What Is a Short Sale?

A short sale is the sale of a property that is underwater on its mortgage—which means the borrower owes more than the current market value of the property. Generally, a short sale is initiated by a distressed seller as an alternative to foreclosure

In most cases, the homeowner has already received a Notice of default from their lender or mortgage servicer. This starts the clock on the pre-foreclosure process, which lasts on average from 30 to 120 days but doesn't always end in foreclosure. During this time, the homeowner can reach out to the lender to request a loan modification or a short sale approval.

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While it is the current homeowner who sells the property in a short sale transaction, all of the proceeds from the sale are used to pay off the lender. There will still be a shortfall from the sale proceeds, which can't cover the outstanding mortgage debt. The lender can either: 

  1. Forgive the remaining mortgage balance owed
  2. Pursue a deficiency judgment (in states where it is permitted). 

The original borrower suffers a hit to their credit score when resorting to a short sale, but it is much less damaging than if the property went into foreclosure. The selling price of a home in a short sale is often below the average market value for comparable properties.

It’s overall more advantageous for a homeowner having trouble with their mortgage to do a short sale versus going through foreclosure. A homeowner who exits an underwater mortgage with a short sale may be able to buy another house right away; this is not the case if they have a foreclosed home on their credit report.

Homeowners with FHA loans can be approved for short sale transactions, but they have to get approval from the Department of Housing and Urban Development (HUD). For an FHA short sale, the borrower must already be in arrears for at least 30 days. Loans with Fannie Mae as the primary lien">lien holder are also eligible for short sales if the homeowner meets their guidelines, which generally include being delinquent in payment for 90 days or having an immediate, demonstrated hardship. 

How Does the Short Sale Process Work?

The process begins with a homeowner in financial distress. They are likely behind in their mortgage payments, or have just suffered an adverse event that will make the homeowner unable to meet mortgage commitments, such as a job loss, death in the household, illness, or disability. 

In addition, the home is currently underwater; the amount still owed (the outstanding principle) on the mortgage is more than the property’s current market value. This most often occurs in a housing market that is seeing declining or stagnant prices. The homeowner has no equity in the home, and limited means to pay the monthly payment, and so the homeowner may go to their lender to propose a short sale. 

The lender has the final say on all short sales—they decide whether to allow the homeowner to initially pursue one, and ultimately whether to accept or reject a short sale offer from the prospective home buyer. If there is private mortgage insurance (PMI) being paid by the current homeowner, the insurer will also have a say in the process as they are insuring the original lender against default by the borrower.

The lender must approve all short sales at all phases of the process. The homeowner, or a real estate agent acting on their behalf, will submit to the lender what’s known as a hardship letter. This letter—really more of a presentation packet—will state the reasons and cite the evidence showing why the homeowner can’t meet their mortgage payments. Typical items included in a hardship letter package would be prior years’ tax filings, pay stubs, the original loan documents, and any large other debt burdens such as medical expenses or a court judgement affecting the ability to pay the mortgage.

The prospective buyer will work with a real estate agent who knows the particulars of working with lenders on short sale buy offers. This will typically be a seller’s agent or listing agent, if the homeowner has already been approved to do the sale and had the property listed. Together the agent and buyer come to an offer price after a thorough home inspection.

In a normal home purchase scenario, there may be healthy negotiation between buyer and seller over any repairs that need done to the property. Maybe the seller is willing to do a repair themselves to sweeten an offer. This will likely never happen in a short sale. There’s already a homeowner in distress here—they’re not going to have any extra cash to put toward repair work. 

Buyers interested in short sales must be prepared to lower their purchase offer to account for any known repairs or work that must be done before the home can be flipped or lived in.

closing costs for the seller may be paid for or waived by their lender, as part of the initial approval for the current homeowner to pursue a short sale. But closing costs for the buyer are going to be non-negotiable, and must be accounted for in either the down payment or rolled into the loan the short sale buyer obtains to buy the property. Sometimes the lender may even put more of an onus on the buyer to cover some closing costs that would normally be paid by the seller, as they're now covering the seller’s expenses and trying to squeeze every penny out of the deal they can.

Where to Look for Short Sale Homes to Buy

Investors who became successful short sale buyers learned to get loan pre-approvals early, before ever making an offer on a house. This is always important, but critical when pursuing a short sale transaction. A lender could immediately reject a prospective buyer who doesn’t have pre-approval in place. 

Many short sale opportunities will show up on standard MLS (multiple listing service) search screens. A home that’s been approved by a lender for a short sale will have verbiage on the MLS listing such as “subject to bank approval." And properties found this way will generally have a realtor attached to the listing.

Many homeowners aren’t aware that a short sale is an option. They just think foreclosure is the only out if things get tight with a mortgage, or the value of the property has fallen substantially below the remaining balance on the mortgage. So a good strategy to find short sale deals can also be to pursue burdened homeowners directly. This includes home owners who have zero or negative equity in the home (a homeowner isn’t allowed to make a profit on a short sale, as the lender isn’t being made whole either).

Is a Short Sale a Good Deal?

In real estate, short sale transactions often come with a bad reputation. Some investors have had great experiences with them, while others may have met a lot of frustration. Most of the frustration stems from the fact that the original lender holds all the cards—they get to decide whether to allow the homeowner to do a short sale, and they get to approve or deny all offers. 

Banks and mortgage lenders can also take a notoriously long time to respond to requests—three or four months is not atypical to wait for a response to a purchase offer from an investor, and that’s assuming all the paperwork, pre-approvals, and hardship letter are in order. 

But there’s a reason why so many investors still pursue short sales—and why lenders accept them: They benefit all parties involved. Most lenders would rather get a property off their books and take a small loss rather than incur the extra time and expenses of reclaiming a property via foreclosure, only to then have to turn around and sell it themselves.  

And for the investor seeking a short sale opportunity, it’s all about price. Getting a piece of property for a below-market price is the goal of the game. The type of real estate investor best suited to pursue these deals is one who has a strong cash base - they can get approvals easily, can make high down payments to avoid mortgage insurance, and lock in some equity right at the beginning on signing day. 

The Risks and Rewards of Buying Short Sale Properties

The risks and “full disclosure” on short sales are prominent. Some real estate agents don’t have experience with short sales. Real estate investors or first-time homebuyers looking at short sale opportunities need an agent who’s done multiple short sales. It’s a different ballgame to be negotiating with a professional lender as opposed to an individual property seller. Find a local agent with experience and you’ll save a lot of time and headaches.

Remember, the lender holds all the cards—they can reject an offer if they think they could get a better deal. And if the lender rejects, it could take weeks or months to get back to the table or receive a counteroffer. And there’s no stipulation that the lender isn’t open to considering other offers, even if a sales contract has been signed by the interested buyer. 

Another sticky situation can result if the original mortgage has been sliced off to multiple lenders, sold outright to a different lender, or there are junior liens on the property. Junior lien holders are other lenders who now have a piece of the property as collateral from a prior loan (such as a second mortgage) or from judgments against the current homeowner. 

Dealing with more than one lender muddies the waters, as now a buyer has to convince multiple parties to agree to the sale, lengthening the time to get an answer. Investors who can come in with all-cash offers or very high down payments are best suited to do short sales on a property with junior liens on it. These lien holders may request a large enough deposit to cash out their portion of the debt (again, all subject to the approval of the primary mortgage lender). 

Benefits of Short Sales

Buying a property through short sale will likely guarantee you have a better relationship with the current homeowner than with a foreclosure situation. If you were to buy a property out of foreclosure, you may have a current occupant of the home who doesn’t want to leave! 

But a current homeowner seeking a short sale is ready to move out and walk away from the property. They’ve already shown themselves to be astute enough to get in front of their financial issues and exit from an underwater mortgage. 

There are some fantastic deals that can be found in short sales for those willing to put in the extra time and effort. The main reason why is simple—there’s just less competition from other buyers. The old real estate maxim “You make your profit on the buy” rings true. The cheaper the purchase price, the faster an investor can gain equity in the property.

Short sales are probably not ideal for a first-time homebuyer, as the time and extra down payment levels may take them out of a comfortable zone. But seasoned real estate investors are drawn to short sales for the deals they offer, and are willing to sit back and wait—even pursuing multiple deals at once—in order to squeeze out that extra profit.
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Related terms
Title Insurance
Every title insurance policy covers either a homeowner or the lender that financed the mortgage for the property. Lenders require you to pay for lender's title insurance as part of your mortgage closing costs. Homeowner's title insurance is mostly optional and is paid for by the seller or the buyer of the property.
An offer is when a buyer puts in a price offer on a home that the seller can accept or counter.
Fractional Ownership
Fractional ownership is a method in which several unrelated parties can share in, and mitigate the risk of, ownership of a real estate property.