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A short sale is one of the last options many homeowners can explore before foreclosure. Short sales involve obtaining approval from your lender to sell your property for less than the outstanding mortgage balance. By requesting a short sale and a satisfaction letter, you’re asking your lender to forgive any remaining mortgage debt that you're unable to pay by selling your home for a lower amount than you owe.
- What is a Short Sale?
- What are the Consequences of a Short Sale?
- Am I Eligible for a Short Sale?
- Should I Short Sell My Property?
What is a Short Sale?
A short sale is when a mortgage lender allows an owner to sell property for less than what's owed on the mortgage. Property owners who attempt to initiate a short sale are usually under financial stress, and the market value of their property must have declined substantially, relative to the borrowed amount.
A short sale is similar to a regular sale in that the seller contracts a listing agent to put the property on the market, but with a short sale the lender gets involved, too. The goal of the short sale is to recover as much of the remaining mortgage debt as possible. If a short sale is successful, it usually ends with the release of the borrower from liability on any remaining mortgage debt left outstanding, however this is not always the case. In some cases, former borrowers have been surprised by banks coming to collect on debt previously thought to be extinguished. This undesirable outcome is known as a "deficiency judgment," and it can occur after both short sales and foreclosures. Homeowners who wish to undertake a short sale for debt relief should consult legal counsel to verify that the short sale agreement actually releases them from all remaining liability.
By contrast, a mortgage lender conducting a foreclosure will repossess the mortgaged property in collection for unpaid debts. This results in more fees and liability to the owner than in a short sale. Foreclosures also end with the eviction of the owner, who exercises no control over the process. By contrast, a short sale allows the owner to reside in the property and retain some control over the short sale process.
For homeowners, short sales are generally preferable to foreclosures, and they can be used to delay the process if your home is already in preforeclosure. A short sale will leave the owner with some control over the process, while a foreclosure ends with property seizure and eviction. Short sales also generally incur fewer fees, penalties and legal expenses when compared with foreclosures. If successfully executed, a short sale can mitigate the financial fallout of an unfortunate situation.
The approval for the short sale will ultimately rest with the lender. A bank may choose to proceed with foreclosure if it believes that it will recover more from a private sale on the open market and any private mortgage insurance payments they're entitled to. Most banks prefer to avoid the added expense of foreclosure proceedings, assuming reasonable purchase offers are available. But it’s important to note that short sales are not always a viable option: If the seller is unable to find an interested buyer on terms the lender approves of, the lender can choose to proceed with foreclosure.
How is a Short Sale Different from a Normal Sale?
A short sale is different from selling your home at a loss in a normal sale. In a normal home sale, you can choose to sell your home for less than what you owe if you're financially capable of taking the loss. The lender will simply require you to make up the difference at closing.
When you attempt a short sale, you'll need the lender to approve the transaction. You will also need an offer from a serious buyer that must also be approved by the lender. Even if you're able to find a buyer, banks can take months to respond to short sale inquiries. If you're deciding whether to short sell your property or are interested in purchasing a short sale property, be prepared for a drawn-out process.
Due to the seller's financial hardship, most or all of the closing costs in a short sale will need to be paid by the buyer. Because the lender is already losing money on the transaction, it will probably be unwilling to cover many standard closing fees.
What are the Consequences of a Short Sale?
The biggest consequence of a short sale will be the negative impact on the seller's credit score. You will also be unable to apply for new mortgage financing for a temporary period. Contrary to popular belief, a short sale can be just as damaging to your credit score as a foreclosure.
How Does a Short Sale Affect My Credit?
A short sale can drop your credit score by as much as 140 points or more, depending on your current score. Further impact on your credit can be mitigated if the lender chooses not to sue for a deficiency judgment, which is when a lender chooses to pursue the borrower for any remaining balance not covered by the proceeds of a short sale. We obtained the following figures from a FICO study about how mortgage delinquencies affect credit scores:
|Consumer A||Consumer B||Consumer C|
|Initial FICO Score||~680||~720||~780|
|FICO score after short sale (no deficiency balance)||610 - 630||605 - 625||655 - 675|
|FICO score after short sale (deficiency balance)||575 - 595||570 - 590||620 - 640|
|FICO score after foreclosure||575 - 595||570 - 590||620 - 640|
- Source Data: FICO Banking Analytics
Based on the data provided by FICO, we observed that a short sale where the borrower was responsible for a deficiency balance was just as damaging as a foreclosure. In comparison, borrowers who had the remainder of their debt forgiven by the lender were less negatively impacted by a short sale.
This may be helpful in states with "non-recourse" laws, which prohibit lenders from pursuing a deficiency judgment on foreclosures or short sales. Such laws lessen the negative financial and credit impact for homeowners in either situation. These regulations vary from state to state, so you should consult an attorney to understand your rights and responsibilities. Both short sales and foreclosures will remain on your credit report for seven years after they're settled.
We also found that individuals who have experienced a short sale are eligible for a new mortgage sooner than those who have experienced a foreclosure, but it will likely take longer than the guidelines established Fannie Mae or the Federal Housing Administration (FHA), as many banks have their own eligibility requirements for applicants who have experienced losses.
What is the New Mortgage Waiting Period After a Short Sale?
Fannie Mae requires a four-year waiting period before applicants are eligible for a new mortgage. Borrowers who can document extenuating circumstances will be eligible for a new mortgage in as little as two years. The FHA allows applicants to apply for mortgages three years after a short sale. Borrowers who can demonstrate that the short sale was caused by extenuating circumstances beyond their control are eligible for an FHA loan in as little as one year.
What is the New Mortgage Waiting Period After a Foreclosure?
By contrast, Fannie Mae requires a seven-year waiting period for applicants who have experienced a foreclosure and three years if the applicant can demonstrate extenuating circumstances. The FHA requires a mandatory three-year waiting period for foreclosures, although this can be reduced to one year with extenuating circumstances.
Am I Eligible for a Short Sale?
In order to qualify for a short sale, you will need to fit the requirements below. Meeting these requirements does not guarantee that your short sale will be approved.
- The property value must be lower than the balance remaining on the mortgage, counting all fees and penalties.
- The seller must be close to default or already in default.
- The seller must demonstrate long-term financial hardship due to:
- Unemployment, either due to layoffs or firing
- Divorce which cuts off income source
- Death which cuts off income source
- Medical emergency
- The seller must lack substantial assets that could be used to offset shortfalls.
While short sales typically occur during the preforeclosure period, homeowners can attempt to initiate short sales if they undergo major life events that materially impact their financial condition. Mortgage lenders are more likely to entertain the prospect of a short sale in the early stages of a preforeclosure than after the foreclosure proceedings have already begun.
The homeowner must submit an application to the bank, documenting evidence of financial hardships. Additionally, homeowners will need to contract a listing agent to put their home on the market. Ideally, this will be an agent who specializes in short sales, which require more documentation and take longer to close than normal sales. A missing document can easily set your short sale back several months.
At the end of the day, both the seller—and any potential buyer of the property—will be at the mercy of the lender. Lenders can take months to respond to short sale proposals, and they have the right to reject your short sale even if all the technical requirements are met.
Should I Short Sell My Property?
If you need to short sell your property, you will need to contact your mortgage lender's loss mitigation department. Many property owners in need explore short sales in addition to mortgage modification and deeds-in-lieu as alternatives to foreclosure. For homeowners who want to avoid the social stigma of a foreclosure, a short sale may a way to keep a roof over their heads while they plan their financial exit strategy.