What is a Short Sale?
A short sale is defined as a type of real estate sale where money received from selling the property will be insufficient – i.e., fall short – to completely pay off the mortgage lender and any other lienholders on the property. The mortgage holder must agree to the sale – that is, to receive less than the total amount owed on the existing mortgage note.
- A short sale refers to a real estate transaction that may occur when a homeowner is financially distressed to the extent that they can neither make their remaining mortgage payments nor can they sell their home for a price sufficient to pay off all lienholders.
- In order for a short sale to be done, all lienholders of the property must approve the deal, including the sales price.
- Short sales are often an attractive alternative to foreclosure, for both the homeowner and the mortgage lender.
Understanding Short Sales
A short sale serves as an alternative for a financially distressed homeowner to possible foreclosure proceedings.
The basic requirement for a short sale is for the lender to be convinced that the homeowner – the mortgage borrower – is incapable of getting caught up on their mortgage payments at any point in the reasonably foreseeable future.
Also, the lender must believe that the current state of the housing market is such that it is unlikely that the home will appreciate in value (within any reasonable amount of time) to the point where the property can be sold for an amount that will enable the homeowner to pay off their mortgage loan in full.
The Short Sale Process
A short sale is often difficult to execute because many different parties, with different financial interests – such as the mortgage lender and the potential buyer of the home – must approve the process in order for it to be completed.
The following is a rundown of the essential steps in the process, including various roadblocks that may be encountered along the way, effectively stopping the process – at least temporarily – until the parties involved can come to an agreement that they can all live with.
A financially distressed homeowner – typically, one who is several months behind on their mortgage payments and who is aware that the current fair market value of their home is less than the amount still owed on their existing mortgage loan – approaches their mortgage lender with the idea of making a short sale. In effect, they ask the lender if the lender would be willing to accept a payoff on the mortgage note for less than the total amount due.
Here, the homeowner and the lender can discuss the situation and get an idea as to whether they think a short sale is potentially a workable solution for each of them.
Assuming the lender is generally agreeable to the basic idea of making a short sale, the homeowner will then begin working with a realtor to find a buyer for the property. When a potential buyer is found – that is, someone wanting to buy the property and willing to pay the amount the seller is asking – then the proposed sale is presented to the lender for approval.
The process gets tricky when it reaches the third stage, as back and forth approvals by both the lender and the potential homebuyer must occur. The fact that there is already an existing agreement between the seller and the potential buyer on the price and terms of sale is of no consequence unless the mortgage lender approves the proposed deal.
The lender might approve the deal, outright reject it, or make what is essentially a counter-offer, outlining changes to the sales contract for the home that, if made, would garner their approval of the sale.
And that’s not the end of the process. If the lender proposes some changes to the deal, then the potential buyer holds the right-of-approval to the new terms. They can reject the proposed changes and just walk away from the deal. Alternatively, they may respond to the lender’s proposal with a new proposal of their own. So, at this point, the deal becomes a negotiation between the buyer and the lender.
Assuming an agreement can be reached, the short sale takes place. The lender is paid all the money from the sale of the home. Even though the mortgage is not paid off in full, the lender releases the financially distressed homeowner from the mortgage loan contract. The buyer, of course, takes possession of the property following the sale closing.
The short sale process can be further complicated if there are other lienholders besides the primary mortgage lender – such as holders of second mortgages or tax authorities. All lienholders must agree to the terms of the short sale before it can take place, as well as work out among themselves who gets what amount of the sale proceeds.
The Reasons Behind Short Sales
Each of the various parties in a short sale transaction is motivated in its own way for wanting to pursue the process.
- For the distressed homeowner, the primary motivation is to be released from a financial obligation that he or she cannot afford to pay. Secondly, a short sale offers a significantly less negative impact on the homeowner’s credit rating than a foreclosure proceeding does.
- For the lender, a short sale offers an alternative preferable to initiating a foreclosure process, which can be an arduous, long, and expensive endeavor. A lender is usually agreeable to a short sale if they view it as the best deal they can get with the least amount of effort.
- The new homebuyer is usually motivated by the opportunity to purchase a home at an attractive price – one that may even be substantially below the home’s most recent appraisal value.
CFI is the official provider of the global Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class credit and risk analyst. To learn more and continue advancing your career, see the following CFI resources: