A Homeowner's Guide to Understanding Short Sales

Facing financial trouble with your mortgage can be incredibly stressful, leaving you to wonder about your options. If you’re in a situation where you owe more on your home than it’s worth, a short sale can be a powerful tool. This guide explains exactly what a short sale is, why it might be a better choice than foreclosure, and how the process works.

What Exactly Is a Short Sale?

A short sale is a real estate transaction where a homeowner sells their property for less than the amount they still owe on their mortgage. This isn’t something a homeowner can decide to do on their own. The lender, the financial institution that holds the mortgage, must agree to accept a lower payoff amount to release their lien on the property and allow the sale to go through.

For example, imagine you owe $300,000 on your mortgage, but due to a change in the local market, your home is now only worth $250,000. If you can no longer afford your payments, you could work with your lender to approve a sale for the current market value of $250,000. The lender agrees to accept this “short” amount to avoid the more costly and complicated process of foreclosure.

Lenders agree to short sales because they are often a better financial alternative for them. A foreclosure can be a long, expensive process involving legal fees, property maintenance, and the costs of reselling a vacant home. A short sale allows the bank to cut its losses more quickly.

The Top Reasons Homeowners Choose a Short Sale

Homeowners facing financial hardship often find themselves weighing a short sale against foreclosure. While neither is an ideal situation, a short sale offers several significant advantages that make it the preferred option for many.

1. To Avoid Foreclosure

The primary motivation for pursuing a short sale is to avoid foreclosure. A foreclosure is a legal process where the lender seizes and sells your property because you have failed to make your mortgage payments. It is a forced process that can be emotionally and financially devastating. A short sale, on the other hand, allows you to maintain a degree of control. You get to work with a real estate agent, list your home, and participate in the sale, making it a more dignified way to resolve your mortgage debt.

2. To Minimize Damage to Your Credit Score

Both a foreclosure and a short sale will negatively impact your credit score, but a foreclosure is typically far more damaging. A foreclosure can cause a FICO score to drop by 160 points or more and stays on your credit report for seven years.

A short sale is often reported to credit bureaus with codes like “settled for less than full balance.” While this still lowers your score, the impact is generally less severe than a foreclosure. The recovery time is also faster, which is a crucial factor for your long-term financial health.

3. A Faster Path to Buying Another Home

The waiting period to qualify for a new home loan after a financial hardship is significantly different for a short sale versus a foreclosure. Guidelines set by major mortgage backers like Fannie Mae and Freddie Mac illustrate this clearly:

After a Short Sale: The waiting period to be eligible for a new Fannie Mae-backed loan can be as short as two years, depending on your down payment and circumstances.
After a Foreclosure: The standard waiting period after a foreclosure is seven years.

Choosing a short sale can put you back on the path to homeownership years sooner than if you go through a foreclosure.

4. The Possibility of Waiving the Deficiency

The “deficiency” is the difference between the sale price of your home and the amount you still owed on the mortgage. In our earlier example, the deficiency was $50,000 ($300,000 owed minus the $250,000 sale price).

In a short sale, one of the most important negotiation points is getting a “deficiency waiver” from the lender. This means the lender agrees to forgive the remaining debt, and you can walk away without owing anything more. In a foreclosure, lenders are more likely to pursue a “deficiency judgment” in court, which legally obligates you to pay back that remaining balance.

How the Short Sale Process Works

The short sale process is more complex than a traditional home sale and requires patience. It involves you, your real estate agent, the buyer, and most importantly, your lender.

Step 1: Prove Financial Hardship

You cannot get approved for a short sale just because your home’s value has dropped. You must demonstrate to your lender that you are experiencing a legitimate and unavoidable financial hardship. Common examples include:

Loss of employment or reduced income
A major medical emergency with large bills
Divorce or death of a spouse
A job relocation that you must accept

Step 2: Assemble Your Short Sale Package

Your lender will require a comprehensive package of financial documents to review your case. This typically includes:

A Letter of Hardship: A detailed letter explaining your situation and why you can no longer afford your mortgage.
Financial Statements: Complete details on your income, expenses, assets, and other debts.
Proof of Income: Recent pay stubs, W-2s, and tax returns.
Bank Statements: Usually the last two or three months of statements for all your accounts.

Step 3: Hire an Experienced Real Estate Agent

It is critical to work with a real estate agent who specializes in short sales. These agents understand the complex paperwork, negotiation tactics, and timelines involved. Look for agents with designations like Certified Distressed Property Expert (CDPE) or Short Sales and Foreclosure Resource (SFR).

Step 4: List the Home and Get an Offer

With your agent’s help, you will list the property on the market. Once you receive an offer from a potential buyer, you will submit it to your lender along with your complete short sale package for their review and approval. This is often the longest part of the process, as the lender’s loss mitigation department must carefully review everything. The wait for a decision can take several months.

Step 5: Lender Approval and Closing

If the lender approves the offer, they will issue a formal approval letter. This letter will outline all the terms of the sale, including any deficiency waiver. Once you have this approval, the sale can proceed to closing, similar to a traditional real estate transaction.

Frequently Asked Questions

How long does a short sale take? Patience is key. A short sale is not a quick process. From listing the home to getting lender approval and closing, the timeline can range from four months to over a year. The timeline depends heavily on how responsive your lender is.

Will I have to pay taxes on the forgiven debt? In some cases, the IRS may consider forgiven debt as taxable income. However, legislative acts have often provided relief for homeowners in this situation. It is absolutely essential to consult with a qualified tax advisor or CPA to understand the specific tax implications for your situation.

Can I do a short sale if I am not behind on my payments? Yes, it is possible. While being delinquent on your mortgage strengthens your case for hardship, some lenders will consider a short sale if you can prove that default is imminent and unavoidable due to circumstances like a pending job loss or relocation.