What is a home short sale, exactly? Simply put, a short sale is when a property sells for less than the amount owed on the mortgage, and all the proceeds go to the lender. It can happen when homeowners find themselves under water on their loan, and their lender agrees to accept less than the remaining mortgage balance. It’s not ideal, but it is a way out of a tough situation.

Short sale vs. foreclosure

Short sales and foreclosures are both options for homeowners in financial distress, but there are some important differences.

A short sale in real estate is more like a managed exit from mortgage debt. It’s initiated by the homeowner before the mortgage goes into default, and it requires the lender’s approval. A short sale gives the homeowner a little control over the sale and causes less damage to their credit score compared to a foreclosure.

A foreclosure, on the other hand, is initiated by the lender after the mortgage goes unpaid for a period of time. This process can significantly impact a homeowner's credit score and is undoubtedly a challenging ordeal.

A short sale resembles a typical home sale in many ways, but the process can take longer because it involves multiple parties and complex negotiations.

Step 1: Hardship documentation

First, homeowners must show they’re having trouble keeping up with bills. This means submitting an in-depth financial package to the lender, including tax returns, W-2s, payroll stubs, bank statements and a hardship letter, which serves as the homeowner’s plea to the bank.

Step 2: Market analysis

Next, the house is compared to nearby properties and priced below market value. The goal is to attract the right kind of buyers and get the sale process in motion as quickly as possible.

Step 3: Property listing

Here’s where hiring a real estate agent who specializes in short sales would help. They’ll list the property, market it in the best possible light and help keep the process on track.

Step 4: Offer and approval

When a buyer makes an offer, the decision isn't entirely in the hands of the seller. The lender also needs to approve the bid since they’ll be receiving less than the amount owed on the mortgage. It’s a delicate balance of negotiation and compromise.

Step 5: Closing

If the lender approves the offer, the transaction moves to the closing phase. This is where legal and financial paperwork is completed and the property is officially transferred from seller to buyer.

Now, let’s look at it from the home buyer’s perspective. If you’re hoping to stretch your budget a bit further and you’re not in a rush, a short sale may be worth considering. Just know that it can take more time and comes with added risks. Here’s a guide to walk you through it:

• Start with research: Dive into the details of short sales to understand what sets them apart from standard real estate deals. Look for short sale listings that match your wish list and budget.
• Choose the right agent: Partner with a real estate agent who has a track record of handling short sales. Their expertise can help you through the maze of finding the right property and negotiating skillfully.
• Line up your financing: Ensure your financing is ready to go. Being pre-approved for a mortgage not only focuses your budget, but it strengthens your position in the eyes of sellers and lenders.
• Inspect thoroughly: Call in the experts to inspect the property from top to bottom. Since short sales are often sold "as is," knowing if you should budget for repairs is always a good idea.
• Make a smart offer: With your agent’s insight and a thorough inspection in hand, craft an offer that’s both appealing to the lender and reflective of the property’s condition and market value.
• Finalize the purchase: If your offer gets the green light, you’ll move forward with closing, which includes finalizing paperwork, completing payments and receiving the keys to your nicely priced new home.

As you’ve seen, a short sale can offer a ray of hope for homeowners wrestling with the possibility of foreclosure.

Another advantage of short sales is potential debt forgiveness. This means that after the sale, your lender may forgive any remaining debt not covered by the sale price. It's not guaranteed, but if it happens, it can lift a big financial burden. Just know that it may affect your taxes, so talk to an advisor to see where you stand.

After a short sale, it's time for a fresh start. You can rebuild your finances by creating a budget that fits your new situation, focusing on saving money and chipping away at any other lingering debts. Keep an eye out for errors on your credit report and continue boosting that score, too. It’s a chance to build a brighter financial future. However, it's important to note that Fannie Mae and Freddie Mac have specific restrictions on lending to consumers with a short sale on their record. Typically, you may need to wait a certain period before becoming eligible for a new mortgage that could range between two to four years after a short sale. Be sure to consult with a lender or financial advisor to understand these restrictions and plan accordingly.

A short sale comes with pros and cons for both buyers and sellers. Here's what to think about as you enter short sale territory.

For buyers:

For sellers:

Because they’re a bit more complicated than your average home sale, short sales can fall through at times. Here are some red flags to look for:

• Lender approval: One of the main reasons short sales can fall through is because the mortgage lender isn’t on board. If they won't approve the loss they would take on from the sale price, they can reject the deal.
• Buyer financing issues: If the buyer can’t secure financing or faces delays in loan approval, the short sale can collapse. Since these deals often take longer to close, financial circumstances for buyers can change, impacting their loan eligibility.
• Appraisal outcomes: If the appraisal of the property comes in lower than the agreed sale price, the lender may nix the loan approval. It’s just part of the tightrope walk that comes with short sales.
• Inspection results: Given that short sales are typically sold “as is,” a thorough inspection might reveal big issues that the buyer can't handle, leading them to back out.
• Unforeseen circumstances: If the seller’s financial situation changes during the process (maybe they find a way to catch up on payments or decide to declare bankruptcy), they might withdraw from the short sale agreement.
• Long waits: Getting a lender's approval for a short sale can take a while, sometimes longer than a buyer can stick around. These delays might lead them to look elsewhere, especially if they need to move or invest soon.

While short sales can be a bit of a gamble, they also offer a chance for buyers and sellers to strike a deal that could be a win-win under the right circumstances.

If you’re facing the possibility of a short sale, here are a few other options that just might save the day:

Loan modification

You can always try to renegotiate the terms of your mortgage with your lender—perhaps a reduced interest rate, an extended loan term or even a reduction of the principal balance, which could make payments more manageable. (You’ll never know unless you ask!)

Refinance

If your credit is still in decent shape and you’ve built up enough home equity, you may be able to refinance at a better interest rate. This can reduce your monthly payments as well as the total interest you’ll pay over the life of the loan.

Renting the property

If market conditions allow, renting your property can provide an income stream that could cover the mortgage payments. It’s a way to hold onto your home, get your finances in order and maybe even turn a profit.

So, that’s the long and short of short sales. While a viable option for homeowners in tough financial situations, short sales are a team effort that take a bit of extra time. Buyers and sellers should go in fully prepared for the twists and turns ahead.