If a divorce, job transfer, job loss or other major life event leaves you unable to keep up with mortgage payments, you may face foreclosure or short sale. A short sale can offer much-needed financial…
If a divorce, job transfer, job loss or other major life event leaves you unable to keep up with mortgage payments, you may face foreclosure or short sale. A short sale can offer much-needed financial relief, but negatively affects your credit history and ability to buy another home in the near future.
How Short Sales Work
A short sale occurs when you sell your home for less than what you owe on your mortgage. In a short sale, “you’re selling a home, you owe more than you are receiving in the sale and you don’t have the liquid cash to make up the difference,” says Elizabeth Mendenhall, president of the National Association of Realtors.
The lender must approve the short sale and, in most cases, agree to accept the lower amount as the full and final payment on the loan. Short sales mean a loss for the lender, however, lenders may agree to a short sale if they believe it will be a better option than foreclosure. A short sale offer may be comparable to the value a property could bring at a foreclosure auction.
Generally, a short sale is only an option when your outstanding mortgage balance exceeds the home’s market value. If the market price exceeds the loan balance, a short sale is not necessary. Having a home value lower than your mortgage balance doesn’t automatically qualify you for a short sale. You must prove financial hardship, too, which requires documentation.
When you put your home on the market as a short sale, you’ll review offers and choose one. However, a short sale can only be completed if your lender approves the offer. As with any other real estate transaction, you can do it yourself. However, the process may be easier to navigate with the assistance of a seller’s agent with short sales experience.
The Short Sale Process
First, you’ll speak with your lender (or sign a release that allows your agent to talk to your lender) to determine the timeline, which depends heavily on whether the loan is only delinquent or the lender has begun preforeclosure proceedings, and set a sale date. “If a sale date is already set,” says real estate agent Mindi Shapiro-Estrada of Bridge Realty in San Diego, “you need to move really quickly.”
Then, you or your agent will order a title report that shows how many liens are in place against the property. Multiple liens against the property, such as a second mortgage, a home equity line of credit or a homeowners association lien, can be an obstacle to short sale approval because all lien holders must agree to the short sale before it can close.
For example, let’s say you owe $175,000 on your first mortgage and $20,000 on a home equity line of credit. Your appraised value is $170,000, and you find a buyer willing to pay that amount. The first lien holder, the primary mortgage lender, would likely be entitled to receive the entire amount, leaving zero for the second lien holder. The equity line holder may decide not to approve the short sale, opting instead to allow foreclosure to proceed and then sue you for the full amount you owe.
After the title report, the next step will be to set a sale price based on market values, then solicit and review offers from potential buyers just as you would for any property sale.
Once you’ve identified your best offer, you or your agent will present it to the lenders for approval and negotiate terms if necessary. After approval, you or your agent will work through the normal process to complete a real estate transaction and hand the property off to the new owner.
Who Is Eligible for a Short Sale?
A short sale is not typically considered an “option,” says Mendenhall. “This is a last resort that most homeowners try to avoid.”
You might be a candidate for a short sale if your property is valued at less than what you owe and you can prove a long-term hardship.
Shapiro-Estrada, who has helped more than 400 sellers through successful short sales, says, “That’s rare these days. But it can happen, especially if the homeowner has a mortgage plus a home equity line of credit that, combined with the primary mortgage, puts the debt over the value of the home.” Today’s short sellers tend to be homeowners who have experienced a life event that renders them unable to make their loan payments. “These are usually people who have lost their jobs, recently divorced or have a costly medical issue,” she says.
Shapiro-Estrada stresses proving hardship as an essential requirement for short sale transactions. “If you can’t prove your hardship, your short sale won’t be approved.”
If you’re eligible for a loan modification or refinance loan, your lender may not approve a short sale.
About nine years ago, short sales were extremely common. In early 2009, 18 percent of single-family home sales were short sales. Many homeowners found themselves underwater when they owed more on the mortgage than the home was worth. When borrowers struggled to keep up with their mortgage payments with no prospects for financial relief, a short sale may have been the best or only option to get out from under an unaffordable loan that could not be modified or refinanced.
One factor that contributed to the spike in short sales during the housing crisis was that many lenders made loans up to the property value in the face of seemingly ever-increasing home prices. This type of lending was not historically popular, but during the housing boom, lenders and borrowers alike relied on borrowers’ presumed ability to refinance as equity grew if they ran into financial trouble. Piggyback loans (second mortgages) to cover all or a portion of the down payment were common, putting borrowers quickly underwater when values declined.
Today, short sales are far less common, making up 1 percent of home sales. Most housing markets in the U.S. are rising in value. About 9 percent of homeowners were underwater as of May 2018, according to Zillow, down from a peak of about 31 percent in 2012.
It is still possible to be underwater on your mortgage, especially in a declining market. Although prices are going up in most of the country, median sale prices have fallen in about 3 percent of metropolitan areas.
One advantage short sales have over foreclosures is the waiting period before you’re eligible to take a new home loan is shorter. Any borrower who experiences a significant derogatory event, such as bankruptcy, foreclosure, deed in lieu of foreclosure or short sale, must wait for years before becoming eligible to take a new loan that is salable to Fannie Mae, which applies to most mortgages.
After a foreclosure, you must wait seven years (three years if you can prove extenuating circumstances) before you are eligible for a new loan. After a short sale, you must wait only four years (two with extenuating circumstances).
A major risk inherent in a short sale is if the sale takes too long, the lender may initiate foreclosure proceedings before you can complete it.
Another risk is that the forgiven debt — the difference between the sale price and how much you owe — will be reported to the IRS and could be taxed as income. The IRS offers an exclusion for forgiven debt on your primary residence and home equity loans taken out for upgrading the property, but not for second homes or home equity lines of credit. You may still be able to avoid taxes on forgiven debt from a second home or home equity line of credit if you can prove insolvency. That’s a conversation you should have with a tax advisor before you negotiate a short sale.
How Short Sales Affect Your Credit
Like foreclosures, deeds in lieu of foreclosure and other significant derogatory credit events, short sales damage your credit history and are considered strong indicators of future risk. “Most borrowers will try to avoid a short sale if they can because it will have a long-term impact on their credit,” says Mendenhall.
However, a short sale is no better or worse than a foreclosure or deed in lieu of foreclosure where your credit score is concerned, according to FICO. The negative impact of a short sale can be lessened if the lender does not report a deficiency balance, which is an amount owed after the property is sold. This term can be negotiated during the short sale process.
On your credit report, a short sale without a deficiency balance will appear as a settled debt. Settled means the lender accepted less than the full amount owed, and all settled debt reflects negatively in your credit score. Settled debt remains on your credit report for seven years from the date the account was reported settled. Likewise, a foreclosure remains on your credit report for seven years.
The higher your credit score is before you do a short sale, the more it may fall. Consumers applying for a short sale may already be financially distressed. If you have missed payments on your mortgage or other bills, your credit score may have already dropped. A short sale will cause less damage to a lower score.
The longer a short sale takes, the more potential risk to your credit standing, particularly if you are unable to pay the mortgage. A 120-day late payment is far more damaging than one that is 90 or 60 days late. Finding a way to get through the process efficiently is in your best interest.
Steps Before You Apply for a Short Sale
When you’re ready to apply for a short sale, you’ll need to submit paperwork required by your lender, such as tax returns for the last two years, bank statements and pay stubs for the last month, in addition to documentation of your hardship. Some items, like bank statements, have a shelf life. If too much time passes during the process, you’ll need to provide updated documents.
For a more seamless experience, find an agent who is well-versed in short sales. “Your short sale package needs to be complete and detailed. Your lender will require specific documentation, delivered in a certain way. If your package is not complete or correct, the bank is likely to reject it. Then you go to the bottom of the stack when you resubmit,” says Shapiro-Estrada.
Although during the housing crisis some short sales dragged out for the better part of a year, lenders have developed processes for this type of transaction and can now complete a short sale in a matter of weeks. “If the package you submit to the lender is well-done, the short sale should take six to eight weeks start to finish,” says Shapiro-Estrada. There is no set schedule for a short sale, however, and the time to complete one will vary depending on the lender and the situation.
Avoiding Short Sale
No homeowner wants to do a short sale. It’s damaging to your credit and takes you out of homebuying for several years. Follow these strategies for avoiding one.
— Check in with your agent periodically to assess the current market value of your home. If you spot a declining trend that could soon put you underwater, it might be a good idea to sell your home before it’s worth less than your mortgage.
— Don’t borrow against your home up to its full value. Avoid taking out home equity loans or lines of credit that max out your debt against the home.
— Explore alternative payment solutions with your lender, including loan modification or refinancing.
— “Look for other ways to obtain the cash you need to remedy the debt,” says Mendenhall. When you apply for a short sale, the lender may examine your finances overall. If you have substantial liquid assets, the lender may deny your application.
— Consider whether it’s possible to continue making payments until the value of your home rises and you can sell it for an amount that will satisfy your outstanding loan. “It’s a bad idea to do a short sale when the market is going up,” says Shapiro-Estrada. “If you can pull off payments for a year or diligently pursue a loan modification, postpone selling until the value comes back up.”