A short sale of a house happens when a lender agrees to release a homeowner from his or her mortgage for less than what is owed so the property can be sold to a third party. Short sales usually occur before foreclosure, when a lender has determined that a borrower is in default and can neither make the payments nor sell the property for enough money to cover the loan balance.
Because of the housing meltdown over the past few years, the number of homeowners who owe more on their mortgages than they can recover by selling their homes has increased substantially. This has prompted an uptick in short sales across the country.
Short sales can be an effective solution for borrowers in financial trouble, buyers who are looking for undervalued properties and lenders hoping to recoup at least part of their investments. For lenders, short sales have distinct advantages over foreclosure. Lenders are not in the real estate business — they do not want to own, manage, maintain or sell property.
If you are considering a short sale of your house because of debt issues, there might be other options to consider. For example, mortgage modification is a process whereby you get your lender to renegotiate the terms of your mortgage in order to give you more affordable payment possibilities.
A mortgage modification can include:
- A reduction in your interest rate, or a conversion from a high adjustable rate to a lower fixed rate.
- A reduction in the principal.
- A reduction or elimination of late fees or penalties you’ve accrued for non-payment.
- A reduction in the amount of your monthly payment in return for an extension of the loan’s term.
- Forbearance, which is an agreement to temporarily allow you to stop making payments or make smaller payments for a period of time.
Short Sale Options
It is estimated that a short sale can save a lender 25 percent to 35 percent over foreclosure. Short sales also are usually more profitable. Foreclosure and eviction procedures have built-in costs and headaches, including inspections, attorney’s fees and delays. Foreclosed properties that can’t be sold become nonperforming assets in a lender’s portfolio, subject to all the costs associated with a property’s upkeep and maintenance, including insurance, taxes and repairs. Lenders also don’t like to keep bad loans on their books.
So there is an incentive for lenders to minimize their losses before having to repossess a property. In fact, most lending institutions have loss-mitigation departments that pursue alternatives to the foreclosure process.
But if no form of loan modification is possible, a short sale may be your best option. Besides being cheaper, easier and faster than foreclosure, a short sale turns a huge potential loss into a smaller one.
A homeowner or potential buyer can instigate a short sale, but it always requires the approval of the lender, who must agree to all terms and conditions, including the selling price. That amount generally will be determined through a Broker Price Opinion (BPO), a document from a real estate agent who proposes a reasonable price for a particular property.
The BPO contains information on comparable houses in the area, the general condition of the home’s neighborhood, and the condition of the property. A potential buyer also may purchase a professional home appraisal as part of the effort to demonstrate potential benefits of a sale to the lender.
For Struggling Sellers, a Way Out
For sellers, a short sale can avert foreclosure and the damage that can do to one’s credit-worthiness. (If a lender does submit the short-sale information to the credit bureaus, the report will stay on the seller’s report for seven years, however.)
In most cases, a lender must forgive the difference between what is owed on a property and the amount of the short sale, unless state law or the terms of the loan allow what is known as a deficiency judgment. In these cases, a seller can be required to repay that difference at some future time.
Even though a seller will not receive any money from a short-sale transaction, he or she may have to declare the discounted amount of the sale — the difference between the mortgage balance and the short sale — as income on federal tax returns. In addition, a seller will have to move from the property quickly if the lender approves the sale and it closes.
Buyers who initiate the short-sale process can talk directly to a lender by having the seller sign an “authorization-to-release-information” agreement. Buyers can then prepare a short-sale proposal and negotiate with the lender or the lender’s loss-mitigation department about a potential sale.
A buyer must produce a hardship letter from the seller, outlining why he or she is desperate for the short sale and why there is little likelihood that the loan can be paid off, now or in the future. Buyers also must provide proof of funds to the lender.
In cases of mortgages backed by either the Federal Housing Administration or the Veterans Administration, buyers will need to follow specific guidelines and regulations that differ from those of conventional short sales.