When a homeowner runs into problems on a mortgage, they may try a short sale to avoid a foreclosure. A short sale is a way for a homeowner to sell a home for less than the remaining mortgage loan balance.
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The process is more complicated than a typical home sale and can have a negative impact on the credit of the seller, affecting your ability to purchase another home for years after the short sale. For bargain-hunter buyers, a short sale could be a good deal, if you can navigate the added complexities.
If you are considering short selling your home, or if you are considering buying a short sale home, here’s what you should know.
What Is a Short Sale
A short sale is a sale at a price that is “short” a percentage of the remaining mortgage debt. It’s a carefully worked out agreement between not only the buyer and seller but also the mortgage lender. In short, it’s a form of debt forgiveness; a way for both the homeowner and the mortgage lender to cut their losses in a declining housing market if a traditional sale is not possible due to a drop in the market value of the home.
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Short sales are typically the last resort for a homeowner trying to avoid the somewhat more negative effects of a foreclosure. Often, but not always, the seller has fallen behind on payments or can no longer afford the mortgage payments. In many cases, a real estate market correction has dropped the value of the property significantly, often by 20 percent. It’s under these circumstances that a homeowner may approach their lender proactively with the option of a short sale.
What to Know Before Purchasing a Short Sale Home
For home buyers, purchasing a short sale can be an investment that pays off in the long run. Only a few years ago, in a better housing market, the same house was worth significantly more money. Now it could be had for a steep discount. That, in turn, could allow a short sale buyer to make a handsome profit when the real estate cycle improves.
However, the challenges of buying a short sale mean it’s not a good choice for buyers with a looming relocation deadline, those with an inflexible budget, or those wanting to close on a home quickly.
The ideal short sale buyer will need to have their offer accepted not only by the seller but also by the seller’s lender. Lenders may choose to reject a short sale offer, or simply not respond promptly. A lender could also come back with a counteroffer, or entertain competing offers from other buyers.
In some cases, property defects, overdue taxes or HOA fees, and renovation expenses could add up for new buyers of short sale properties, decreasing your potential profit. It’s often a good idea to work with a short sale real estate professional or attorney.
What You Should Know Before Deciding to Short Sell Your Home
If you are a homeowner with an “underwater” mortgage, meaning you owe more than the home is worth, you may decide to approach your lender about a short sale. Lenders consider the prospect of a short sale on a case-by-case basis. It’s possible your lender may decide you’re a good short sale candidate, as a smaller loss to the lender now outweighs a bigger loss later if the home falls into foreclosure. Or, the lender may not want to approve a short sale owing to its own financial best interests.
One of the first steps will be submitting a hardship letter to your lender explaining your financial situation and making the case that your loan warrants a short sale. But this is only the first step. You’ll also want to find a seller’s agent that is experienced in short sales to help you find the right buyer.
It’s also a good idea to consult with an attorney. A few states have laws that protect short sale home sellers from facing a deficiency judgment; that is, a legal procedure where a lender can sue for the difference between the short sale price and the amount still owed on the mortgage. In states that don’t have such limitations, many lenders will offer a settlement for a portion of the difference which can be negotiated between the seller and the lender. Tax implications of a short sale are another consideration.
How a Short Sale Can Affect Your Credit
For homeowners that do go through with a short sale, the effect on your credit can be significant. How much a short sale will affect your credit depends on your specific situation.
A foreclosure is said to be somewhat worse for your credit score than a short sale, primarily because the missed payments leading up to a mortgage default will impact your credit negatively in addition to the foreclosure itself. With a short sale, you may not have those additional missed payments before approaching your mortgage lender.
However, if you had excellent credit before a short sale, you can expect a drop in your credit score of more than 100 points. This is because a short sale represents to creditors a failure to pay a mortgage debt. Like a foreclosure, the credit impact of a short sale will lessen with time and with proper management of your other financial obligations, eventually aging off your credit history after seven years.
How to Get a Mortgage After a Short Sale
Despite the negative impact a short sale can have on your credit and finances it is possible to buy another home. Some loan products require a waiting period of one to four years, depending on your circumstances.
There is no waiting period for FHA or VA loans if you have qualifying extenuating circumstances, such as a loss of income or serious illness and meet other lending criteria. Credit score also matters to lenders after a short sale, as well as how large a down payment you will be able to make and whether you have kept on top of other financial obligations since your short sale.
Because of the negative impact on credit and finances, a short sale should be considered as a last resort by most homeowners. Owners who can weather the down cycle will often see their equity increase after a few years. However, if you can’t keep your home, be sure to consult with an experienced real estate agent and attorney about your short sale options. If you are a home buyer, a short sale can be a good bargain, provided you can manage the added complexity of a short sale.