also search through public records by getting in touch with the local county court.

Identifying and navigating a short sale can be tricky, but an experienced real estate agent can help you. An agent can assist with and explain all aspects of the home buying process, including locating short sales.

If you’re looking for a real estate agent who aligns with your goals, our friends at Rocket Homes® can help by pairing you up with an agent in their partner network.

Step 3: Do Your Research

Before you make an offer, you want to gain all the information you can about the property. You’ll want to begin by reviewing comparable sales in the area to find out the actual value of the home. Real estate agents are an excellent resource for determining home value because they have access to the Multiple Listing Service, which provides information on the prices of homes currently on the market and recently sold.

Since short sales are transactions in which the seller owes more on the home than it’s worth, you’re going to want to find out exactly how much the seller owes the lender. Before you purchase a short sale, you must make sure that you know of every person or entity that has a claim to the property (these are called lienholders). So, you should also double-check that there are no other liens on the home. You can ask the seller, their agent or lender for this information. However, to be safe, you should also ask a title company to do a title search on the property.

Step 4: Make An Offer

When making an offer on the property, you must use your knowledge of local home values to consider what the lender will think of your offer. You might be looking at the short sale as a way to get a deal on the home, but keep in mind that the lender is still trying to recoup as much of the remaining mortgage balance as possible – and likely also has to meet investor guidelines to accept the offer. Your offer should be close to the market value of the home if you want it to be accepted.

When you’re looking at properties, beware of fraudulent activity. If the seller asks you to pay money under the table for the opportunity to apply for a short sale, refuse and report it.

Step 5: Have The Home Inspected

Short sale properties are sold “as-is,” which means you won’t be able to negotiate a lower purchase price if there are problems with the property. However, you should still know the condition of the home you’re buying before you decide to close on it. While the seller is required to disclose any known defects, sometimes this type of information falls through the cracks.

Be sure to get a home inspection so you know what you’re getting yourself into. If repairs are needed, research the cost or get estimates, so you can find out if the home will make financial sense for you in the long run.

Step 6: Close On The Property

Even after the lender has accepted the short sale, you need to ensure that the lender and any other lienholders are willing to release the collateral. The more lienholders there are, the longer this process can take.

For the sale to close, the seller must also provide the following documentation:

  • Hardship letter: A letter that explains the seller’s financial burdens and exactly why they can’t afford to make further mortgage payments.
  • Proof of income and assets: The seller must provide at least 2 years’ worth of bank statements and tax documents. This information must prove that the seller has no funds available to pay off their remaining debt.
  • List of liens: While some sellers may only be in debt as a result of their primary mortgage, others may have multiple debts. The seller must provide an up-to-date list of all liens on the property.
  • Comparative market analysis: A lender will insist upon seeing a list of comparable properties that are currently on the market and have sold in the last 6 months to prove that the seller owes more than the house is worth.

Assuming approval and documentation is in order, you will be able to close on the property, receive the keys and move in.

Benefits Of A Short Sale

Short sales can be beneficial for all parties involved. They provide greater investment opportunities for buyers and minimize the financial repercussions that both lenders and sellers would face if the properties went into foreclosure. Let’s take a closer look at the benefits for both buyers and sellers.

Short Sale Benefits For Buyers

  • Discounted price: Although the property will be priced according to market value, the lender is highly motivated to sell in order to cut the bank’s losses. As a result, buyers can often get a better deal on the home than they would if it was purchased through a typical sale.
  • Less competitive market: Given the lender’s entanglement in the deal, short sales are far more complicated than traditional sales. Since most buyers are not experienced in short sales, they tend to shy away from them. With fewer interested buyers, there is less competition and a better chance of getting an offer accepted.

Short Sale Benefits For Sellers

  • Foreclosure prevention: A short sale will prevent a seller’s home from going into foreclosure, which can have a far more detrimental impact on their credit score.
  • Debt absorption: The majority of a seller’s debt will be paid off by the home buyer.
  • Savings on fees: In a typical sale, a seller would have to pay for agents’ commissions, but in a short sale, the lender pays these fees.
  • Potential debt forgiveness: It is possible that the lender will accept the proceeds of the short sale and write off the remaining debt as a loss. In these cases, the seller is not held accountable for paying off whatever debt remains after the short sale.
  • Housing market reentry: A short sale enables the seller to reenter the market and obtain a mortgage immediately with an FHA loan under the right circumstances. In order to do this, you have to have no late mortgage or installment payments in the last year prior to the short sale and no late mortgage or installment payments in the year prior to applying for the new mortgage.

Drawbacks Of A Short Sale

Despite the benefits involved, there are still quite a few drawbacks that come with short sales. The process is complex and drawn out, which can increase the riskiness of the transaction and negatively impact buyers, sellers and lenders financially. Here’s a list of some of the issues that both buyers and sellers face when involved in a short sale.

Short Sale Drawbacks For Buyers

  • Time-consuming: A short sale usually takes longer than a traditional sale because of the lender’s involvement. In an attempt to recoup as much money as possible, the primary lender and any junior lienholders involved will take their time negotiating and closing the deal. Remember, the more lienholders there are, the longer the process will take. Furthermore, there are times when the seller delays the sale because they either second-guess their decision or are unprepared with the necessary paperwork.
  • Increased risk: Since short sales are sold “as-is” without typical disclosures, the condition of the home and the quality of the deal is not always clear to the buyer. Moreover, there is no guarantee that the deal will actually close, so the buyer may risk spending time and money on a home they’re unable to purchase in the end.
  • More homework: A short sale requires the buyer to put in a lot more work upfront. Doing research to figure out the true value of the home, discover all liens on the property and identify any issues with the property’s condition is essential to determining whether the purchase is worthwhile.
  • Property condition: Given the fact that short sale sellers are financially strapped, their properties tend to be in worse condition than average homes sold on the market. Therefore, the buyer often has to spend a lot more money on repairs and improvements.

Short Sale Drawbacks For Sellers

  • No negotiation power: Although a seller plays an active role in the sale of the property, the lender is the only one who has the power to negotiate the purchasing price of the home.
  • Lack of profits: Since a seller owes money to the lender, they will not receive any of the proceeds of the sale of their home.
  • Credit score damage: A short sale can do real damage to a seller’s credit score. The higher your credit score, the larger the hit it will take. However, short sales tend to cause sellers’ credit scores to drop by fewer points than foreclosures.
  • Delay in obtaining another mortgage: After a short sale, a seller must complete a waiting period before qualifying for a new mortgage. Outside of an FHA loan, the waiting period may be anywhere from 2 – 7 years.
  • Deficiency judgment: In some circumstances, the lender will sue the seller in an attempt to retrieve the remaining debt after the short sale. If a seller is sued, their credit score will receive a blow similar to a foreclosure. However, this process is not legal in all states.

5 Buyer Tips For Navigating Short Sales

  1. Get estimates for repairs: The property may be sold “as-is,” but you should still have the home inspected and get estimates for any repairs that must be made. Having this information at hand will not only help you determine if the home is worth buying, but it will also give you more power when it comes to negotiating with the lender. If you can prove that the property is in worse condition than it appears, you’ll be more likely to persuade the lender to sell at a lower price.
  2. Make sure your offer is realistic: Though lenders are motivated to sell, they’re also trying to make as much from the transaction as possible. If you submit a low-ball offer or try to ask for contingencies, it’s unlikely that your offer will be accepted.
  3. Provide as much cash as possible: After having lost money on a risky investment, lenders are looking for a sure thing. If you can pay in cash, lenders will be jumping at your offer. If not, the larger your down payment, the safer and more enticing your offer will appear. (Don’t forget: If you require financing, you must get preapproved before you make an offer.)
  4. Offer to pay seller’s closing costs: Although the lender typically pays the commission and any other fees the seller is responsible for, agreeing to pay them will make your offer more appealing. If there are other buyers interested in the property, this offer will give you a leg up against the competition, as it will enable the lender to recoup more money.
  5. Enlist the help of a real estate professional: Real estate agents are indispensable resources when it comes to short sales. Short sales are complicated transactions, and with lenders calling all the shots, it’s vital that you have representation. An agent who is knowledgeable about the process will be able to research the property, advise you on its value, negotiate a better deal and ensure that your interests are protected.

Is Buying A Short Sale Right For You?

The answer is not necessarily a simple one. To decide if a short sale is right for you, you must consider your needs as well as the specifics of the property you’re interested in. Remember three key facts:

  • The process will take longer, so you must be prepared to wait.
  • You will be buying the home as-is.
  • You will need a larger down payment.

Make sure you know the condition that the home is in and how much repairs will cost. Saving money on the purchasing price will mean nothing if you ultimately have to spend more to make the home livable.

If you’re ready to start the process, don’t forget that getting preapproval for a loan is a necessary first step. Create an account through Rocket Mortgage® to learn about your options.

If you’re a Rocket Mortgage® client looking for assistance with your mortgage payment, we’re here to help! Fill out an Application for Success.

1 Participation in the Verified Approval program is based on an underwriter’s comprehensive analysis of your credit, income, employment status, debt, property, insurance, appraisal and a satisfactory title report/search. If new information materially changes the underwriting decision resulting in a denial of your credit request, if the loan fails to close for a reason outside of Quicken Loans’ control, or if you no longer want to proceed with the loan, your participation in the program will be discontinued. If your eligibility in the program does not change and your mortgage loan does not close, you will receive $1,000. This offer does not apply to new purchase loans submitted to Quicken Loans through a mortgage broker. Additional conditions or exclusions may apply.

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Miranda Crace

The Rocket Mortgage Learning Center is dedicated to bringing you articles on home buying, loan types, mortgage basics and refinancing. We also offer calculators to determine home affordability, home equity, monthly mortgage payments and the benefit of refinancing. No matter where you are in the home buying and financing process, Rocket Mortgage has the articles and resources you can rely on.