Real Estate Law
What Is a Short Sale?
In this article
- When Do Short Sales Occur?
- Who Decides the Price of a Short Sale?
- Deficiency Judgments in Short Sales
- Does a Short Sale Stop Foreclosure?
- A Short Sale Requires Time and Cooperation
- The Downside of Short Sales
- Do I Qualify for a Short Sale?
- Steps to Take Before a Short Sale
- Does H.A.F.A. Apply to Me?
- How Long Do I Have To Sell My House as a Short Sale?
- What Marketing Happens During Short Sale?
- Can Any Property Be Sold as a Short Sale?
In the real estate context, a short sale occurs when a homeowner sells their home for less than they owe on the property. For example, a homeowner might owe $100,000 on a house but choose to sell it for $70,000. This is sometimes the only option for a homeowner because they:
- Can avoid foreclosure on their record.
- Can find cheaper housing they can afford.
- May not need to come up with the shortfall (with approval from their mortgage company).
- Do not need to have the cash to cover closing costs like a typical home sale.
A short sale typically leaves the mortgage company with less money than they loaned out. However, it is often the better option when a homeowner cannot afford payments — instead of receiving nothing for the loan, the mortgage company could recoup part of the money back through a short sale.
Typically a short sale happens when a mortgage company buys a home from someone facing foreclosure. It is an option with most mortgage companies if you can no longer afford the mortgage on your home.
A real estate attorney or licensed salesperson may engage in negotiations with a homeowner’s lender. The homeowner does not make a profit or get any money back on the short sale, so the mortgage company will typically decide the sale price. They will try to recoup as much cost as they can.
Except in eleven states where residential mortgages are classified as “non-recourse,” mortgage companies have the choice to seek a deficiency judgment. This means they want the homeowner to pay back whatever money is lost between the home loan and the short sale price. In the example above, the $100,000 house sells for only $70,000, so the homeowner would owe the missing $30,000. However, in a non-recourse jurisdiction such as California, the law under Code of Civil Procedure – CCP § 580b prohibits this from occurring in most cases.
In most other states, however, the deficiency judgment is a legal way for the mortgage company to demand this money back. It is a personal legal “judgment” against you. You are responsible for getting a new loan to cover the money owed, establishing a payment plan, or finding the money another way. States have different time limits ranging from 30 days to 20 years to pay the judgment back.
If a mortgage company does not seek a deficiency judgment, the homeowner does not need to pay the cost difference. In this situation, the lender will try to minimize the financial loss they take by asking for a higher short sale price.
Yes, when the short sale is final, the mortgage company will:
- Consider your debt on the mortgage satisfied.
- Remove any liens on the property so a new buyer can purchase the home.
- Stop the foreclosure process.
Keep in mind that a lender will probably only agree to a short sale if:
- The homeowner lists and actively markets the home to prospective buyers (taking good photos, putting the home on real estate listing websites, or hiring a realtor or qualified real estate attorney).
- The house is listed at fair market value at first (for example, you cannot list a $400,000 home at $200,000 just to get a fast sale).
- The sale is an “arm’s length market transaction.” This means all the proceeds (after selling costs) are applied to the discounted mortgage payoff. For example, if you put a $450,000 house up for the fair price of $400,000 and someone offers $420,000, you do not pocket the profits of $20,000. The mortgage company takes all the money.
Many people need to cooperate during a short sale process. It is a complex transaction that requires careful coordination of:
- Mortgage borrowers.
- Real estate agents.
- Title agencies.
- Mortgage insurance companies.
- Junior lien holders.
Generally, a short sale property is a good idea for all parties involved. It often provides a better outcome for borrowers, investors, and communities, instead of letting the homeowner go into foreclosure. For the homeowner, avoiding foreclosure will help protect their credit score and mortgage debt.
Due to the complexity of short sales, and the significant time required, these transactions are not as popular. Mortgage company servicers historically choose to pursue foreclosure instead.
The time and people needed to make a short sale work can prevent a short sale transaction (even if it would have provided a substantially better outcome for everyone).
Short sales can be more popular during unique circumstances. For example, most lenders are more willing to make a reasonable short sale during financial and housing market crises.
You must be able to show specific criteria to sell a home in a short sale. You, as the mortgage owner or borrower, generally must be able to demonstrate:
- You are unable to pay the mortgage.
- You are currently experiencing a financial hardship.
- There is an involuntary loss of income.
- There is a divorce (with one spouse in the home who cannot afford the mortgage payments).
- An injury or illness prevents you from paying the mortgage.
These are all common financial hardship reasons to ask for a short sale. Explaining the reason to your lender is sometimes called a “hardship letter.”
Some lenders require the homeowner to take certain steps before they can make a short sale:
- Attempt to do a loan modification.
- Submit various forms and other documentation.
These steps will help the lender determine whether you and your property qualify for a short sale.
You should research your rights under the Home Affordable Foreclosure Alternatives (HAFA) Program. Under this program, a homeowner may qualify for a short sale.
This program is sponsored by the government as part of the Making Home Affordable Program. HAFA gives homeowners and lenders a financial incentive from the government to make short sales of “delinquent” properties or homes behind on payments.
The H.A.F.A. program was specifically created to help homeowners who do not qualify for a trial mortgage modification. This modification is part of the Making Home Affordable Program. It is also intended to help people who: did not complete a trial loan modification period successfully. This usually means you missed at least two payments in a row during the trial modification period.
H.A.F.A. may be available to homeowners who are behind on their mortgage and simply request a short sale under the program. You could qualify for up to $3,000 to help with relocation costs. This is an added benefit for some homeowners after selling your house in a short sale under H.A.F.A.
To know if you can make a short sale under H.A.F.A., you should contact your lender to discuss the qualifications.
The length of a short sale depends on:
- Your lender’s requirements.
- Qualifying for special government-sponsored programs (that focus on helping homeowners avoid foreclosure).
For example, the Foreclosure Alternative Program (part of the Making Home Affordable Program) gives borrowers 90 days to market and sell the property. More time is often allowed based on local market conditions.
The seller must follow criteria to get this time before a short sale offer:
- List the property with a licensed realtor.
- The realtor is experienced selling properties in the neighborhood.
- You and your realtor actively market to home buyers.
Marketing your short sale home can happen at the same time as the foreclosure process. This is called being in pre-foreclosure. While this is worrying to homeowners, no foreclosure sale can take place during this marketing period. The exact timeframe will be specified in the short sale agreement.
As long as the homeowner is acting “in good faith” to sell the property, the foreclosure will not happen; however, to ensure servicers and borrowers move quickly to complete the short sale, a mortgage company may impose reasonable time limits to the marketing period.
Any home can be sold as a short sale if the mortgage lender agrees to it. Typically the house or homeowner also must clear:
- Junior liens.
- Mortgages (this happens when you and the lender agree on a sale price and the home sells).
- Other debts against the property.
Once those items are cleared, the property can be sold as a short sale. In some cases, the short sale servicer can choose to proceed with a short sale before those items are cleared. They must have a reasonable belief that all liens on the property can be cleared to proceed.
Will Selling My Home in a Short Sale Affect My Credit Score?
Yes, selling your home in a short sale will negatively affect your credit score. Damage to credit and credit implications depend on many factors. These factors include payment history, your ability to pay other debts, the housing market, loss mitigation, and purchase price of the home.
How Many Points Will My Credit Score Change in a Short Sale?
Typically a short sale home will reduce a borrower's credit score between 100 to 200 points depending on the circumstances of the sale, depending on the credit bureaus. In most cases, the short sale will be an entry on your credit record that says something along the lines of "paid in full; settled for less than originally owed."
Is a Short Sale Better for My Credit Score?
Typically the damage to a credit report from a short sale is much less than the foreclosure process or bankruptcy. Having bankruptcy or foreclosure on your record can be seriously damaging to your credit score and result in longer-term effects. When considering your credit rating, most borrowers may decide that a short sale is better than filing for bankruptcy. A short sale can make it easier to repair the damage over time.
Is Short Sale a Good Idea If I Have Other Debts?
Yes, it can be a good idea in certain circumstances. Choosing to resolve your mortgage debt problems through a short sale will damage your credit for a while, but may put you in a much better financial situation in the long run. Without the high payment amount of a mortgage, the hope is you can improve your credit score by paying off other debt. However, your credit rating recovery will generally take time. You should consult with a qualified real estate attorney to ascertain whether a short sale is a good option for your circumstances.
Do I Pay Realtor Sales Commission in a Short Sale?
In a short sale, the homeowner has no money in escrow to pay commissions. The primary lender ends up paying the real estate agent's sales commission instead. From the moment the short sale happens, the profits belong to the lender, so they need to take care of the fees and real estate agent commissions. The commission may be up to 6% of the home's sale price.
Do I Pay Closing Costs in a Short Sale?
No, you will not pay any closing costs or closing fees. When the home is sold for market value during a successful short sale transaction, the mortgage lender will take control of the sale and sale proceeds. It is up to them to handle the closing costs of the real estate transaction and work with the listing agent and potential buyer to complete the sale.
What Is "Deed in Lieu of Foreclosure?"
After a "good faith" effort to sell your property, your lender might consider a different approach. A deed instead of foreclosure means the distressed owner voluntarily gives up their home ownership and transfers the sale property title to the mortgage company. Unlike a traditional sale, this short sale process is only allowed when the property does not have mortgages, liens or lien holders, or other encumbrances. When completed, the deed in lieu of foreclosure means the property belongs to the lender, who can sell it. Selling it gives money back to the mortgage company to help make up the money they lost.
How Do I Qualify for a Short Sale?
The current owner needs to talk to their original lender about not being able to pay your mortgage payments. This can happen because of job loss, illness, financial hardship, medical bills, or lifestyle changes. You may need to write a hardship letter that explains your situation and your need for a new home that is more affordable.
Other Considerations About a Short Sale
There are other implications with a short sale, including how it might affect your taxes. For example, in Florida, "the taxable consideration for a short sale transfer does not include unpaid indebtedness that is forgiven or released by a mortgagee holding a mortgage on the grantor's interest in the property." (Florida Statutes Title XIV 201.02(11))
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