Life can take some unexpected turns—whether through career changes, family transitions or shifts in the housing market—that compels homeowners to explore alternative solutions to the traditional sale. One path that occasionally emerges in these situations is the short sale, a process that continues to spark curiosity and conversation in the real estate world.
Let’s explore how short sales work, including the pros and cons for buyers and sellers, and what all parties can expect during the closing process.
What is a Short Sale?
A short sale in real estate happens when a homeowner sells their property for less than what they owe on the mortgage loan. This usually happens when the following instances occur:
- The outstanding loan balance is higher than the current home’s value.
- The seller can’t afford to pay the difference at closing.
- The lender agrees to accept less than the debt they’re owed.
Example Scenario:
- Home value: $500,000
- Closing costs: $50,000
- Loan balance: $600,000
- The seller is short by $150,000.
Shorts sales can help homeowners who can no longer afford their mortgage sell their home, often due to situations like unemployment, debt, divorce or disability. It’s also an option for property owners seeking to sell when market conditions have caused a significant decline in home values—resulting in the property's current market value falling well below the outstanding mortgage balance.
What are the Pros & Cons of a Short Sale?
FOR SELLERS
Pros:
- Avoid foreclosure: Foreclosure is the legal process by which a lender can seize property from a homeowner who defaults on their mortgage loan and sell it to recover the debt owed.
- Lower credit impact: A short sale is often less damaging to a borrower’s credit score than foreclosure. A short sale typically reduces a borrower’s credit score by 50 to 150 points, while a foreclosure can lower it by 200 to 300 points.
- Possibility of debt forgiveness: In some cases, lenders may forgive the remaining balance on the borrower’s mortgage debt once the property is sold – although federal and state laws can influence how deficiency balances are handled.
- Relocation not required: Sellers are often allowed to remain in the property during the short sale process.
- Lenders often cover closing costs: In addition to accepting a reduced payoff, lenders typically pay for closing costs and broker fees.
- Quicker financial recovery: Short sales typically involve a shorter waiting period for borrowers to apply for a new mortgage than a foreclosure.
- Peace of mind: A short sale offers the borrower relief from the emotional and financial strain of an unaffordable mortgage, or one where the home’s value has dropped below the loan balance.
Cons:
- Lender approval is required: Homeowners must request a short sale from their lender, but there is no guarantee the request will be granted.
- Long process: Because of their complexity, short sale transactions typically take much longer (sometimes months) to close than traditional sales.
- No profit: Sellers involved in a short sale do not receive any equity or proceeds from the sale of the property. All funds are allocated to repaying the debt to the lender.
- Credit impact: Although less severe than foreclosure, a short sale still negatively impacts credit.
- Possible legal and tax implications: In cases where a lender forgives a borrower’s debt following a short sale, this amount could be considered taxable income – thus adding to the seller/borrower’s financial burden.
- Deficiency judgment: In some states, lenders can legally seek repayment of the difference between the outstanding mortgage balance and the sales price of the short sale transaction.
FOR BUYERS
Pros:
- Cost savings: Short sale properties are often priced slightly below market value, offering buyers a chance to purchase property at a discount.
- Opportunity for investment: Investors may find short sale properties attractive for flipping or rental income, due to the reduced sale price.
- Less competition: The time, risk and complexity associated with short sales tends to discourage some buyers, which reduces market competition and potential bidding wars.
Cons:
- Uncertain outcome: There is no guarantee the lender will approve a short sale, even once an offer is made. The lender may also counter with a higher sales price.
- Long process: Short sales can take months to finalize, due to lender negotiations and additional paperwork.
- "As-is" condition: Sellers involved in short sales often lack the funds to repair or maintain their property, leaving buyers to absorb these costs.
- Title problems: Short sale properties are more commonly linked to unpaid liens, HOA fees, or other encumbrances than properties involved in traditional sales. Even with thorough title searches, some liens can go undetected. That’s why protecting the property with title insurance is so important.
What to Expect During the Closing
There are several key components that all parties should keep in mind during a short sale closing.
- The seller still owns the property in a short sale, but the offer must be approved by the lender – which can take time.
- The closing agent may require additional or different documentation than a traditional sales transaction, such as a copy of the short sale approval letter and an Arms-Length Affidavit confirming no relationship between the buyer and seller.
- Lender approval letters often expire in 30-45 days, so be mindful of deadlines.
- Buyers can conduct inspections and appraisals. These steps are allowed in short sales, unlike foreclosure auctions.
- The closing agent will coordinate with the lender, follow lender instructions and verify that no funds go to the seller unless explicitly allowed in the short sale agreement.
- A property may already be in pre-foreclosure when an offer on a short sale is approved, but it does not automatically stop the foreclosure process. Timing and communication with the lender are key.
Making the Choice
Whether you are a homeowner hoping to avoid foreclosure, or an investor looking for a rental property, it’s important to educate yourself about the short sale process and conduct thorough due diligence.
Consulting with a real estate attorney and tax professional can help you understand the legal, financial and tax implications involved. Additionally, working with title and real estate agents who know how to navigate the complexities of these transactions can facilitate a smoother, less stress experience from start to finish. Our nationwide network of highly experienced professionals is ready to deliver the expertise and tailored services you need. To locate an office near you, visit Old Republic Title.
This material is for educational purposes only and does not constitute legal advice. Old Republic Title strongly recommends that consumers obtain guidance and advice from qualified professionals, including attorneys specializing in real property law, probate law or tax law, to get more detailed and current information as to their particular situation.
