What is a short sale in real estate? A guide to the process

If you’re in the market to buy a home, you might see some listings that are advertised as being short sales. These homes can be tempting because they are often priced very competitively, but short sales can involve some additional complexity and risk because they involve a seller who is underwater on their mortgage and selling their home for less than they owe.

Understanding what a short sale is, how they work, and what makes them different from other types of home sales, including typical home sales or foreclosure sales, can help you understand the risks and benefits of buying a short sale home.

‘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 a short sale?

A home may go into short sale when the homeowner realizes that they cannot afford to make their monthly mortgage payments, but do not have enough home equity to cover the difference in the home’s potential sale price and the remaining balance of their mortgage.

For example, if the owner owes $400,000 on the loan but can only sell the home for $350,000, they’d have to do a short sale because they can’t pay off the full balance of the loan with the sale proceeds.

Often, short sales occur when the homeowner is experiencing financial distress, such as a job loss. They may then approach the lender and apply to go through with a short sale to avoid foreclosure. Lenders may, but are not required to, approve the request.

Some factors lenders look at when deciding whether to allow a short sale include:

• Whether the home is worth less than the remaining mortgage payoff amount. The lender will assess other comparable properties to determine a market-supported sales price.
• The homeowner also must show and prove financial hardship. The lender must determine that the homeowner does not have the assets or income to repay the outstanding mortgage.

Short sale vs. foreclosure

Short sales and foreclosures can both happen when a homeowner can no longer afford their mortgage payments or the home is underwater. Both have the same end result: the homeowner has to move out of their home, but the impacts and ramifications of each differ.

Short-sale process

A short sale is a voluntary sale by the homeowner, with the permission of the lender, as a way to avoid foreclosure. To begin the process, the homeowner submits an application to the lender describing their finances and why they cannot afford their payments and requesting permission for a short sale.

Foreclosure, by contrast, is involuntary.

If and when the lender approves the short sale, the homeowner is responsible for selling the property, but the lender manages the offers received, handling negotiations and deciding whether to accept or reject offers. Lenders seek to limit their losses, so they typically accept the highest possible offer.

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.

How to buy a short-sale home

Buying a short-sale home follows most of the same steps as buying any other home, though the lender's involvement on the seller’s side may make the process a bit more complex. You have to work with both the homeowner, who is selling the property, and the lender, who makes the final decision about accepting or declining your offer.

Use these steps when buying a short-sale home.

1.  Get approved for financing

Any time you want to buy a home, you should start off by getting preapproved for a mortgage. You need to be able to prove to the seller, in this case, the current owner’s lender, that you can afford to buy the home. Having a mortgage lined up already makes this clear and shows that you’re serious about buying the property.

2.  Pair with a real estate agent and find a home

Next, hire a real estate agent who can help walk you through the home buying process. A good agent will be able to help you find properties that match your desires and can walk you through the slightly more complex process of buying a home through a short sale.

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

Short-sale homes are usually priced competitively, so it may seem like a good opportunity to buy a home at a great price. Keep in mind that the lender’s goal is to minimize its losses, so the lender will be looking to sell the home for the highest price possible.

Do some research on homes in your area to get a sense for what the home may be worth. You should offer as close to the market value as possible, which may mean making an offer above asking. Your agent can help you decide on the right amount to offer for the home.

Also, be on the lookout for odd or unusual behavior. Short-sale fraud can happen. If the homeowner asks for money under the table, report them and do not proceed with the purchase.

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

The last step is to go to closing, sign all of your paperwork, get the keys, and move in. You can finally enjoy your new home.

Benefits of a short sale in real estate

There are a few reasons that both buyers and sellers can benefit from short sales.

Short-sale benefits for buyers

If you’re looking to buy a home, some benefits of looking at short sales include:

• Affordability. Short-sale homes are often priced competitively, so you can have the chance to get a home at a relatively lower price. Lenders want to get the highest price possible, but each month the home sits on the market may cost the lender a loan payment, encouraging them to sell quickly.
• Less competition. Short sales can be more complicated than normal transactions, meaning some potential buyers might stay away.
• Less risk than foreclosures. Buying a foreclosure home opens you up to additional risk, such as not being able to inspect the property and a lack of disclosure requirements. With a short sale, you can get the home inspected.

Short-sale benefits for sellers

Sellers also benefit from a short sale. Some reasons they may consider a short sale include:

• Avoid foreclosure. The simplest reason to go with a short sale is that it will let you avoid foreclosure, which can be expensive and put a big negative mark on your credit.
• Get out of most of your debt. With a short sale, you can often pay off most of your remaining mortgage debt. Your lender may opt to forgive the remaining balance if you don’t have sufficient equity.

Drawbacks of a short sale in real estate

There are also drawbacks to short-sale real estate, so keep these in mind if you’re buying or selling with a short sale.

Short-sale drawbacks for buyers

Some downsides of short-sale homes for buyers include:

• Short sales take more time. Because you’re dealing with both the homeowner and the lender, the buying process will usually take longer. If there are multiple liens on the home, it can take even longer as multiple parties will be involved in negotiation and approving the deal.
• Increased risk. Short-sale homes are often sold as is and may not come with Seller’s Disclosures, meaning you may buy a home that is in poor condition and needs repairs.
• More homework. You’ll have to do more upfront work when buying a short-sale home, trying to determine the proper amount to offer, the condition of the home, and more. This can sometimes be more effort than it’s worth.
• Property condition. Short sales happen when homeowners are in financial distress. That means that there may be issues with the home that have gone unrepaired and other general maintenance issues, leaving you to handle the repairs after closing.

Short-sale drawbacks for sellers

There are also downsides for sellers to consider when doing a short sale. Some drawbacks include:

• No negotiation power and no profit. You won’t get any money out of your home after a short sale. You are also beholden to the lender’s negotiations and decisions about the price of the home.           
• Credit score damage. Usually, a short sale will go on your credit report. It won’t hurt your score as much as foreclosure, but the impact can be significant, and it will stay on your report for 7 years.
• Delays in obtaining another mortgage. Resorting to a short sale can make lenders view you as a risky borrower. Many have waiting periods from two to seven years before you can successfully apply for a new mortgage, though you may still be able to qualify for an FHA loan, which has a waiting period of just 3 years.
• A deficiency judgment. Depending on your deal with your lender, your remaining mortgage balance may not be forgiven. In other words, you’ll be responsible for whatever balance is left on your loan after putting the proceeds from the sale toward the loan. Your lender could sue you to recover the remaining amount, which could see your credit damaged and you facing further financial hardships. Deficiency judgments don’t exist in all states, so make sure you understand the laws in your area.

Tips for buying a short-sale home

If you want to buy a short-sale home, use these tips.

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

Just because short-sale homes are typically priced low doesn’t mean you can always buy them on the cheap. You need to make a realistic, competitive offer that the lender believes will help minimize its losses.

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 the seller’s closing costs

The seller, in this case, the current homeowner’s lender, wants to recover as much money as possible from the short sale. Offering to pay the seller’s closing costs may help make your offer more appealing by reducing the seller’s transaction costs.

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.

Short-sale FAQ

Short sales can be complicated, so make sure you understand the ins and outs of how they work before you try to buy a home through a short sale.

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: Understand the pros and cons of a short sale

Short sales happen when a homeowner experiences financial distress and works with their lender to sell their home and avoid foreclosure. For buyers, this can present an opportunity to get a home at an attractive price from a motivated seller. However, the process of buying a short-sale home is a bit more complex than buying a typical property, so understanding how it works, and common pain points, can help you prepare for any issues.

If you’re ready to start looking for a home, you can apply for a mortgage with Rocket Mortgage^® today.