A short sale can be a helpful option to avoid foreclosure on a distressed home. However, selling your house in a short sale comes with some advantages and disadvantages. Additionally, it may not always be approved by your bank or lender.
What Is a Short Sale?
A short sale is a real estate process where a bank or lender agrees to sell a distressed home for less than is owed on the mortgage. It gets the name “short sale” because the sale falls “short” of what the mortgage lender is due. Once the sale is complete, the bank or lender forgives the debt.
Short sales were more common during the 2008-2012 housing crisis. During the crisis, the price of homes fell dramatically. As a result, many people found themselves past due on their payments with underwater mortgages.
A short sale offers borrowers a chance to get out of these negative equity loans. Additionally, in some cases, homeowners can avoid bankruptcy and foreclosure without too much damage to their credit score.
Selling your house in a short sale doesn’t involve directly selling to the bank. Instead, a third party buys the property, and the money goes to the bank or lender. Let’s talk about how a short sale works…
How a Short Sale Works?
How a short sale works? Before you start the short sale process, you need to be sure that you will qualify. You will most likely need to satisfy these three conditions to proceed in selling your house in a short sale
The three short sale qualifications that your bank will look for are:
#1.) Proof of Financial Hardship
Your bank will ask you for proof of financial hardship to qualify for a short sale. Financial hardships are provable issues that have or will cause you to go past due on your mortgage payments.
Some examples of financial hardships are:
- loss of job or income
- illness (your or a co-borrowers)
- death of a co-borrower
- declining local property prices
#2. Monthly Shortfall
Most banks or lenders will want to see evidence that you can’t afford to pay your current mortgage. A monthly profit and loss statement can give a clear indication to your bank that you can’t meet the payments.
It’s pretty easy to calculate a monthly shortfall. You take your total monthly income and minus your total monthly expenses. If that results in a negative number, you have a monthly shortfall.
To qualify for a short sale, you need to demonstrate to your bank that you don’t have the means to pay your mortgage. In effect, the bank needs to see that you owe more in past due payments than you have in cash. Additionally, you need to show that you can’t meet your obligations with your bank or lender as your debts become due.
Some people believe that you need to be completely out of cash to qualify. However, that is not true. The bank just needs to see that you will not be able to service your mortgage over time. Having money in the bank to cover living expenses won’t disqualify you.
It’s worth noting that your bank or lender will also want to see a financial statement that outlines any assets you hold. If your bank discovers that you have significantly valued assets, they may reason that you could sell them and pay the shorted difference. Indeed, sellers with assets can still get a short sale, but the bank may require they meet the difference.
There’s a lot more to know about how a short sale works and this is a very important topic for you to have a seamless transaction when you are selling your house in a short sale. So if you need a more detailed explanation about how a short sale works, give us a call. Let’s continue…
Short Sale Steps
Each bank or lender will have its own requirements for agreeing to a short sale. Most of them will require a considerable amount of documentation. Selling your house in a short sale? This will give you an idea of how a short sale works and what to expect.
#1. Contact Your Bank or Lender
The first step you need to take is to call your bank or lender. Inform them of your situation and ask to speak to whoever deals with short sales in the bank. Generally, your real estate agent can manage this step for you.
#2. Send a Letter of Authorization
If an agent is dealing with the bank on your behalf, you should provide them with a letter of authorization. This legal document allows them to discuss your private financial information with the bank.
#3. Send a Net Sheet
A net sheet takes into account:
a) the sale price you expect to receive
b) the past due amounts owed, closing costs, late fees, etc.
The balance between these totals will show how “short” the sale is for the bank.
#4. Hardship Letter
As mentioned above, the hardship letter will tell the bank why you can no longer meet your obligations.
#5. Proof of Income and Bank Statements
A financial statement is a declaration of your current financial position, including any assets you hold. The bank requires this information to make sure you qualify for a short sale.
#6. Comparative Market Analysis
If the reason for your short sale is that local property prices have declined, your bank will require a comparative market analysis. However, this is less common with the US property market boom nowadays.
#7. Purchase and Listing Agreements
The bank will require a purchase agreement alongside your listing agreement if you find a buyer. From here, expect the bank to renegotiate fees and closing costs.
If the bank is happy, they may approve your short sale.
One aspect of negotiating with the bank is asking them not to report your payment deficiency to relevant credit bureaus. However, not all banks can (or will) accept this request.
Who benefits from a short sale?
A short sale can benefit all parties involved in the deal: i.e., the buyer, the seller, and the bank or lender. However, it won’t always be the best solution for everyone and contains some downsides.
Selling your house in a short sale will hurt your credit score. But not as much as a foreclosure would. In fact, a short sale can obstruct a foreclosure and its destructive impact on your credit.
However, to stop your bank or lender from taking possession of your home, you need to work out a deal and convince the bank to report your loan as “paid in full” to the relevant credit bureaus.
If your home is distressed and there is little prospect of you turning the situation around, a short sale can be the best outcome available to you.
But, it does have a downside. A short sale can mean that you have to walk away from your home with nothing from the deal, making it challenging to find a new place to live.
A short sale can be an attractive option for a bank or lender because it allows them to get out of a non-performing loan. A distressed property is considerably past due on mortgage payments, so it is not generating any money.
Banks have a few options to recover the money they are owed. A foreclosure means they take possession of the home and sell it at auction. Depending on a variety of market factors, a foreclosure can generate more money than a short sale.
However, should a short sale bring in a price that is close to market value, banks may be receptive to a deal.
The downside of a short sale for a bank is that they are the party that is taking the biggest loss.
The buyer can be the biggest beneficiary of a short sale because they can buy the property at a discounted price. However, there is a strong likelihood that the property will have some issues that require renovation.
Additionally, a short sale is a complex legal agreement. A buyer will need to navigate a significant level of red tape to push through a deal. In some cases, the bank or lender might instruct the buyer to pay additional closing costs that would typically be the seller’s responsibility.
Overall, a short sale has some positives and negatives based on each individual scenario.
The proceeds from a short sale are less than the total of:
a) the amount the seller owes on the mortgage
b) the fees associated with selling.
As a result, everyone who is owed money needs to compromise and either take less or take no money at all. For this reason, short sales are challenging and slow-moving transactions. Frequently, the complexity of a short sale will cause it to fall through.
More generally, though, a short sale holds benefits for all parties. For sellers, buyers, and banks, and lenders, there are some upsides and some compromises. However, a short sale is often considered the best option because it avoids the worst-case scenario for the homeowner and the bank: a foreclosure.
Short Sale: Pros and Cons
A short sale is a good option for sellers who are deficient in their mortgage payments. However, it’s a long and complex legal process that needs to be considered carefully. Avoiding foreclosure on a home is just one of the many short sale advantages. However, there are a few drawbacks that you need to consider too.
Selling your house in a short sale: PROS
1) A Fresh Start
Owning a home is a dream for most people. But it can turn into a nightmare if you become past due on payments and face foreclosure. Being deficient in your mortgage payments can happen for several reasons, like losing your job, a change of living circumstances, or illness.
Whatever the reason, if you owe more than you can repay, a fresh start can be the best decision.
2) Avoid Foreclosure
While defaulting on a mortgage payment will hurt your credit score, things can get far worse. If your mortgage is underwater, the bank might decide to foreclose and repossess your home.
A foreclosure will do more damage to your credit score. While you do get to walk away from your home, your credit will be destroyed, and you’ll have to declare bankruptcy. Selling your house in a short sale can help you avoid these dire circumstances.
3) Possibility to Save on Repayments
If you are deficient in your mortgage payments, it could mean that you owe a lot of money. However, depending on the agreement you make with your bank, and you negotiating with the bank, those debts might be forgiven.
For example, if you owe $250,000 and the short sale proceeds are $230,000, sometimes the bank or lender will forgive the deficiency of $20,000, allowing you to make a fresh start.
4) Quicker Re-entry to the Housing Market
As mentioned earlier, a foreclosure, and the resulting bankruptcy, will hurt your credit score. Under Fannie Mae guidelines, it will also stop you from taking out a mortgage for between 5 and 7 years.
Under these same guidelines, a short sale will allow you to buy a new home in about two years. In fact, in certain circumstances, you may be able to secure an FHA loan immediately. However, you’ll need to have no past-due mortgage or installment payments in the year leading up to your short sale, so not everyone will qualify.
Selling your house in a short sale: CONS
A short sale typically takes longer than traditional sales. Generally, this is due to the bank or lender. The time you have to give in negotiating with the bank. These parties will try to recoup as much of the past due payments as they can, which means they will take their time to negotiate and close the deal.
Additionally, many mortgages that have multiple lien holders can be more complex to solve via a short sell. For example, if you’ve taken out a home equity loan or remortgage, senior and junior lienholders may be involved. The more parties with a financial stake in your mortgage, the longer and harder it will be to negotiate.
Also, sellers can also end up delaying the sale too. For example, they might be indecisive or be slow to pull together the required paperwork.
2) Gathering Documents
Your bank or lender will require a lot of paperwork for them to consider a short sale. In short, this is a set of documents that demonstrates your financial hardship.
The bank calls this a “short sale package.” Some of the documents your bank will ask you to submit are:
- an executed listing agreement
- an executed purchase contract
- an authorization letter
- your hardship letter explaining how your payments became past due, tax returns
- wage documents
- your last two bank statements.
A short sale MIGHT count as income earned. As a result, you would have to pay taxes on it. However, a short sale can only be taxed if your mortgage terms hold you personally responsible for the full amount of the loan. So check your agreement.
4) Credit Score
While better than a foreclosure, a short sale will still affect your credit score. In some scenarios, your bank will not report your deficiency balance. However, if it does, expect your credit score to drop.
Getting the help you need
Selling your house in a short sale isn’t something that you can do alone. You’ll need to deal with several parties, from your bank to a prospective buyer. Additionally, negotiating with the bank take time and require a considerable amount of documentation.
Selling your house in a short sale can be an excellent option to get you out of a messy situation. It’s preferable to foreclosure and bankruptcy. As a result, the stakes are quite high, so it’s not something you can afford to do alone.
There are two professionals that you’ll need to hire to help you through the legal process of a short sale.
Find a Short Sale Realtor
While it may be tempting to seek out the services of the Realtor that sold you your home, this might be a mistake. Even if you have a great relationship and rapport with a realtor, they might not be specialists in the short sale process.
Remember, a short sale is a complex transaction. It requires negotiating with the bank and potential buyers. Additionally, there are compliance and regulatory issues to consider too.
When navigating this tricky process, an expert short sale agent is your best bet. For starters, a short sale realtor will need negotiating with the bank or lender how much money they are prepared to lose on your mortgage. Your bank might feel a foreclosure is a more advantageous proposition, so you need someone in your corner who knows how to argue your case.
Finally, as mentioned above, putting together a “short sale package” is a bit of work. A short sale expert can help you with this process.
Find a Short Sale Buyer
The next important step is to find a short sale buyer. Listing your property with local real estate agents can take time, and often they aren’t exactly experts on the short sale process.
Instead, it’s best to find a buyer who understands the short sale process and knows how to navigate the ins and outs of the procedure.
Short sales are our specialty. We have years of experience with the short sale process. We understand the various regulatory and compliance issues involved and can advise you on the best short sale resolution possible.
Getting through a short sale is a challenging time. However, we are here to help you through the process with advice that will get you the best deal. Let us give you a more in debt knowledge on how a short sale works so you can sell your house with ease!