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

May 21, 2024



If you’re interested in buying a house, a short sale might be worth considering. You often can find these homes priced very competitively. However, a short sale transaction is far more complex than your average sale and can come with risk.

Before you decide to purchase, it’s important to know exactly what you’re getting yourself into. Let this guide arm you with the knowledge you need to navigate a short sale and determine whether it’s the best home buying option for you.

‘Short Sale’ Meaning

A short sale occurs when a homeowner in dire financial trouble sells their home for less than they owe on the mortgage. The lender collects the proceeds from the sale and forgives the difference or gets a deficiency judgment requiring the original borrower to pay the leftover amount.

When Does A Home Go Into Short Sale?

A home is eligible for a short sale when the homeowner realizes they can no longer afford their mortgage payments and there’s no equity left in the home to pay off the loan. Instead of waiting for the lender to foreclose on the home, the homeowner initiates the short-sale process by submitting an application to the mortgage lender.

Here are two critical factors the mortgage company will consider when deciding whether to approve a short sale:

  • The home has to be worth less than the homeowner’s payoff amount. The lender will want to get a property evaluation by reviewing recent sales of comparable properties to determine a market-supported sales price.
  • The homeowner 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 outstanding mortgage loan.

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Short Sale Vs. Foreclosure

Short sales and foreclosures are both processes that occur when homeowners struggle to keep up with their mortgage payments or find that their mortgage is underwater. An underwater mortgage is 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.

Short-Sale Process

In a short sale, the homeowner will submit a financial package seeking a lender’s approval to sell the property for less than the amount they owe on it. Therefore, the homeowner enters into this process voluntarily, which isn’t the case with a foreclosure.

Once a lender approves a short sale, a homeowner is in charge of selling the property. However, the lender is responsible for the negotiations and determines whether to accept or reject buyers’ offers – since it’s the lender trying to avoid a loss.

Foreclosure Process

Different from a short sale, a foreclosure is a legal action a lender takes to seize the property after the homeowner falls too far behind on their mortgage payments. Although both processes can negatively impact a homeowner’s credit, a foreclosure can have a far more damaging impact on a seller’s FICO® Score and how long the homeowner must wait to get a mortgage again.

The foreclosure process can be expensive for the homeowner (and lender) and ultimately force the homeowner to file for bankruptcy in some cases.

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How To Buy A Short-Sale Home: The Process For Buyers

Although the steps involved in a short-sale process are very similar to the ones in a traditional deal, the short-sale process is more complicated because of the lender’s involvement. The typical home buying journey merely requires the seller to transfer their property 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 everything tends to be more time-consuming and convoluted. Next up is a breakdown of how a short sale works.

1. Get Approved For Financing

With any short-sale home purchase, the first step is getting approved. While it’s always beneficial for buyers to obtain an initial approval before making an offer, it’s even more important in a short sale. That’s because the lender will want to ensure the new buyer is capable of purchasing the short-sale property.

2. Pair With 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 contacting the local county court.

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

3. Do Your Research

You’ll want to begin by reviewing comparable sales in the area to find out the value of the home. Real estate agents are an excellent resource for determining home value because they have access to the multiple listing service (MLS), which provides information on the prices of homes currently on the market and recently-sold homes.

Since short sales are transactions in which the homeowner owes more on the home than it’s worth, you’ll want to find out exactly how much the homeowner owes the lender. Before you purchase a short sale, you must make sure you know of every person or entity with a claim on the property (these are called lienholders.).

You can ask the homeowner, 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.

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 must 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.

5. Have The Home Inspected

Short-sale properties are sold “as is,” meaning you won’t be able to negotiate a lower purchase price if the property has issues. 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, this type of information can fall through the cracks.

Be sure to get a home inspection so you know what you’re getting 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.

6. Close On The Property

Assuming the approval letter and documentation are in order, you’ll be able to close on the property, receive the keys and move in. By this stage, things should proceed normally because the lender has already done all the legwork on your offer.

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Benefits Of A Short Sale In Real Estate

A short sale can be beneficial for all parties involved. It provides greater investment opportunities for buyers and minimizes the financial repercussions that both the lender and seller would face if the property went into foreclosure.

Let’s take a closer look at the benefits for both buyers and sellers.

Short-Sale Benefits For Buyers

Short-sale homes provide buyers with several advantages, which we’ll explore momentarily.

May Be Less Expensive

Although the short sale property will be priced according to market value, the lender is highly motivated to sell to cut the bank’s losses. As a result, buyers can often get a better deal on the home than they would if they purchased it in typical fashion.

A Less Competitive Market

Given the lender’s entanglement in the deal, short sales are far more complicated than traditional sales. Since most buyers aren’t experienced in short sales, they tend to shy away from them.

There’s less competition and a better chance to make an offer and get it accepted when fewer buyers are interested.

Less Risk

Buying a short-sale home could potentially be less risky than buying a foreclosed home. If you buy a short-sale home, you have an idea of what you’re getting yourself into, especially if you request a home inspection. When you buy a foreclosed home, banks aren’t required to disclose information about the home. As a result, you could later have to deal with issues you aren’t presently aware of.

Short-Sale Benefits For Sellers

How exactly do sellers stand to benefit from a short sale? Here’s how.

Foreclosure Prevention And Fewer Fees

In a typical sale, the seller pays the agents’ commission fees. However, in a short sale, the lender pays these fees. A short sale will also prevent a seller’s home from going into foreclosure. Foreclosure can have a more detrimental impact on the seller’s credit score.

Debt Absorption And Forgiveness

The short-sale home buyer will pay off much of the seller’s debt. And, it’s possible that the lender will accept the proceeds from the short sale and write off the remaining debt as a loss if there’s no equity to cover the payoff. In these cases, the seller may not be responsible for paying off whatever debt remains after the short sale.

Housing Market Reentry

Under the right circumstances, a short sale enables the seller to reenter the market and obtain a mortgage with a Federal Housing Administration (FHA) loan. To do this, you must have no late mortgage or other installment loan payments in the year leading up to the short sale. The same is true for the year leading up to applying for the new mortgage.

Drawbacks Of A Short Sale In Real Estate

Despite the benefits involved, a short sale can be problematic. The process is complex and drawn out, which can make the transaction riskier and have a negative impact on the finances of buyers, sellers and lenders.

What are some examples of this impact? Let’s delve a bit deeper.

Short-Sale Drawbacks For Buyers

If you’re a buyer looking to obtain a short-sale home, be sure you understand some of the drawbacks discussed in detail below.

More Time

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 in the mix will take their time negotiating and closing the deal. Remember, the more lienholders involved, the longer the process will take.

Keep in mind: A seller will sometimes delay the sale because they either second-guess their decision or don’t have the necessary paperwork.

Increased Risk

Since short sales are sold “as is” without typical disclosures, such as a Seller’s Disclosure, the condition of the home and the quality of the deal aren’t always clear to the buyer. Moreover, there’s no guarantee the deal will close, so the buyer may risk spending time and money on a home they’re unable to ultimately purchase.

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, discovering all liens on the property and identifying any issues with the property’s condition are essential to determining whether the purchase is worthwhile.

Property Condition

Given that those who part with their home via short sale are financially strapped, short-sale properties tend to be in worse condition than the average home on the market. As a result, the buyer often has to spend a lot more money on repairs and improvements.

Short-Sale Drawbacks For Sellers

Although a short sale on real estate offers multiple benefits to the seller, it also comes with the drawbacks – both real and potential – detailed next.

No Negotiation Power And The Absence Of A Profit

Although a seller plays an active role in the sale of the property, they won’t have the power to negotiate the purchasing price of the home.

Since a seller owes money to the lender in excess of the market value, they likely won’t receive any of the proceeds from the home sale.

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. However, a short sale tends to cause a seller’s credit score to drop by fewer points than it would drop with a foreclosure.

Delays In Obtaining Another Mortgage

After a short sale, a seller typically 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.

A Deficiency Judgment

In some circumstances, the lender can 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 the blow it would receive with a foreclosure. Deficiency judgments aren’t legal in all states, however, so you may not need to worry about this.

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Tips For Buying A Short-Sale Home

If you’re a buyer going through a short sale, take a look at these tips designed to help you navigate the process.

Get Estimates For Repairs

The property may be sold “as is,” but you should still have the home inspected and request estimates for any necessary repairs. Having this information at hand will both help you determine if the home is worth buying and give you more power when 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.

Make Sure Your Offer Is Realistic

Although 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 include multiple contingencies, it’s unlikely your offer will be accepted.

Provide As Much Cash As Possible

Having lost money on a risky investment, lenders are looking for a sure thing. If you can pay in cash, most lenders will accept your offer. If not, a large down payment will go a long way toward making your offer seem safer and more enticing.

Don’t forget: If you require financing, you must get preapproved before making an offer.

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 closing costs will make your offer more appealing. If other buyers are interested in the property, this offer will likely give you a leg up against the competition since it’ll enable the lender to recoup more money.

Enlist The Help Of A Real Estate Professional

Real estate agents are indispensable resources for short sales. Short sales are complicated transactions, and with lenders calling all the shots, it’s vital that you have representation. An agent who’s knowledgeable about the process can research the property, advise you on its value, negotiate a better deal and ensure that your interests are protected.

Short-Sale FAQs

Below are a few frequently asked questions about short-sale homes.

Should I buy a short-sale home?

To decide if a short sale is right for you, it’s important to 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’ll be buying the home as is.
  • You’ll 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 purchase price will mean nothing if you ultimately spend more to make the home livable.

How can short sales be beneficial?

Although a short sale can seem like a less-than-ideal arrangement for the lender – especially if the difference in the money they’re owed and the home sale proceeds is forgiven – it’s a preferable alternative to foreclosure. A short sale is a way for a homeowner and their lender to find a resolution for a difficult financial situation, and it allows someone to buy a house less expensively.

That said, purchasing a house on a short sale isn’t always a wise investment.

What does a short sale mean for the buyer?

Oftentimes, a short-sale home gives buyers the opportunity to get a good deal on a piece of real estate. Short-sale homes are also often in better condition than distressed properties.

Still, buying a short-sale home comes with a time commitment and a certain amount of risk, so home buyers should be fully aware of the advantages and disadvantages before making an offer.

The Bottom Line

Short selling often indicates a homeowner is giving up their house due to financial difficulties. That said, a short sale provides a homeowner a relatively desirable alternative to foreclosing on their house, and it can offer benefits to all parties involved. Included among those involved is the home buyer, who’s able to purchase the house for less money than it would otherwise cost.

Ready to get started on your home buying journey? Get started on your application with Rocket Mortgage® today.

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Miranda Crace

Miranda Crace is a Senior Section Editor for the Rocket Companies, bringing a wealth of knowledge about mortgages, personal finance, real estate, and personal loans for over 10 years. Miranda is dedicated to advancing financial literacy and empowering individuals to achieve their financial and homeownership goals. She graduated from Wayne State University where she studied PR Writing, Film Production, and Film Editing. Her creative talents shine through her contributions to the popular video series "Home Lore" and "The Red Desk," which were nominated for the prestigious Shorty Awards. In her spare time, Miranda enjoys traveling, actively engages in the entrepreneurial community, and savors a perfectly brewed cup of coffee.