What is a Short Sale?

By Arvin Sahakian · Mar 3, 2015 · Real Estate

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Image courtesy of Flickr, Diana Parkhouse

In real estate, you've heard the term short sale. But what does that mean? And is this option for selling or buying property something you should consider?

In real estate, "short sale" is one of the most misunderstood transactions. For example, often it's confused with "foreclosure." Although both involve distressed properties, the process for each is totally different. Also very different are the consequences for the seller's credit score and ability to get a future mortgage.

Read on to learn what a short sale is and is not, some facts, how to navigate the process, the benefits for sellers, lenders and buyers and possible disadvantages.

The Definition of "Short Sale"

Essentially a "short sale" is the selling of real estate for less than the amount of debts held as liens against it. It's also known as a "pre-foreclosure sale." Those liens might include the original mortgage, second and third mortgages and special assessments by home-owners associations. In addition, insurers of the loan also might have financial obligations to settle.

The transaction involves a real estate agent. That is, a short sale has many of the components of a traditional real estate sale.

In contrast, in a foreclosure the bank already has taken possession of the property. That's called "REO" or bank-owned property, which is auctioned off. There is none of the conventional sales process involved.

Facts About Short Sales

• During the worst of the real estate crisis there were about 2.2 million short sales nationally. Currently, according to the Trulia Housing Barometer, the number of distressed properties has returned to about 76 percent of what was normal before the crash. That means that, overall, there are fewer short-sale listings.
• Only about two out of five short sales wind up approved. That is because usually other creditors, in addition to the primary lender, have to sign off.
• Sales which are approved usually take two to five months.
• Buyer offers lower than 30 percent of the mortgage amount will likely not even be considered. "Bargain-basement" prices shouldn't be expected.

The Short Sale Process

For the seller that consists of:

• Submitting to the lender a formal letter describing your financial hardship, in detail, and financial statements documenting that. Check to make sure that the financial institution received all of this.
• Waiting for an approval.
• If approved, hiring a real estate agent, with experience in short sales, to list property, set price, accept offers from buyers and present them to lender.
• Communicating through your real estate agent, not directly with the bank.

For the buyer:

• Conducting market analysis of comparable properties in order to determine what your offer should be. In a region where property values fluctuate rapidly, that offer should factor in the probable market value at closing.
• Having lawyer with expertise in short sales to write the contract with appropriate terms and conditions, such as bailing out if inspection turns up too many problems.
• Hiring a real estate agent, with expertise in short sales, to present offer to lender, not seller. Be ready to increase the amount if you really want the property.
• Calculating the amount of mortgage you can obtain
• Assembling the financial documents you need to apply for mortgage
• Shopping around for the best mortgage for your needs. It might be necessary to be pre-approved.
• Calculating closing costs.
• Waiting, patiently. Meanwhile searching for other short-sale properties to bid on.

For primary lender:

• Reviewing offers, hoping to increase the amount through counteroffers.
• Presenting appropriate ones to other lien holders.
• Closing the deal if there is agreement from all other lien holders.

How a Short Sale Benefits The Seller

Obviously, through a short sale property owners rid themselves of that financial burden. The real estate commission is paid by the bank. Just as importantly, there is less damage to your credit rating than with a foreclosure. The effect on your credit can be reduced further if the lender notifies credit bureaus the debt has been "paid in full." Within two years, you may be able to apply for a mortgage.

How a Short Sale Benefits The Buyer

The payoff for being patient during this slow process could be a purchase price below current market value for a comparable property. The average discount ranges from 10 to 30 percent. This has also given you the know-how to conduct other searches for short sales. Some buyers specialize in this niche for re-sale or investment purposes.

How a Short Sale Benefits Lender

Short sales prevent foreclosures. As the foreclosure looms, those being evicted may trash the property out of spite. Also, during the time from foreclosure to auction, the vacant property can be stripped of valuable components such as copper plumbing. Squatters may move in as well.

According to Stop Foreclosure Now, the short-sale process is less expensive for lenders than foreclosures. In addition, with short sales, payment is immediate upon closing. In a foreclosure, the property remains a liability on the books.

Possible Disadvantages Of a Short Sale

The low approval rate for short sales means this is a gamble for sellers. You might wind up in foreclosure anyway, with the all negative consequences for your credit rating. In foreclosure it could take up to seven years to able to apply for a mortgage. Another negative is the tax liability for you the seller. What some don't realize are the tax implications of the debt forgiveness. The IRS classifies the dollar amount of the reduction of debt as income that will be taxed.

For potential buyers, going the short-sale route is also a gamble. Given that lenders will push for the highest bid, you the buyer may not wind up with the "bargain" anticipated in the beginning of the search. In addition, you buy the property as-is. Although the home inspection disclosed the problems, you might not have adequately calculated all of the expenses for repairs. Consequently, there might not be a genuine bargain.

The Short Sale As One Option For Distressed Property Owners and Entrepreneurial Buyers

The real estate business is dynamic. For example, many new ways have emerged to find the right mortgage lender. Meanwhile, though, the short sale remains a proven tool to solve the problems of a distressed property owners and for entrepreneurial buyers to, as the saying goes, "mine for gold."

Specifically you the seller can get a fresh financial start. Your mortgage and other debts associated with the property are wiped out. The only residue are the taxes you will have to pay on the amount of forgiven debt. In about two years there are types of mortgages you can apply for. When doing that you will be more prudent in calculating the amount of monthly payment you can afford. To give yourself some financial "wiggle room" you might consider buying a two-family. The rent from the other unit can help insulate your monthly budget against unexpected bills.

In regions of the U.S., such as California, in which property values continue to escalate, the only way into the market might be hunting for a short sale. Buyers who become experienced in doing business in this niche could have a variety of new career paths open to them. Those range from becoming licensed as a real estate agent to developing a business investing in distressed properties.

Going the short-sale route isn't for everyone. But for those who can navigate the process it is a multi-dimensional financial tool that can clear the way to the American Dream.

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