What Is a Short Sale?

Every transaction is unique in real estate, especially regarding short sales. In this article, we outline what a short sale is, how it works, its potential pitfalls, and what real estate brokers should know about these types of transactions.

A short sale is when a seller owes more on their house than they can get selling the property. For instance, if the seller owes $400,000 on their mortgage, but the home is only worth $350,000, the seller would owe $50,000 to their mortgage lender. Typically, the seller can’t pay the $50,000 balance as they tend to be financially strapped and are selling their home out of desperation.

Key Takeaways

A short sale occurs when a homeowner sells their property for less than the amount owed on the mortgage. This often happens due to financial distress, such as during a housing market crash or because of predatory lending practices.
In a short sale, the homeowner initiates the sale and finds a buyer, whereas a foreclosure is initiated by the lender, who then takes ownership and handles the sale. Short sales have advantages like less impact on credit scores and potential debt reduction.
To conduct a short sale, the homeowner must convince the lender, hire experienced professionals, set an appropriate selling price, and submit a proposal to the lender. This process can be lengthy and may not always succeed.
Buyers may find good deals with short sales but must be aware of potential pitfalls such as property disrepair and additional costs. Real estate brokers are crucial in guiding buyers through the complexities and risks associated with short sales.

What Prompts a Short Sale?

What could compel someone to sell their home at a loss? Here are just a couple of scenarios a seller may encounter.

Housing market crash

When the housing market crashed in 2008, many people found that they paid more for their homes than they were worth, potentially due to a “housing bubble.” Since many people lost their jobs during the 2008 financial crisis, some people had to sell their homes at a loss because they could no longer make the mortgage payments.

Victim of predatory lending

Another scenario that could result in a short sale is if someone bought more houses than they could afford, which unfortunately happened all too often leading up to the 2008 market crash. Luckily, government regulation in the aftermath of the 2008 financial crisis, like the Dodd-Frank Act, has helped crack down on predatory lending, making it more difficult for lenders to approve high-risk borrowers.

In both situations, the homeowner sells their property before the lender forecloses.

What’s the Difference Between a Short Sale and a Foreclosure?

While selling a property at a loss may seem like a financial faux pas, the alternative could be even more financially damaging. One of the key differences between a short sale and a foreclosure is that the homeowner initiates the short sale, and a foreclosure is initiated by the lender, typically a bank. Additionally, with a short sale, the homeowner is responsible for finding a buyer. In contrast, with a foreclosure, the lender takes ownership of the property and is thus in charge of selling it.

There are a few advantages of short-selling a property over being foreclosed upon:

The homeowner’s credit score doesn’t take as much of a hit as it would with a foreclosure.
With a short sale, the lender typically covers closing fees.
In some cases, the homeowner may reduce their debt burden by having the lender write the remaining debt on the property as a loss.

Short Sale Steps

Once a homeowner has decided to short-sell their home, they must follow a series of steps.

Step 1: Convince the lender.

While lenders are not required to agree to short sales, they can be convinced. Provide documentation that showcases the source of your newfound financial distress, such as a job loss, medical issue, or family problem (i.e., divorce, death in the family, etc.).

Step 2: Hire professionals.

Once the lender agrees to a short sale, hire professionals with short sale experience, such as real estate brokers, tax professionals, and attorneys. While it may be costly to hire professionals, foreclosure can be even more financially detrimental.

Step 3: Set a selling price.

A real estate broker can help you determine a selling price and may also have tips that can help showcase the property without breaking the bank. Remember that you will want to price it to sell quickly since the longer you own the house, the longer you stay in a financially detrimental situation.

Step 4: Submit your proposal to the lender.

Once you find a buyer for the home, you need to submit the offer to your lender, as they are ultimately the ones who will accept or reject it, as well as a proposal. Your proposal should include a hardship letter outlining why you need to short-sell your home and the steps you took to remedy the situation, such as reducing your expenses and increasing your income.

Even if you can convince your lender to agree to the short sale, it may fall through. Short sales require more paperwork and time to process, and your buyer may back out of the offer if they find another home before the closing date. Additionally, if the lender determines they can make more money from a foreclosure than approving a short sale, they will go the foreclosure route.

What Do Short Sales Mean for Real Estate Brokers?

Some buyers may be interested in short-sale homes because they usually get a good deal compared to non-short-sale homes. However, as their real estate broker, you should help your client understand the potential pitfalls of buying a short sale and how to avoid them.

For instance, short sales do not require the same disclosures as typical homes, so hiring a skilled home inspector is essential to discover any prior damage or code violations. Since short sales are usually in some disrepair, the buyer should consider these additional costs, not just the home’s listing price, in their budget. Plus, going over budget tends to be the rule and not the exception regarding home renovations. Moreover, short-sale homes are sold as-is, so there is no negotiating with the seller about making repairs before purchase.

While purchasing short-sale homes is more risky than purchasing typical homes, they can be profitable. As such, short sales tend to attract house flippers who are more comfortable taking on risk and have experience calculating a property’s after-repair value (ARV).

Whether a buyer is looking to flip a short sale or use it as their primary residence, a knowledgeable real estate broker can help make the buying experience seamless.

You’ll learn about short sales from the buyer’s and seller’s perspectives when taking pre-licensing courses with the Superior School of Real Estate. Superior offers in-person, livestream, and at-your-own-pace online courses. Are you interested in audio real estate courses? Superior offers those as well. Get started today, and you will be a licensed agent in just a few months.

Source:

“Dodd-Frank Act.” CFTC. Accessed July 5, 2024. https://www.cftc.gov/LawRegulation/DoddFrankAct/index.htm.