A short sale is one of the last options many homeowners can explore before foreclosure. Short sales involve obtaining approval from your lender to sell your property for less than the outstanding mortgage balance. By requesting a short sale and a satisfaction letter, you’re asking your lender to forgive any remaining mortgage debt that you’re unable to pay by selling your home for a lower amount than you owe.
What is a Short Sale?
A short sale is when a mortgage lender allows an owner to sell property for less than what’s owed on the mortgage. Property owners who attempt to initiate a short sale are usually under financial stress, and the market value of their property must have declined substantially, relative to the borrowed amount.
A short sale is similar to a regular sale in that the seller contracts a listing agent to put the property on the market, but with a short sale the lender gets involved, too. The goal of the short sale is to recover as much of the remaining mortgage debt as possible. If a short sale is successful, it usually ends with the release of the borrower from liability on any remaining mortgage debt left outstanding, however this is not always the case. In some cases, former borrowers have been surprised by banks coming to collect on debt previously thought to be extinguished. This undesirable outcome is known as a “deficiency judgment,” and it can occur after both short sales and foreclosures. Homeowners who wish to undertake a short sale for debt relief should consult legal counsel to verify that the short sale agreement actually releases them from all remaining liability.
By contrast, a mortgage lender conducting a foreclosure will repossess the mortgaged property in collection for unpaid debts. This results in more fees and liability to the owner than in a short sale. Foreclosures also end with the eviction of the owner, who exercises no control over the process. By contrast, a short sale allows the owner to reside in the property and retain some control over the short sale process.
For homeowners, short sales are generally preferable to foreclosures, and they can be used to delay the process if your home is already in preforeclosure. A short sale will leave the owner with some control over the process, while a foreclosure ends with property seizure and eviction. Short sales also generally incur fewer fees, penalties and legal expenses when compared with foreclosures. If successfully executed, a short sale can mitigate the financial fallout of an unfortunate situation.
The approval for the short sale will ultimately rest with the lender. A bank may choose to proceed with foreclosure if it believes that it will recover more from a private sale on the open market and any private mortgage insurance payments they’re entitled to. Most banks prefer to avoid the added expense of foreclosure proceedings, assuming reasonable purchase offers are available. But it’s important to note that short sales are not always a viable option: If the seller is unable to find an interested buyer on terms the lender approves of, the lender can choose to proceed with foreclosure.
How is a Short Sale Different from a Normal Sale?
A short sale is different from selling your home at a loss in a normal sale. In a normal home sale, you can choose to sell your home for less than what you owe if you’re financially capable of taking the loss. The lender will simply require you to make up the difference at closing.
When you attempt a short sale, you’ll need the lender to approve the transaction. You will also need an offer from a serious buyer that must also be approved by the lender. Even if you’re able to find a buyer, banks can take months to respond to short sale inquiries. If you’re deciding whether to short sell your property or are interested in purchasing a short sale property, be prepared for a drawn-out process.
Due to the seller’s financial hardship, most or all of the closing costs in a short sale will need to be paid by the buyer. Because the lender is already losing money on the transaction, it will probably be unwilling to cover many standard closing fees.
What are the Consequences of a Short Sale?
The biggest consequence of a short sale will be the negative impact on the seller’s credit score. You will also be unable to apply for new mortgage financing for a temporary period. Contrary to popular belief, a short sale can be just as damaging to your credit score as a foreclosure.
How Does a Short Sale Affect My Credit?
A short sale can drop your credit score by as much as 140 points or more, depending on your current score. Further impact on your credit can be mitigated if the lender chooses not to sue for a deficiency judgment, which is when a lender chooses to pursue the borrower for any remaining balance not covered by the proceeds of a short sale. We obtained the following figures from a FICO study about how mortgage delinquencies affect credit scores:
- Consumer A Consumer B Consumer C
- Initial FICO Score ~680 ~720 ~780
- FICO score after short sale (no deficiency balance) 610 – 630 605 – 625 655 – 675
- FICO score after short sale (deficiency balance) 575 – 595 570 – 590 620 – 640
- FICO score after foreclosure 575 – 595 570 – 590 620 – 640
- Source Data: FICO Banking Analytics
Based on the data provided by FICO, we observed that a short sale where the borrower was responsible for a deficiency balance was just as damaging as a foreclosure. In comparison, borrowers who had the remainder of their debt forgiven by the lender were less negatively impacted by a short sale.
This may be helpful in states with “non-recourse” laws, which prohibit lenders from pursuing a deficiency judgment on foreclosures or short sales. Such laws lessen the negative financial and credit impact for homeowners in either situation. These regulations vary from state to state, so you should consult an attorney to understand your rights and responsibilities. Both short sales and foreclosures will remain on your credit report for seven years after they’re settled.
We also found that individuals who have experienced a short sale are eligible for a new mortgage sooner than those who have experienced a foreclosure, but it will likely take longer than the guidelines established Fannie Mae or the Federal Housing Administration (FHA), as many banks have their own eligibility requirements for applicants who have experienced losses.
What is the New Mortgage Waiting Period After a Short Sale?
Fannie Mae requires a four-year waiting period before applicants are eligible for a new mortgage. Borrowers who can document extenuating circumstances will be eligible for a new mortgage in as little as two years. The FHA allows applicants to apply for mortgages three years after a short sale. Borrowers who can demonstrate that the short sale was caused by extenuating circumstances beyond their control are eligible for an FHA loan in as little as one year.
What is the New Mortgage Waiting Period After a Foreclosure?
By contrast, Fannie Mae requires a seven-year waiting period for applicants who have experienced a foreclosure and three years if the applicant can demonstrate extenuating circumstances. The FHA requires a mandatory three-year waiting period for foreclosures, although this can be reduced to one year with extenuating circumstances.
Am I Eligible for a Short Sale?
In order to qualify for a short sale, you will need to fit the requirements below. Meeting these requirements does not guarantee that your short sale will be approved.
- The property value must be lower than the balance remaining on the mortgage, counting all fees and penalties.
- The seller must be close to default or already in default.
- The seller must demonstrate long-term financial hardship due to:
- Unemployment, either due to layoffs or firing
- Divorce which cuts off income source
- Death which cuts off income source
- Medical emergency
- The seller must lack substantial assets that could be used to offset shortfalls.
While short sales typically occur during the preforeclosure period, homeowners can attempt to initiate short sales if they undergo major life events that materially impact their financial condition. Mortgage lenders are more likely to entertain the prospect of a short sale in the early stages of a preforeclosure than after the foreclosure proceedings have already begun.
The homeowner must submit an application to the bank, documenting evidence of financial hardships. Additionally, homeowners will need to contract a listing agent to put their home on the market. Ideally, this will be an agent who specializes in short sales, which require more documentation and take longer to close than normal sales. A missing document can easily set your short sale back several months.
At the end of the day, both the seller—and any potential buyer of the property—will be at the mercy of the lender. Lenders can take months to respond to short sale proposals, and they have the right to reject your short sale even if all the technical requirements are met.
Should I Short Sell My Property?
If you need to short sell your property, you will need to contact your mortgage lender’s loss mitigation department. Many property owners in need explore short sales in addition to mortgage modification and deeds-in-lieu as alternatives to foreclosure. For homeowners who want to avoid the social stigma of a foreclosure, a short sale may a way to keep a roof over their heads while they plan their financial exit strategy.
Whether you should do a short sale or let the home go to foreclosure depends on several factors. While for some homeowners, it is easier to throw up their hands and let the bank take the home, that might not be the wisest thing to do. Regardless of which approach you choose, always obtain legal and tax advice before making a decision between a short sale or a foreclosure.
Short Sale Benefits
Here are a few benefits for doing a short sale:
- You are in control of the sale, not the bank.
- You may sleep better knowing who is buying your home.
- You will spare yourself the social stigma of the “F” word, foreclosure.
- Contrary to popular belief, you can often stay current on your payments and still apply for a short sale.
- Your home sale will be handled like any other home sale, with respect and dignity.
Here are a few benefits for choosing to do a foreclosure:
- It’s an immediate solution.
- You can stop making payments and live in the home until you get kicked out.
- For some, it’s revenge; you might feel better initially telling the bank where to go when it refused your loan modification.
- If something breaks or malfunctions, you don’t have to fix it.
- You can leave the home behind and simply walk away.
Buying After a Foreclosure
If your foreclosure was due to extenuating circumstances, you may be eligible to buy another home in three years. Otherwise, the standard waiting period remains seven years, notes Fannie Mae in its latest guidelines. Similar to its short sale guidelines, FHA allows those who foreclosed on their homes to reapply for mortgages after 12 months.
Affects on Credit
A short sale may be considered to be a derogatory mark on your credit even though credit bureaus do not use the word “short sale” on your credit report. Your credit report may read “paid in full for less than agreed” or “settled for less,” among other categories. Certain HAFA guidelines allow for “no hit to credit” and can show up as paid in full. Depending on your credit history, Myfico.com offers two examples in which a credit score could fall significantly after a foreclosure. Generally, a foreclosure remain on your credit report for seven years.
Judgments are often negotiated between the seller and the short sale lender. In some states, such as California, if the home is your personal residence and was financed through purchase money, there is no deficiency judgment.
Banks are generally unwilling to negotiate deficiency judgments with the homeowner after a foreclosure. In California, for example, according to the California Association of Realtors, a deficiency judgment may be filed regarding a hard-money loan if the lender forecloses under a judicial foreclosure versus a trustee sale, or if the second loan is a hard money loan and the sale takes place as a trustee’s sale.?
Loan Application Questions
Loan applications typically do not require you to include information about short sales. You may report that you sold your home. You are, however, required to answer the question: “Have you ever had a property foreclosed upon or given a deed-in-lieu thereof in the past seven years.” If the lender sees you have had a foreclosure, your loan may be denied.
Length of Time to Relocate
If you’ve had a foreclosure notice filed, you may be able to postpone that action while the bank considers a short sale. The wait for short sale approval can be from two to three months, or longer. In a foreclosure, unless prior arrangements have been made, the lender may want you to immediately vacate the property and may commence eviction proceedings if you delay.
A personal residence is exempt from mortgage debt relief on a federal level as long as the government continues to extend this exemption. Some states still tax you unless you qualify for an exemption. An investor is not exempt from mortgage debt relief, subject to certain conditions. For owners who foreclose on their homes, some lenders immediately send out 1099s, which report the amount of relief as compensation to the owner, even if the owner is exempt.
No homeowner, on the signing day for a new home, imagines he or she will face a foreclosure. But the economic downturn and real estate market crash combined to plunge an unprecedented number of homeowners into the distressing process of losing their homes. The foreclosure process can be long, stressful and severely damaging to the homeowner’s savings, assets and credit. It’s a frightening situation.
However, there is another option for some homeowners. A short sale is a transaction in which the bank lets the delinquent homeowner sell the home for less than what’s owed. The borrower finds an agent and puts the house on the market, often at a substantial discount. The hope is that, if the home sells, the lender will recoup the majority of what the homeowner owes. This saves the lender the expense of a foreclosure suit and the possible long-term cost of owning a hard-to-sell foreclosed home.
Let’s take a look at 10 reasons why a short sale may present a better option than letting your home slide into the long, draining process of foreclosure.
10. It can protect your credit.
From a lender’s perspective, it’s better to recover a portion of a mortgage loan than to absorb a total loss. Therefore, in lieu of a foreclosure, banks will often settle for a short sale. This allows both the lender and the homeowner to end up in a better position.
One concern for many homeowners, however, is whether the bank will sue for a deficiency judgment after foreclosure. In an attempt to recover the difference in the amount that was paid and the amount of the loan, the bank can file a lawsuit against the homeowner. A deficiency judgment will appear on a homeowner’s credit report and have a negative impact, just as a foreclosure would.
But rather than endure a costly and possibly lengthy litigation process, a bank will often cut its losses with homeowners who are unable to pay their mortgages due to a proven hardship, such as a divorce or loss of income. And the reduced amount of money owed will ease the burden on the homeowners and not irreparably damage their credit.
9. It can prevent a foreclosure.
If you can short sell your home before it goes into foreclosure, your credit will take less of a hit.
A foreclosure on a home adversely affects the homeowner in a number of ways, and it also has a negative effect on the lender and the housing market in general. The homeowner receives a mark on his or her credit that can make it difficult — sometimes impossible — to borrow money for another home, car or major purchase. This can essentially remove the former homeowner from the pool of large-purchase consumers, a key part of the nation’s economic engine, for years. Banks nearly always lose money on foreclosures; between the lower sale price they receive at auction and the resources they must assign to administer the foreclosure process, it’s rare for them to come out ahead at the end of a foreclosure.
The housing market also suffers from foreclosure, due to decreased home values. A 2010 report by the Federal Reserve Bank of Cleveland estimated that a foreclosed home not only dropped in value, but caused homes within a 260-foot radius to lose up to 1 percent of their value, as well [source: Hartley]. Foreclosed homes are less likely to be maintained and more likely to remain on the market for an excessive period of time, and they make it difficult for homeowners with good credit to upgrade into more expensive homes.
Therefore, if a foreclosure can be avoided, it’s in the best interest of everyone involved.
8. It can save you money.
The average legal cost to a homeowner going through a foreclosure is around $7,500, according to the U.S. Congress Joint Economic Committee. Add in the additional costs that can accumulate throughout the sometimes lengthy foreclosure process, which could be just the tip of a burdensome financial iceberg. And if the homeowner is unable to afford payments, the foreclosure could eventually lead to a financial situation where bankruptcy — with its significant credit implications for the borrower and costs for the lenders — is the only option.
Mortgage lenders won’t always file for a deficiency judgment in a foreclosure case. It depends on the situation and the likelihood that they can win back the amount owed on the property. However, if all sides agree on a short sale, a new buyer in a better financial state could absorb some of what the original homeowner owes the lender. This would ease the original homeowner’s hardship and put him in a more manageable position.
Likewise, a short sale can drastically reduce the amount a bank may be looking to recoup from the homeowner. For example, if a short sale lets the homeowner sell a $200,000 home for $175,000, the bank will be much less likely to pursue a deficiency judgment.
7. It can help your lender.
Lenders are generally relieved to avoid the legal filings and documentation that go along with foreclosure.
As we mentioned, a lender is also negatively affected by a foreclosure. After the cost — and time expense — of sending multiple notices and warnings to a delinquent homeowner, the lender faces additional costs as the foreclosure moves into the courts. Legal filings, hearings and the associated documentation all take time and money to prepare. After the foreclosure sale, the lender may sue to recover money that’s owed above the amount that a home was sold for in a foreclosure, adding to legal costs. Also, since the lender gains ownership of the property, the lender faces the expenses and dilemmas every homeowner faces when selling a property: If it takes time to sell, it can become a very expensive burden. Even if the sale doesn’t stretch on, the lender must still hire a real estate broker to administer the sale of the house.
However, in opting for a short sale, the lender can recover a portion of the money that’s owed on the property, thus reducing the loss without the extensive legal process of a foreclosure. In many cases, a short sale reduces the lender’s total loss to a level where it’s more financially savvy for him to write it off, rather than sue the former homeowner.
6. It can benefit the housing market.
Many homeowners have spent years building up equity in their homes, only to watch it vanish as a result of the housing crisis. The housing market has been saturated with underpriced homes due to foreclosures, and finding buyers for many of these properties can be very difficult.
The wave of foreclosures has been damaging to the economy on a number of levels. Property values drop in neighborhoods occupied by multiple foreclosed houses. Once vibrant areas must now manage blight as it creeps into neighborhoods filled with empty, bank-owned houses.
Short sales can help resuscitate a neighborhood by making it easier for buyers to get into homes at affordable prices. By giving buyers and sellers an option that avoids the nuances of a foreclosure sale, short sales can reduce the number of excess homes for sale in a neighborhood, in turn reducing the number of unkempt, vacant houses.
Like sellers who wish to get out of unaffordable homes, prospective homebuyers benefit by not having to endure the red tape and bank auctions associated with the purchase of a foreclosed home. And since a short sale may be able to recoup a higher percentage of a home’s value than a foreclosure auction could, short sales can keep overall home prices from falling to abnormally low levels.
5. It presents opportunities for agents.
A real estate agent who specializes in short sales has found a potentially profitable niche.
The short sale process may be less complicated than a foreclosure, but it still requires the homeowner to go through a multistep process that’s more complicated than a traditional home sale. The benefits of this work, however, are great: The homeowner will most likely be in much better shape in the long run by opting for a short sale over a foreclosure..
Short sales present a profitable niche to real estate agents who take the time to understand the process. Capitalizing on the growing number of short sales in many areas can help an agent stand out from other local agents, and it may create a new source of business in the face of a still-slow housing market. Specialized short sale training is increasingly available to agents, and the effort that goes into learning this angle of the real estate market can pay big dividends.
4. It can benefit investors.
There’s no certainty surrounding any investment, and the word “foolproof” should never enter the mind of a prospective investor. But a savvy investor can do well for himself, while at the same time benefiting struggling homeowners, by considering short sales.
The purchase of short sales can be advantageous to an investor in a number of ways. Below-market-value buying prices, competitive selling prices and the easy accessibility to information about the home are a few of the incentives. Plus, the increased popularity of the short sale market can present a wealth of opportunities to an astute investor.
A short sale investor will also have the latitude to work out deals with homeowners, such as renting their property back to them or setting up a workable plan that may give them the chance to rebuild their credit.
3. It gives homeowners more control.
Tired of a mailbox full of bills and demands? A short sale will help you take control of the situation.
Once the ball starts to roll in a foreclosure, an arduous and stressful process begins for the homeowner. The mailbox starts to fill up with demand letters and confusing documents, and constant exchanges with the lender’s legal team ensue.
In a short sale, there are still negotiations, meetings and paperwork for the homeowner to weave through. But the process plays out more like a traditional sale, as opposed to a litigious and pressure-packed foreclosure proceeding.
Any real estate sale can be somewhat stressful, but a short sale will allow the homeowner to play more of an active role in the process and deal mainly with the bank, the homebuyer and the real estate agent. Overall, a short sale is much more manageable for the homeowner than being at the mercy of a bank’s attorneys during a foreclosure.
2. It can help the seller avoid scams.
Facing a foreclosure on one’s property is disheartening enough. But there are dishonest opportunists waiting for the chance to pounce on stressed, vulnerable homeowners, potentially making matters much worse.
A number of well-publicized scandals related to foreclosures have taken place over the last decade. Many involve scam artists who offer money-back guarantees, catchy slogans and promises to save homes from foreclosure in order to get access to struggling homeowners’ funds. The homeowners often come out of these fraudulent deals owing even more money and with no relief from foreclosure.
Opting for the short sale route will greatly diminish opportunities for scam artists to dig their claws into vulnerable homeowners. The short sale process works very much like a regular sale, and the homeowner will get to know the professionals with whom they’re working. This will all but eliminate the possibility of a scam artist becoming involved in the transaction.
1. It can offer the seller peace of mind.
Going through a short sale is less stressful than a foreclosure, and it will leave you in a better financial position.
Real estate transactions generate a whirlwind of activity between the buyer and the seller, and they’re often stressful by nature. But they don’t compare to the pressure that a homeowner is under during a foreclosure. The major credit hit, the drawn-out legal process and the overall stigma attached to foreclosure can be quite unnerving.
Short sales are not exactly risk-free when it comes to the seller’s credit, and they won’t completely diminish the financial implications when homeowners are unable to pay for a home that they purchased. But a short sale will open the door to solutions for homeowners that can allow them to avoid legal action and the lengthy, laborious foreclosure process.
Short sales can leave homeowners in a much more positive position, lessen their financial burden and salvage their credit to a degree. A short sale can provide “light at the end of the tunnel” to homeowners and offer them a platform from which to start rebuilding financially.