How a short sale in real estate works

When you're facing severe financial difficulties and cannot make your mortgage payment, you may think that attempting a loan modification or going through a foreclosure are your only options.

But there is another way to get financial relief: the short sale.

What is a short sale in real estate?

A short sale puts your home on the market for a lower price than your outstanding mortgage balance. For example, you owe $200,000 on your home loan but can only sell your home for $150,000. Your purchase price is $50,000 "short" of what you owe. A lender must agree to be paid less than the mortgage balance and forgive the $50,000 shortfall.

The only incentive for a lender to agree to a short sale is to avoid the added legal expenses and extended time required to foreclose on a house.

However, there are at least a couple of possible drawbacks. In some states, the mortgage lender may sue you for the balance owed. If not, the amount written off by the lender — in our example, $50,000 — may trigger a tax bill.

Yet, a short sale can help you avoid the foreclosure process and repair your credit faster, and you may receive some money for relocation assistance.

Short sale vs. foreclosure

As you can see from the table above, while neither option is ideal, a short sale may be favorable. It's a matter of weighing how much time you have to spend on the effort required to launch a short sale compared to the lack of control and extended negative impact of a foreclosure.

The steps to a short sale

1. First, gather bank statements, credit card and loan statements, pay stubs, medical bills, and other paperwork to document your financial hardship. You must prove that you have no additional assets to cover the mortgage.
2. The next step is to contact your lender or loan servicer to delay any planned foreclosure action and to discuss possible "workout" solutions, as discussed below.
3. If you have more than one lender — for example, one lender for your original mortgage and another for a home equity loan or line of credit — you must also contact them. Subordinate lenders need to agree to the short sale too.
4. You will also want to contact an approved housing counselor. These advisers are authorized by the U.S. Department of Housing and Urban Development.
5. Then, find a real estate agent who is knowledgeable and experienced in short sales.
6. Meet with a real estate attorney to address all the legal details.
7. List the home for sale through your Realtor.
8. Finally, once the short sale is complete, ask your lender for a "deficiency waiver" so that you are cleared of any additional financial liability.

Pros and cons of a short sale

Pros

• You avoid foreclosure.
• You will have some control over the timeline and your living situation.
• The impact on your credit score may be less than in a foreclosure.
• You may be able to purchase a home sooner than in a foreclosure.

Cons

• You must take the initiative to sell your home and all the related details.
• All home loan lenders must agree to the sale.
• It can be a time-consuming process.
• You will lose any equity in your home.
• You may owe tax on any unpaid debt.

Alternatives to a short sale

A HUD counseling agency in your area can help you examine all workout solutions to keep your house — or guide you through the short-sale process. Some of the options can include:

• Forbearance: Allows you to reduce or temporarily suspend mortgage payments.
• Repayment plan: An agreement to repay a portion of past-due payments.
• Mortgage modification: A lender agrees to change the terms of your loan to make it more affordable.
• Offer a deed in lieu of foreclosure: Instead of selling the house at a loss, you may be able to transfer ownership to the lender. In some cases, you might be able to lease the home from the lender so you can continue living in it.
• Mortgage assumption: If you have an assumable mortgage, you might be able to transfer ownership of your mortgage to a buyer.
• Bankruptcy: If your financial situation is beyond repair, filing a Chapter 13 or Chapter 7 bankruptcy may be a way to keep your home — or delay a foreclosure so you have time to move. Just beware of the impact bankruptcy will have on your financial profile.

Be aware of short sale scams

You may be approached by "agents" or "negotiators" offering to help you get a better deal from your lender. They will likely misrepresent the house's value or work to obtain your ownership to flip it.

Short sale negotiators, processors, coordinators, or so-called debt resolution agents are often required to be licensed by the state. Always ask for credentials and customer references when engaging with a short sale agent.

Real estate short sale FAQs

Is a short sale a good idea?

Short selling your home can be a good idea if your financial status is dire and you can't agree with the lender on another way to keep your home. All sale proceeds go to the lender — you will lose any equity in the house and may still be pursued by the lender for the unpaid balance remaining after the sale.

Does a short sale hurt your credit?

Yes, any nonpayment of mortgage debt will hurt your credit report. A short sale may impact your credit score less than a foreclosure, but your score will still take a substantial hit.

Is a short sale risky for a buyer?

As a homebuyer, it could be less risky to buy a short sale than a foreclosure. You may get a good deal by buying a short sale because the lender and owner are motivated. Yet, the sale approval process can be complicated and time-consuming. If a homeowner has had money problems, the house may need maintenance, repairs, and upgrades.

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