What Is a Short Sale in Real Estate?
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Unexpected life events, like changes in employment or divorce, can sometimes cause a homeowner to fall behind on their mortgage. If you’ve suddenly found yourself unable to keep up with your mortgage payments, you may be able to benefit from a short sale.
What is a short sale?
A short sale in real estate is an option for homeowners in poor financial standing who owe more on their mortgage than what their home is worth. A homeowner in this situation can mitigate their loss by selling their home if they meet the criteria set by their mortgage lender.
How does selling a home via a short sale work?
For the most part, a short sale works the same way as any other home sale. The key difference is that in a short sale, the profit goes to the mortgage lender rather than the seller. That means that the lender will need to approve various aspects of the sale.
Generally speaking, to get a lender’s approval for a short sale, a homeowner must:
- Have an outstanding mortgage balance higher than the current value of their home
- Be in a state of financial hardship that prevents them from continuing their monthly mortgage payments
- Either be behind on their mortgage payments or be at a severe risk of defaulting
- Not have sufficient assets to sell to pay off the loan
Some lenders may have stricter guidelines for short sales than others. Homes financed through government-backed loans tend to be subject to higher standards.
To qualify for a short sale, a home financed with an FHA loan must be your primary residence and not a rental property, have a clear title, and have only one FHA loan. A home financed with a VA loan must have no other significant liens and be sold with “reasonable and customary” closing costs.
After the home is put on the market, what can you expect from the short sale process?
After your lender approves your application to carry out a short sale, the home will be listed on the market with a disclaimer that it is a short sale property. From here, the selling process functions similarly to a typical home sale, and buyers will have the opportunity to make offers on the property.
After you find a buyer to purchase your home, you’ll need to put together a short sale package to send to your lender. While the specific documents needed for a short sale package may vary depending on your lender, you will typically need to submit:
- The initial listing agreement between you and your agent
- A letter of hardship explaining why you cannot continue your mortgage payments
- A purchase contract specifying that the sale is contingent on your lender’s approval
- Proof of your financial state, such as bank statements and tax returns
- An authorization letter that approves communication between your agent and your lender
- A closing disclosure detailing the terms of the sale
After reviewing this package, your lender will either approve the sale, reject it entirely, or reject it unless certain adjustments are made.
How long does a short sale take?
From start to finish, the short sale process can take as little as two months or as long as a year. The exact timeline of a short sale can vary greatly depending on the location of the property, the difference between your mortgage balance and the value of your home, and how quickly your lender responds during various steps in the process.
Realistically speaking, you should plan on waiting about 6 months to finish selling your home.
What is the difference between a short sale vs. foreclosure?
Short sales and foreclosures are similar in many ways but there is one major difference between the two: A short sale is voluntary, while a foreclosure is forced upon a homeowner.
Because a short sale is a choice, it is less damaging to a homeowner’s credit than a foreclosure. As such, many homeowners use a short sale as a preventative measure to avoid a foreclosure.
Is a pre-foreclosure a short sale?
A pre-foreclosure is not the same as a short sale. A pre-foreclosure is when a home is at risk of foreclosure due to missed mortgage payments, but the homeowner still has some time to try and stop the foreclosure.
While a short sale is one method that can be used to prevent foreclosure once the pre-foreclosure period begins, it is not the only option. A homeowner can also avoid foreclosure by refinancing or modifying their home loan, signing a deed in lieu of foreclosure, filing for bankruptcy, or obtaining enough money to become current on their mortgage.
Can you sell a house in foreclosure in a short sale?
Once a home has been foreclosed, it becomes the property of the lender, and the previous owner has no right to sell it. However, it is possible to sell a house in pre-foreclosure. In fact, most properties sold in short sales are pre-foreclosure.
Preventing foreclosure through a short sale not only lessens the hit to your credit score; it also makes it easier for you to buy another house in the future. If you are in pre-foreclosure and your lender approves a short sale, it is usually worth going through with it.
Can you sell a house to a family member through a short sale?
Most lenders will not allow a home to be sold to a family member through a short sale, as they expect that a relative will try to buy the house for less than what other buyers would offer.
Lenders typically require the buyer and seller in a short sale to sign an arm’s length affidavit. This affidavit not only states that the two parties are not family, but also that they don’t have any sort of business relationship.
If you have two mortgages on a home, what happens to the second mortgage in a short sale?
If you have two mortgages, you’ll need both of your lenders to sign off on a short sale. However, approval from the lender of your second mortgage depends largely on the decision of the primary mortgage lender.
Your first mortgage gets first priority, meaning that when your home is sold in a short sale, the primary mortgage lender gets the money from the sale. That means the second lender has no incentive to agree to a short sale unless the primary lender offers to give them a share. This is why getting approved for a short sale is more difficult with two mortgages.
Can you sell a home with a reverse mortgage in a short sale?
A home with a reverse mortgage can be sold in a short sale just like a home with a traditional mortgage. However, FHA reverse mortgages are subject to FHA short sale guidelines.
How does a short sale affect your credit?
A short sale has a significant negative impact on a homeowner’s credit score, sometimes lowering it by as much as 150 points. The higher your credit score was prior to the short sale, the more dramatic the drop will be.
Finding your short sale on your credit report may be tricky. You most likely won’t see the words “short sale” printed anywhere. Instead, you may see a charge-off, a settlement, or a phrase like “settled for less than the full amount due.”
Once a short sale appears on your credit report, it will stay there for seven years, but the start date of those seven years depends on the events leading up to the short sale. If you were late on any mortgage payments prior to selling the home, the seven years begin on the date of your first delinquent payment. Otherwise, they begin on the date your debt was marked as settled or paid.
How does a short sale affect your ability to purchase another home in the future?
After selling your home in a short sale, you will need to wait a set amount of time before you can take on another mortgage. Different types of loans require different waiting periods.
For a conventional loan, your waiting period depends on the down payment you make on a home. You’ll need to wait 2 years for a 20% down payment, 4 years for a 10% down payment, and 7 years for a down payment in the single digits.
FHA loans typically have a waiting period of 3 years, but you may be able to buy a new home immediately after a short sale if you did not have any late payments prior to the sale.
While the VA itself does not require any specific waiting period after a short sale, most lenders will require a 2 year wait before they allow you to take out a VA loan.
Note that some loans may provide the option to shorten your waiting period if you provide proof of extenuating circumstances that made the short sale necessary. Some examples of extenuating circumstances include the loss of a job, divorce, medical debt, or the death of a spouse.
As a buyer, is it a good idea to purchase a short sale home?
Short sale homes tend to come with low price tags and little competition. However, bear in mind that these homes are sold as-is, and they may be in need of extensive repairs that will make them more expensive in the long run.
Before committing to buying a short sale home, be sure to have an inspection done and thoroughly weigh the pros and cons of the property.
Can you get a mortgage to purchase a short sale home?
To get a mortgage when buying a short sale home, the property will need to be appraised. An appraisal estimates the value of a home based on features such as size, age, neighborhood, and the prices of other similar homes in the area. If a home is appraised to be worth less than its sale price, the buyer will need to make a higher down payment to get approved for the loan.
How we can help
If you are a homeowner facing a potential foreclosure or short sale, AMI might be able to help. We have plenty of experience buying pre-foreclosure homes in as-is condition and can make you a no-obligation cash offer. Contact us today to learn more.