What is a short sale? In the most basic definition, a short sale is the process of selling a primary residence for less than what is owed with the approval from the current loan company.
In other words, if you must sell your home that you owe $500,000 on but the home is only worth $400,000, the bank may approve a short sale and allow you to sell the home for a lower amount. However, this article is going to go into a lot more depth than simply “what is a short sale?” Below, you’ll learn:
- Short Sale Basics: What is a Short Sale?
- Short Sale Eligibility
- Alternatives to a Short Sale
- The Short Sale Process
- Short Sale Pros and Cons
- Tax Consequences of a Short Sale
Short Sale Basics: What is a Short Sale?
Wondering “what is a short sale and how do they work”? The below will give you the basics.
How long does a short sale take?
The length of time a short sale can take greatly depends on a number of factors, especially who the lender is. Some lenders can approve a short sale in as little as two weeks, whereas other lenders can take a year or longer. However, most short sales can be completed in a three to five-month time period.
Why do people sell with a short sale?
If a home is currently “underwater,” which means the owner owes more than the property is worth, a property cannot be sold on the open market without the homeowner having to pay the difference. If the new purchase price can’t pay off the old loans and the homeowner can’t come up with the shortfall, everyone is stuck. This is when a short sale comes into play.
Why would a bank agree to a short sale?
Typically, a homeowner will choose to sell their home via a short sale in order to avoid a foreclosure. If the foreclosure is completed, it allows the lender or a cash buyer to take possession of the home. However, this process can be tremendously time consuming and costly for lenders.
The length of time and type of foreclosure process the lenders can pursue depends on the state the home resides in; each state is different. The foreclosure process can range from several months to several years, and thus cost the lender tens of thousands of dollars in legal fees and holding costs. Additionally, the lender would need to place the home on the market to sell as a foreclosure (see my other article, “How to Buy a Foreclosure,” for more information on this process), which involves even more time and costs. This is typically known as “REO,” meaning, real estate owned by the lender.
Therefore, many lenders choose to accept a loss from a short sale to save the time and fees that a foreclosure would take. Essentially, a bank will agree to a short sale if it’s in the bank’s best interest to accept a short sale. Although there is no guarantee a lender will complete a short sale, even if it seems to be everyone’s interest, it is typically advisable for the homeowner to pursue the short sale in good faith. Lender guidelines change often so it’s important to set expectations going in.
Who is responsible for the remaining balance on the loan?
This depends entirely on the agreement made between the lender and the homeowner, so it is important to get this detail spelled out in writing before completing a short sale in the short sale approval letter. Unless the lender explicitly waives their ability to pursue the homeowner at a later date, the borrower (seller) may be on the hook for the difference of what the home sold for versus what they owed. A few select states have anti-deficiency statutes that offer additional protection to homeowners, but every situation is still on a case-by-case basis. This is critical component of a short sale, where borrowers are encouraged to seek legal council if they are unsure if they will be responsible for any forgiven debt.
Short Sale Eligibility
Homeowners pursuing the traditional short sale are not always approved. Certain qualifications have to be met in order for a short sale to be considered or approved. While each bank will have different requirements for short sale approval, typically a bank will want to see:
- Homeowner is behind on payments.
- Property is underwater.
- Homeowner is experiencing financial hard times and does not have significant assets.
Again, these are not hard and fast rules. Some short sales do not require the homeowner to be behind on payments or to be in significant financial trouble, but these do help qualify a home for a short sale. Again, it largely comes back to the simple truth that a bank will want to do what’s in a bank’s best interest.
Alternatives to a Short Sale
In learning “what is a short sale,” it’s still important to understand alternatives to this process.
A short sale is simply one option of many that a homeowner can use if they are experiencing trouble with their home mortgage. This section is going to look at 4 other options a homeowner may have instead of a short sale and explain some of the pros and cons of those options.
A loan modification happens when a lender changes the terms of the loan to make the loan more affordable for the homeowner, or as the U.S. Department of Housing and Urban Development defines it, a “Loan Modification is a permanent change in one or more of the terms of a Borrower’s loan, allows the loan to be reinstated, and results in a payment the Borrower can afford.”
While some banks will do this on their own initiative, most lenders will look at a loan modification under a program known as the Home Affordable Modification Program, also known as HAMP. Created in 2009 to help struggling homeowners, HAMP is a government program that requires lenders, in certain cases, to modify the terms of a mortgage to make it more affordable for homeowners. The HAMP program typically will enable lenders to re-spread out the loan over 30 years and drop the payment to a maximum of 31% of the homeowner’s gross income.
For more information on the HAMP program, see MakingHomeAffordable.gov.
(Statistically, loan modifications have not proved as a permanent solution for distressed homeowners. Although there are short-term benefits for both parties, loan modifications can still heavily affect your credit and very rarely erase inequity on the property.)
Deed in Lieu of Foreclosure
A deed in lieu of foreclosure, also known as a “mortgage release,” is kind of a halfway point between a short sale and a foreclosure in which the homeowner gives the property’s legal title back to the lender. Most lenders will want to see that attempts have been made to sell with a real estate agent for at least 90 days before allowing a deed in lieu of foreclosure.
While it’s not the best alternative, foreclosures are still a choice made by the majority of struggling homeowners. Depending on the state the home is in, it can go through a judicial foreclosure or non-judicial foreclosure. Either way, if the foreclosure is completed, the home can revert back to the lender or sold to a third party. Whoever holds legal title to the property at that point will have the ability to re-sell the property. If the homeowner is still living in the property, they can be evicted, although many lenders/new owners may try to negotiate “cash for keys” to facilitate a cleaner transition. In some cases, a foreclosure may be better for the borrower than a short sale, but overall, it is recommended only allowing a foreclosure if all other options are exhausted.
If the property is not upside down (more is owed than it’s worth), then simply selling the home may be a good option. This would be the best case scenario for the homeowner. However, selling a property can be difficult if the home is not in a great condition or if there is not enough equity to pay for a real estate agent to sell the home. Additionally, any late payments missed will already be affecting the homeowner’s credit, but avoiding the impact of a short sale or foreclosure on the credit report would be ideal.
The Short Sale Process
When learning about what is a short sale, it’s important to understand the process.
The short sale process is not always the most enjoyable event, but by following the proper steps and keeping excellent records, the short sale process can be navigated. The following section will detail the short sale process, but keep in mind that different lenders may have a slightly different process, so use this as a general guideline, but don’t bet your life on this information.
Read the rest of the article here…
Contact ORENDA Real Estate Services
For more information on the Kansas City Real Estate Market, or to learn more about how you can increase the value of your investment property, contact us today by calling (816) 355-4242 or CLICK HERE to connect with us online.