What Is a Short Sale, and Should You Buy a Home Through One?

Bargain-hunting homebuyers sometimes consider short sales in the hope they’ll find a property selling for less than market value.

In fact, short sales do sometimes sell for less than comparable homes, but it could be months before you know whether the sale will close.

What is a short sale?

A short sale is when you sell your home for less than what you owe on your mortgage because you’re unable to continue making payments.

For example, you sell your home for $175,000 even though you still have a $200,000 mortgage balance.

Since a short sale won’t net you enough cash to repay your mortgage, it’s not a decision you should take lightly. For that same reason, the mortgage lender must approve a short sale before you can move forward with it.

Short sale vs. foreclosure

Although short sales and foreclosures both result in you losing your home, the processes are very different. Here are some of the key differences:

• As the homeowner, you initiate a short sale by choice, whereas a foreclosure is imposed by the lender.
• You might sell your home short to ward off foreclosure, but it’s the lender that sells a foreclosed property after it has repossessed it.
• By the time your home gets to foreclosure, you’ll have missed several mortgage payments. That’s not necessarily the case with a short sale.

From a legal standpoint, short sales can put you at a disadvantage if you live in a state that allows deficiency judgments. A deficiency judgment is when the lender sues you for the difference between the sale proceeds and the amount needed to pay off the mortgage.

Alternatively, the mortgage lender can simply forgive the deficiency, in which case you might have to pay tax on the amount forgiven, according to the IRS.

How short sales work

To kick off the short sale process, you or your listing agent must contact your lender to get permission to sell the home for less money than you need to pay off the mortgage. The lender will ask you for a hardship letter to explain why you can’t keep making payments.

The lender must also approve the specific terms of the sale. After you accept a buyer’s offer, you or your agent will submit the sales agreement along with a short-sale package containing the following items:

• The buyer’s pre-approval letter or proof of funds
• Net proceeds estimates
• Title instructions
• Tax returns, pay stubs, and a list of assets for the homeowner
• A comparative market analysis to support the sale price.

The lender will then evaluate the contract and package and decide whether or not to approve the sale.

Qualifications for a short sale

Lenders generally won’t approve a short sale except as a last-ditch effort to avoid foreclosure. Therefore, the most important qualification is a hardship that renders you unable to make your payments now and/or in the foreseeable future.

The lender will look at your income along with your assets in case you have savings or investments you could use to make your payments.

The other major qualification is that your home is worth less than your mortgage balance. This might be the case if home values in your neighborhood have fallen since you purchased your home.

How long does a short sale take?

There’s no hard-and-fast rule on how long a short sale takes, but it’s a good idea to allow at least a few months for the seller to get approval and another 30 days for the sale to close.

When you sign a sales agreement for a short sale, you’ll also sign a short sale addendum that specifies how long you’re willing to wait before you terminate the sale.

Here are some factors that determine the timeline:

• Lender’s decision: Lenders go through a complicated review process involving the investor on the loan (Fannie Mae or Freddie Mac, for example), the private mortgage insurer, if applicable, and junior lienholders.
• Seller delays: If the seller is slow to submit their documentation to the lender, or the documentation is incomplete, the sale will be delayed.
• Offers submitted: Lenders only consider one offer at a time. If your sale is contingent on one currently under review falling through, you could be in for a lengthy wait.
• Number of lienholders: A seller who has additional liens, such as from a second mortgage or unpaid homeowner association dues, must get all the lienholders to sign off after the primary lienholder approves the sale. To give you a sense of how long that might take, note that the standard short sale addendum used in New Jersey allows up to 90 days for these additional approvals.

Pros and cons of buying through a short sale

For a prospective homebuyer, short sales can present an opportunity to buy a home for less than you’d pay in a traditional sale. You might also face less competition because buyers might be unwilling to risk the pitfalls of a short sale home.

One major pitfall is how long it can take to buy a home through a short sale. It’s not uncommon for the process to take many months, and you might have to sign a short-sale addendum agreeing to wait for a period of time — 45 days, for example — until the sale is approved.

Here are the advantages and drawbacks to consider before buying a short sale home:

How to buy a short sale home in 6 steps

Buying a short sale home is similar to buying a regular home. Here’s how to do it:

1. Find short sale homes

Your best bet is to work with a real estate agent who’ll find the properties for you. It’s important to choose an agent based on their experience in your market, and in particular, their experience with short sales. This includes communicating with the seller’s lender, protecting your interests as the buyer, and negotiating the best deal.

Tip: You can take a more proactive approach by contacting the owners of homes in danger of foreclosure before they list the homes for sale. Each of these sellers will have received a notice of default from their lender. The notices are public records you can search at your county recorder’s office.

Alternatively, you can search for pre-foreclosures using a database like RealtyTrac, which lets you focus your search on pre-foreclosures that have not yet been listed for sale.

2. Research the property

Ask your agent for a comparative market analysis showing how much similar properties have sold for recently.

It’s also important to have your agent contact the listing agent to find out how many loans and other liens there are on the property. While the title company will perform a title search after the lender approves the sale, it’s good to know in advance if there are junior lien holders who’ll need to sign off on the short-sale transaction.

3. Secure financing

Unless you’re paying in cash, you’ll need a pre-approval to submit an offer. It’s best to have an experienced loan officer who understands the process and documentation requirements.

Tip: You can speed the pre-approval process along by having your documents ready to submit to the lender. Try to have the following ready in advance:

• W-2 or I-9 forms
• Pay stubs from the last 30 days
• Recent bank statements
• Details on certain debts like credit cards, car loans, or student loans
• Recent tax returns

4. Make an offer

The last thing you want to do is wait months for a response, and then have to start from scratch because the lender nixed the deal. Such a delay might cost you the sale if the home forecloses before you can get an offer accepted.

So, your best bet is to work with your agent and make your best offer from the start, based on the sold prices of comparable properties. A strong offer also gives the lender plenty of time to work through its short sale approval process.

You’ll include your deadline in the short sale addendum to the sales contract. Your offer should also include a sizable earnest money deposit.

5. Get a home inspection

A short sale home is likely to be sold as-is, meaning the seller won’t make repairs, so it’s vital that you know its condition.

Order the home inspection from a licensed home inspector right after the seller’s lender has approved the sale. That way you’ll know what kind of repairs the home needs and if it still makes sense to purchase the home.

Important: The fact that it’s a short sale doesn’t automatically mean the home is in poor condition. Sellers are usually required to disclose information about a property’s condition that could impact the value of the home. However, the hardship causing the homeowner to default on their mortgage might also have caused them to neglect maintenance and repairs.

6. Close on the home

In the weeks leading up to closing on a home, check with your bank and title company to go over instructions for wiring funds. At the same time, avoid any changes to your finances, like a large bank deposit or withdrawal or new debt.

Tip: You’ll receive your closing disclosure within a couple of days of closing. Review it carefully to make sure there are no errors.

The title or closing agent will have all the documents you need to sign at the closing table. They’ll also provide you and the seller with a detailed list of everything you need to bring to closing.

Here’s what’s typically required from each party:

Buyer:

• Photo ID
• A copy of your sales agreement
• Receipt for wire transfer
• Proof of homeowners insurance (if the title company doesn’t have it yet)
• A copy of the closing disclosure you received prior to closing
• Any other documents specified by the lender

Seller:

• Photo ID
• A copy of your sales agreement
• Cashier’s check or wire transfer receipt for any mortgage balance due at closing
• House key, mailbox keys, garage door openers, and other devices needed to enter the home
• A copy of the closing disclosure received prior to closing

Is a short sale home right for you?

A short sale makes sense for buyers who have a great deal of flexibility with their closing date and are willing to wait in exchange for the chance to save money on a home purchase.

Here are some questions to ask yourself before you invest your time in a short-sale property:

• Will waiting for lender approval cause undue hardship?
• Am I willing to wait until after closing to make necessary repairs, and then pay for them out of pocket?
• Is the comparatively small pool of available short sale properties too restrictive to justify the savings?

If you have any doubts after answering these questions, a short sale may not be the best fit for you.

A short sale isn’t the only way to land a great deal on a home, though. With a lower mortgage rate, you can save a bunch of money over the course of your home loan.