If your dream of homeownership feels further out of reach than ever before, you're certainly not alone. An April 2022 report from the National Association of Realtors (NAR) showed that the median sales price for existing homes is currently at $375,300, up 15% from one year before. If you're trying to save up the down payment for a home so you can buy your way in, this level of housing inflation can make even keeping pace an impossible feat.
With that in mind, a short sale could help you get your foot in the door. With this type of home sale, it may be possible to purchase a property at a price that's well below market price. Plus, short sale homes tend to be in better shape than foreclosed homes, which are often distressed properties.
Short sales can be complicated, however, and you need to know everything that's involved before you try to purchase a home using this alternate route. This guide will explain everything you need to know about short sales, from how this type of sale comes about to how short sales work and their pros and cons.
What is a short sale?
According to the Consumer Financial Protection Bureau (CFPB), a short sale is a type of loss mitigation that can be described as "a sale of your home for less than what you owe on your mortgage."
This type of sale typically takes place when a homeowner owes more on their mortgage than their property is worth, yet they cannot wait for property values to rise before they sell. Homeowners might choose to go through a short sale over other alternatives (such as foreclosure) since this type of sale results in less of an impact to the seller's credit overall.
When a home is sold in a short sale for less than the current owner owes on their mortgage, the difference may be forgiven by the lender. That said, there are also situations where homeowners are required to settle the remainder of the debt before the sale can proceed.
The CFPB states that residents in some states can be sued by the lender when there is a deficiency between the sales price of a home and the mortgage amount. In this case, applying for something called a "waiver of deficiency" means that the lender agrees to waive the right to collect this amount.
If a homeowner plans to sell their home with a short sale, the CFPB recommends getting a waiver of deficiency in writing before they move forward.
How do short sales work?
Generally speaking, homes become a short sale when the homeowner becomes aware that they cannot keep up with mortgage payments. However, short sales can also come to fruition any time a homeowner needs to sell their home and realizes the market value of their property is less than they owe on their mortgage.
According to the National Association of Realtors (NAR), many home sales that ultimately wind up in this category start out as a "potential short sale." This type of listing is one where "the listing agent reasonably believes the purchase price may not be enough to cover payment of all liens and costs of sale and the seller is unwilling or unable to bring sufficient liquid assets to the closing," they write.
Also note that homeowners cannot simply opt for a short sale because they owe more on their mortgage than their home is worth. They have to prove they do not have the income or assets to sell their home and pay off all liens and debts the traditional way.
Either way, many short sales start out as a pre-foreclosure sale, and you'll have to sift through available listings to find them. Working with an experienced real estate agent is the best way to find short sales, although buyers can also search for them using a Multiple Listing Service (MLS) or by searching courthouse records.
Short sale versus foreclosure
Borrowers who cannot keep up with their mortgage payments or owe more than their home is worth can move toward a short sale or let their property fall into foreclosure. While both of these processes are geared to distressed homeowners, short sales and foreclosures work very differently in practice.
Generally speaking, short sales happen because the homeowner is trying to take control of the situation. Homeowners who opt for a short sale must seek their lender's approval to sell their home at a loss ahead of time, and they may or may not have fallen behind on their mortgage payments. Further, the homeowner still oversees the sale of their property during a short sale, although the lender has the final say when it comes to negotiating the price and accepting or rejecting offers made on the property.
On the flipside, a foreclosure is not voluntary by any means. In fact, foreclosure is a legal action that "allows the lender to seize the property, removing the homeowner and selling the home, as stipulated in the mortgage contract," according to USA.gov.
The foreclosure process may begin as soon as a homeowner has fallen behind on their mortgage payments by at least 120 days. From there, the actual timing of the full foreclosure process (i.e. when a homeowner loses legal ownership of your home and has to leave) can vary based on the situation.
Both short sales and foreclosures can stay on a past homeowner's credit report for up to seven years. However, homeowners who get rid of a property with a short sale tend to see their credit rebound at a much faster rate.
Short sales: 6 steps for buyers
If you're looking for a home to live in or you're an investor who is trying to purchase properties at below market value, a short sale may be exactly what you need. However, there are several steps involved in shoring up a short sale of your own, some of which are unique from the traditional home buying process.
Step 1: Get approved for financing
Whether you are planning to buy a home that is listed traditionally or a distressed property that's listed as a short sale, you need to get approved for financing ahead of time. Not only will prequalification help you gauge how much you can borrow, but it will show the home seller and short sale lender you are in a strong position to purchase the property.
Getting approved for financing is fairly easy to do online, although you will have to prove information such as your income and employment, any assets you have, your credit score and standing, and more. Once you have been pre-approved for a home loan, you should get a pre-approval letter that you can submit with any offers you make.
Step 2: Work with a real estate agent who is experienced in short sales
Finding short sales isn't always easy, and this is especially true in areas where the housing market is highly competitive. Many short sales are listed as pre-foreclosure sales at first, so it helps to work with an experienced agent who may know the background of various properties, including whether they may be listed as a short sale in the future.
Buyers can also find out about short sales through online real estate websites as well as networking.
Step 3: Research properties thoroughly
Once you find a short sale property you're interested in, you'll need to research information like the sales price of comparable homes in the area. You can do this on your own by looking up sales price information for recently sold homes in your zip code, yet real estate professionals have additional tools they can use.
In addition to determining a fair sales price for the property, you'll also want to find out how much the seller actually owes on their mortgage. Another important step involves checking for additional liens on the property, which you can find out by having your agent do a title search on the property.
Step 4: Make an offer on a short sale property
Once you have done your due diligence on the short sale you hope to score, you'll want to make an offer on the home that takes into account what the property is worth, the condition of the home, and how much the seller owes on their mortgage. Also note that homes being sold through a short sale are sold "as is," so you should make an offer that takes into consideration any and all repairs that need to be made. In the meantime, make sure your home offer has a contingency that lets you back out of the purchase if major issues are uncovered during the home inspection phase.
Generally speaking, you should strive to make a strong enough offer to entice the lender to accept the deal. However, you should make sure your offer still makes the purchase a "good deal" on your end.
Ideally, you'll make an offer that gives everyone involved — the home seller, the mortgage company, and yourself — part of what they want.
Step 5: Pay for a home inspection.
While homes sold through a short sale are sold "as is," you should still pay for a home inspection from a qualified professional. You won't get anything fixed by the seller if the inspection uncovers problems, but you can find out what you're dealing with and if any deal-breaker problems exist with the home.
While replacing appliances or fixing drywall can be a breeze, home inspection issues to watch out for include foundation problems, major water damage, black mold, major plumbing or electrical problems, and more. Knowing about big issues before you close on the short sale can help you figure out how much repairs might cost and if the short sale makes sense for you in the long run.
Step 6: Close on the property
Finally, you'll be in a position to close on the short sale property and take possession. This part of the sale will look like any other closing meeting on the buyer's end, with the buyer bringing a state-issued photo identification (e.g. a driver's license or passport) and the funds required to close on the home.
Short sale sellers may have to bring additional paperwork to the closing, such as a hardship letter that explains their dire financial situation, a list of liens on the home, and documentation that shows their lack of income and assets to sell their home through traditional means.
Either way, both parties sign a range of documents that wrap up the legal transfer of the property, and the buyer leaves the meeting with the keys to their new home.
Short sale pros and cons for buyers
If you're considering a short sale but not sure whether the potential savings will be worth the trouble, you should think over all the advantages and disadvantages of this option. Also remember that some individual short sales can be a better deal than others, and that the specifics of the property in question will play a major role.
- Potential to pay less than a property is worth: The main benefit of buying a short sale is the potential for instant equity. While the value of individual short sales can vary dramatically, some sources show that short sales can result in discounts as high as 21% off.
- Less competition: There may be fewer buyers competing for short sales in your area, although this is not always the case.
- Short sales are less risky than buying a foreclosed property: Where buying a foreclosure can come with various risks, including undisclosed liens, vandalism, and neglect, short sale homes tend to be in better shape.
- Process can be slow and unpredictable: Buying a short sale property means you are entirely beholden to the seller's lender and their timeline. Getting a response to your offer could take longer than normal, and the process often drags on for months.
- Not all short sales are a good deal: Buying a short sale does not necessarily mean you are paying less than a property is worth.
- No negotiation for repairs: Even if a short sale property needs considerable repairs, you won't get any help from the home seller or their lender.
Should You Buy a Short Sale?
At the end of the day, buying a home that is being marketed as a short sale comes with pros and cons. Like any other home sale, you'll have to do research to know how much a property is worth and whether it's the best home to live in or invest in.
That said, a short sale can be a good deal if you're hoping to gain instant equity and willing to take a few risks along the way. A qualified real estate agent can help you navigate short sales and determine whether pursuing one makes sense for your needs and goals.