While they do not make up a majority of house sales in the United States, roughly 200,000 foreclosures happened throughout 2022. These events cause a homeowner to lose their residence and take a big hit to their credit while locking themselves out of buying a home for years to come.
Short sales act as a way to prevent the worst of foreclosure from happening, leading to house listings with lower prices than average. Homebuyers might try to take advantage of these opportunities to secure a house for less, but several differences make short sales risky.
Let’s look at what makes up a short sale and how savvy homebuyers can navigate the risks to give themselves a better chance at securing a good deal when buying a home for sale in Phoenix, Arizona or anywhere else in the US.
What Is a Short Sale?
A short sale is a property offer for sale where the asking price of the sale is less than what the current homeowner owes on that property. Once the property sells, all of the proceeds from that sale go to the lender of the home’s mortgage, rather than the homeowner.
Because the mortgage balance is not fully paid off, the lender has to decide if they want to forgive the homeowner of the difference to pursue a deficiency judgment to obtain the rest of the mortgage’s value. Some states in the United States require that these differences be automatically forgiven, but not all of them.
Overall, this makes a short sale an alternative to foreclosure. While there are still downsides to a short sale, it tends to be a better outcome for a homeowner than a foreclosure.
When Does a Home Go Into Short Sale?
Most short sales happen when a homeowner encounters financial distress. Whether it be due to an unexpected job loss, injury, or greater market issues at play, the homeowner is no longer able to make the payments on their mortgage. Thus, the homeowner reaches out to their mortgage lender to inform them about the issues and try to establish a short sale.
A short sale requires the permission of the lender to go forth. Some lenders may allow the homeowner to freeze payments or interest for a short period, especially if the overall market conditions are rough, but this isn’t a common practice. These options remain at the discretion of the lender.
Does More Short Selling Occur in an Advancing Market or a Declining One?
Homeowners don’t usually rely on short sales as a way to solve mortgage debt issues outside of major market downturns. When housing prices collapse, a homeowner may only be able to sell a home for less than their original mortgage value, turning that sale into a short sale.
This situation happened often during the 2007 housing recession which saw many homes lose large portions of their value. As homeowners couldn’t keep up with their payments, they turned to short sales as a way to get out of an expensive home and into something they could afford while the market downturn worked itself out.
Otherwise, short sales don’t come up often in a standard market. Advancing housing markets tend to be the domain of homeowners leveraging their home’s worth to sell above mortgage value and buy into a bigger or better home with a larger down payment.
The Short Sale Process
Overall, there are four main parties involved with a short sale: the homeowner, the buyer, the lender, and the associated real estate and tax agents for the buyer and seller. Each of these parties has a distinct role to play in the short sale process.
To make the process clear, these are the general steps that short sale tends to follow:
The Homeowner Convinces the Lender to Do a Short Sale
Unlike the foreclosure process, homeowners need to convince their mortgage lenders to agree to the arrangement. Homeowners have the best chance of convincing their lenders when they present something new as the reason for the short sale, such as an injury, job loss, or divorce.
Lenders are not likely to agree to a homeowner’s request if they present reasons that should have been made clear at the signing of the mortgage. Lenders are more likely to take disagreeable actions toward dishonest borrowers compared to those that have a history of honesty and previously timely payments.
Some lenders will also look out for some behaviors that indicate the homeowner does not have the dire financial difficulties they want to present. New non-essential purchases, or access to assets available for the lender to obtain through a foreclosure, might be enough reason for a lender to deny a short sale request.
So long as the homeowner is truly in a bad financial situation and has no other recourse, many lenders will agree to a short sale.
The Homeowner Gets With Real Estate Agents to Set A Price
Once the lender agrees to a short sale, the homeowner will need to reach out to several legal and real estate experts to begin the short sale process. Specifically, the homeowner will need an attorney, a tax professional, and a real estate agent. Each of these professionals covers a different facet of the short sale process.
The attorney will work with the homeowner in reviewing and signing legal documents related to the transfer of ownership of the house’s title to the lender and other legal processes requested by the lender.
A tax professional will review the process and ensure that the sale of the home follows the state and federal guidelines when it comes to paying income and sales taxes for the two parties.
Finally, a real estate agent will work with the homeowner to quickly find a buyer for the home and determine the best sale price for the house, given the short sale status of the home.
The Buyer Inspects the Home and Establishes Financing
Once the listing goes up, the homeowner and real estate follow many of the same steps to market the sale as possible. Potential buyers go through the property, inspecting it as best as they can despite the shorter duration.
Financing can be tricky for a short sale, though. Due to the length of time it takes for a short sale to clear, many lenders hesitate to lock in an interest rate when pre-qualifying for a mortgage loan. Thus, many buyers lock in a maximum sale price and discuss interest rates later, especially when a short sale takes months or a year to clear.
The Buyer Partners With a Real Estate Agent to Finalize the Transaction
Buyers partner with real estate agents on short sales for the same reasons as with a traditional sale. Real estate agents will have the professional knowledge to navigate the paperwork and offer property tours, appraisals, bids, and legal guidelines needed to get through a short sale purchase.
Some real estate agents specialize in short sales. These agents offer expertise and experience in a way that a regular real estate agent won’t offer.
Ideally, the real estate agent a short sale buyer brings on has these qualities while also knowing the area well enough to estimate a maximum purchase price.
The Buyer Purchases the Home and Pays the Lender
Once the buyer and the homeowner agree to a sale/purchase price, the buyer needs to contact their lender and mention they have found a property for purchase. The buyer provides the listing price to the lender, ideally keeping that value below the maximum offer given by the lender.
The buyer then needs to work out with the homeowner’s lender about how to transfer the funds. Things can be tricky with multiple loans, meaning that this process can take a while to resolve while keeping everyone’s books straight.
Finally, the buyer should begin any necessary arrangements for expected repairs and renovations. While the buyer might not be allowed to work on the property right away, having crews or businesses lined up and quotes drawn up will prevent any further slowdowns in the future.
Advantages and Disadvantages of a Short Sale
Short sales are not a position a homeowner wants to be in. Thankfully, there are some positives to a short sale over a foreclosure for both the homeowner and the lender for the mortgage. Some of those positives include:
- The homeowner can get out of debt they cannot repay in a better way than through a foreclosure
- The homeowner has fewer fees to pay than a traditional sale
- Homeowners that manage to get a lender to agree to a short sale can have the lender write the debt off as a loss for their bottom line
- The lender receives some of the money back in a clear and honest way
Plus, the homebuyer has a few perks to buying a short sale house over a standard listing, such as:
- The new buyer can obtain the sale property at a discount
- Many short sales receive better financing terms to encourage buyers to buy the home
- Most homeowners in a short sale cooperate with the new buyer, making the transfer process smoother than with a foreclosure
Still, short sales aren’t a perfect solution to the problem at hand. The owner, buyer, and lender all have downsides to accepting a short sale agreement:
- The homeowner receives a hefty penalty to their credit score and loses the house they lived in
- The new homebuyer most likely buys a home that will need some repairs to bring it up to good condition
- Homebuyers also have to cover more closing costs than a traditional sale
- The lender doesn’t receive the full amount of their loan, hurting their bottom line if the difference is significant
Overall, a short sale tries to make the most out of a bad situation. It won’t fix all of the problems each party has with the previous agreement, but it does allow all three parties to move forward with the least friction possible.
Tips for Homebuyers Considering a Short Sale
For homebuyers interested in buying a short sale property, there are some considerations to keep in mind before going through the process. A short sale is a difficult process to go through, meaning it won’t follow the same steps as a traditional sale.
Know Where and When to Look
Finding short-sale properties is easier than you might expect. Many real estate agents and web search tools specialize in finding short-sale properties. Some portals, like the Multiple Listing Service (MLS), have tags on properties or language included in the listing description to clue viewers into short sales.
Also, you want to time your searches with overall market trends. Since short sales don’t occur as often in rising housing markets, you might find that short sales are hard to come by during these upward markets. Waiting until the housing market cools off could yield better results.
Expect Delays
Short sales take longer than lenders say they do. Often, it takes longer due to the increased number of parties involved in the process.
The main difference is that the lender for the homeowner’s mortgage needs to review the short sale package, including documents like a hardship letter, credit score reports, the sales application, and more, it can take weeks or months for these reviews to finish.
Additionally, many lenders request extra documentation to account for the new loan replacing the previous mortgage loan or the new buyer’s financial status. Appraisals can take a while too since most short-sale properties tend to be of lower quality than traditional sales.
Overall, expect there to be delays in the short sale process.
Factor In Repair and Renovation Costs
All of the repair and renovation costs for the property fall onto the new buyer. Because the old homeowner can no longer afford the property, these homes don’t go onto the market with the love and care most receive before listing. Plus, the old homeowner cannot afford the upgrades.
Thus, prospective buyers need to be prepared to factor in repairs and renovations as part of their budget. These can be severe enough to total out much higher than the original sale/purchase price would suggest, meaning buyers need to be careful that a short sale doesn’t end up more expensive than a traditional one.
This fact is why property appraisals are important in short-sale situations. Appraisers can find issues and make them known to prospective buyers before they worsen.
Don’t Forget Carrying Costs
For properties that require a lot of time to repair, carrying costs can add up. These costs refer to ongoing costs the homebuyer will need to pay regardless of if they live in the home while the repairs happen. These costs include property taxes, mortgage payments, insurance fees, and utility bills.
While many of these fees are fine for one property, having to split between two properties can be a drain for a homebuyer not ready for an extended wait to move into their short-sale home.
Key Takeaways
Overall, a short sale is a fallback option for homeowners that can no longer pay back their mortgage. Initiating a short sale requires that the homeowner contact their lender and provide evidence that a short sale is a better path forward than a foreclosure discovery.
Buyers that look at short sales as a way to buy houses cheaply will find that the initial sale price isn’t the only expense. Repair and renovation costs, extra closing fees, and carrying costs like insurance and utility bills will add further costs to a short sale that do not come up in a traditional one.
Overall, understanding the short sale process and how it works will give buyers the knowledge and time to tackle the problems that tend to come up with short sale purchases. Short-sale buyers should look at not just general guides for short sales, but also local short-sale history to see what they can expect when buying one of these homes.
FAQs
Here are the answers to some other questions home buyers tend to have about short sales:
Who benefits from a short sale?
Ideally, a short sale benefits all associated parties of the sale. The homeowner has a chance to move into a new home that matches their current financial capabilities, the lender receives a portion of their initial mortgage amount back, and the new buyer has a new home for themselves.
What’s the difference between foreclosure and a short sale?
A short sale refers to a property on the verge of foreclosure that went up for sale to pay off some or all of the mortgage. A foreclosure is an action done by a lender to a homeowner who has lapsed on mortgage payments to reclaim the property and sell it to a new owner.
How long can a short sale be held?
Most short sales last a few weeks, at most. The lender wants to reclaim their loan amount as soon as possible, incentivizing the homeowner to sell their property quickly and pay off the mortgage. Some short sales can last longer than this, but such cases are rare.
Who pays on a short sale?
The new homebuyer pays all of the associated fees and closing costs for the property, as part of the usual home-buying process. The difference in a short sale is that the funds transfer over to the mortgage lender rather than the previous homeowner.
Do short sales hurt your credit?
Short sales hurt your credit report, but not as much as a foreclosure. Credit agencies recognize that a borrower who wants to stay transparent and honest to lenders has a better chance of following through on loan agreements in the future than a borrower that never communicates.
How long after a short sale can you buy again?
The time a homeowner must wait before buying again after a short sale depends on the buyer’s unique circumstances and the amount of money they can put down for the new home. If a buyer can put down 10%, they must wait at least four years before buying a new home. For 20% down, a buyer only needs to wait two years.
Does FHA cover short sales?
In cases of hardship, FHA can cover short sales. Often, this process takes months due to the involvement of several government agencies, meaning these short sales last longer than those handled through private lenders. Additionally, FHA only covers short sales in instances of hardship, meaning financial negligence disqualifies a homeowner from FHA programs.
What is a short sale example?
Most short sales happen due to new financial hardship caused by a sudden change in a homeowner’s life. Events like divorce, illness, injury, and the long-term loss of income can all be why a homeowner would short sell their home. More rarely, major housing market downturns can cause homeowners to request short sales to downsize their homes.
What is a short sale and how does it work?
A short sale is the sale of a property before it reaches foreclosure. Often, these arrangements are also called pre-foreclosure sales. Homeowners in financial trouble reach out to their lenders to explain why they can no longer pay their mortgage and must sell the home. If they agree, the lender receives the payment for the house instead of the homeowner paying back the mortgage.
Why is it called a short sale?
Short sales derive their name from the financial situation the homeowner finds themselves in. Because the homeowner can no longer make payments for their mortgage, they are short on funds to pay the lender. Thus, a short sale refers to a home sale involving an owner shorting their mortgage lender.
Why is a short sale risky?
A short sale often involves a homeowner in hardship and a home that requires work to get back into a liveable state. Additionally, many fees that would be paid by the seller instead go to the buyer. Short sales also cause the seller to take a similar hit to their credit score (and credit report) or only delay until foreclosure happens.
