What Is a Short Sale in Real Estate?

Reviewed by: Brandon Brown

Plans can change on a dime. Even if you planned to stay in your home for decades, job relocation, unexpected health difficulties, or financial strain can all lead to real estate challenges. When you’re looking to speed up the timeline, a short sale may be the answer—but what is a short sale in real estate? A short sale occurs when a homeowner sells property for less than what they still owe on it. It’s often a last-ditch way to avoid a foreclosure. If you’re delinquent on your mortgage or need to sell quickly, a short sale might make sense, but it’s not the only option. Struggling homeowners can also consider a faster, stress-free alternative with FlipSplit.

What Is a Short Sale?

In real estate, a short sale occurs when:

A homeowner still owes money on a property.
The owner sells the property for less than the outstanding mortgage debt.

In some cases, a short sale can mean that the property owner could continue to owe a mortgage debt for a house after they no longer live in it.

When Is a Short Sale an Option?

Short sales can occur due to a combination of a seller’s personal circumstances and the realities of real estate market changes. A homeowner can opt to sell their property at any time if the sale yields enough to pay off the outstanding mortgage, but the lender’s approval is required for a short sale. If they aren’t guaranteed to receive a full payoff amount at closing, then you may need to:

Face severe mortgage delinquency
Be on the brink of foreclosure
Prove financial hardship to the lender

Without the lender’s approval, a short sale cannot occur. From a lender’s perspective, a short sale that offers guaranteed income is usually preferred to the costs and uncertainty of foreclosure, but not always.¹ Additionally, if you have more than a single mortgage against your home (e.g., a home equity loan or line of credit), you’ll also need to obtain those lenders’ approvals for a short sale. You may find it more difficult to negotiate with them—since they’re second in line behind a primary mortgage lender, they know they’re unlikely to collect from you on a short sale. Instead, they may demand a cash payment prior to releasing their claim on your property.²

How Does the Short Sale Process Work?

While individual states’ real estate regulations and individual lender policies vary, there are common steps in the process of pursuing a short sale.

#1 Contact Your Lender

Before you do anything else, connect with your lender to explain your situation and find out how they can help you. Most traditional lenders will require you to submit documentation of financial hardship explaining why you need to sell the home now. These may include filling out an application with a detailed income statement and providing:

Hardship letters
Bank statements
Tax returns
Employment (or unemployment) documentation

They’ll review with an eye toward your ability or inability to continue to make mortgage payments. If they agree you’re not likely to meet your obligations, they’ll provide you with approval to proceed and instructions on how to move forward. If they refuse your appeal for a short sale, they may instead offer you solutions such as:

Loan modification
Loan forbearance
Refinancing

In addition to simply giving you a yes or no on a short sale, the lender may also seek to work out a payment agreement for your outstanding debt after the property is sold.

#2 List the Property

You’ll need to find a real estate agent with experience in short sales. This agent should be familiar with the unique role that a lender takes in short sale offer reviews and negotiations. Short sale properties are typically listed at market value. The lender will usually order either an appraisal or broker price opinion (BPO) and require you to adhere to their market valuation.

#3 Receive and Review Offers

The lender will be in the driver’s seat when it comes to negotiating with buyers, though you’ll still have some opportunity to suggest tactics and respond to offer components that impact your time and money directly. Lenders may take this opportunity to:

Reject offers below the listing price
Ensure the buyer’s financial capacity
Incorporate the remaining debt into the negotiation
Negotiate on closing costs that could inhibit the seller’s further debt repayment

#4: Obtain Lender Approval and Close the Sale

Your lender ultimately acts as the decision-maker in short sale offers. You’ll need their sign-off on the final sale agreement and closing documents before you hand off your house keys.

Pros and Cons of a Short Sale

While it may feel like you have little control during a time of financial hardship, there are still decisions to make. Before you jump in, consider the advantages and disadvantages of a short sale.

Benefits of a Short Sale in Real Estate

While a short sale isn’t the most desirable outcome for homeowners, there are worse situations you can land in. A short sale may:

Help you avoid foreclosure
Have less impact on your credit history than foreclosure
Allow you to move on from unaffordable mortgage debt

Drawbacks of a Short Sale in Real Estate

The biggest con to short sale real estate is inherent—you’ll be selling for less than what you still owe on a mortgage. However, there are other drawbacks:

The short sale application and approval process can be time-consuming.
Your lender isn’t guaranteed to agree with you (at multiple stages of the process).
Secondary lenders tend to withhold approval unless you pay them ahead of time.
Short sales usually feature a longer time to closing than a traditional sale.³
There are possible negative tax consequences (more on this below).
Your lender may seek a deficiency judgment to recover the remaining debt.

How a Short Sale Affects Your Credit

A short sale causes a major hit to your credit score and history. The repercussions include:

A “settled debt” listing, meaning it wasn’t paid in full
A likely 100 – 150 drop in your credit score⁴
A blemish on your credit history for up to 7 years²
A typical 2 – 7 year waiting period to qualify for another mortgage loan²

How a Short Sale Affects Your Taxes

One potential silver lining to a short sale is that you can negotiate with your lender to forgive your outstanding debt. Since a short sale can be a better outcome for a lender than a foreclosure, they may agree to do so. On the flip side, forgiven debt can be construed as income—and therefore add to your income tax liability at the end of the year. Before you complete (or even apply for) a short sale, consult a tax advisor or attorney for guidance on how it may affect your tax situation. Since considering a short sale often means you’re already in financial distress, you may want to see free legal consultations from the Legal Services Corporation (LSC), your local bar association, or HUD foreclosure assistance programs⁵.

Alternatives to a Short Sale

There’s usually more than one way to get out from under a house you can no longer afford. Before you apply for a short sale, look into alternative options.

Loan Modification or Forbearance vs. Short Sale

What if you could tweak your mortgage payments or get a temporary break from them? Lenders have multiple approaches to working with homeowners to avoid foreclosure. While it could seem like a great deal for the bank to sweep in and grab your property in addition to all the payments you’ve made to date, the reality is different. It takes time, money, and hassle for lenders to foreclose on a property, and they’re often left with unoccupied houses in poor condition that sell at a loss. Instead, they may offer:

Loan modification – Changing the terms of a loan to make payments more affordable (usually by increasing the length of the loan and/or decreasing the interest rate)

Forbearance – Temporarily suspending monthly mortgage payments or reducing their amount with a plan to catch up later through a lump-sum repayment or repayment plan

Other arrangements – Offering a repayment plan, missed payment forgiveness, refinance, partial claim through an FHA loan, or deed in lieu of foreclosure

Before you agree, consider whether these can help you with your current budget crunch and long-term financial capacity.

Foreclosure vs. Short Sale

As noted above, banks aren’t eager to see a mortgage loan end in foreclosure. And there are serious drawbacks for homeowners—a major hit to your credit history, inability to get credit for years, plus the possibility of the lender suing you for the difference between what you owed and their foreclosure profit. Allowing a foreclosure is typically a worst-case scenario for both the borrower and lender.

Selling to a Cash Buyer

If you’d like to close on a sale independently—before foreclosure proceedings begin and without the lender oversight and delays of a short sale—consider selling to a cash buyer like FlipSplit. A direct buyer may offer a fast, as-is property purchase that bypasses your lender and gets you out of hot water. It’s a solid option to investigate for homeowners who don’t want to wait on lender bureaucracy, risk foreclosure, or lose control of an already-precarious situation.

Weighing the Right Option for Your Situation

A short sale can be a useful path for homeowners in financial trouble—but it’s not the only option. Direct buyers offer a fast, transparent way to sell without red tape. Before you make a decision, consider your timeline and financial status, and reach out to see if FlipSplit is a better fit for your Southern California home. We’re not like most cash homebuyers: We buy your home as-is, renovate it, sell it, and share any excess profits with you. Learn more about our client-first approach to real estate.

Reviewed by: Brandon Brown

As a long-time Asset Manager, Investor, Real Estate Agent, and Broker/Owner of BayBrook Realty in Orange County, Brandon Brown is one of FlipSplit’s lead Real Estate experts. Having worked on over 2,000+ real estate transactions, Brandon brings a depth of knowledge that ensures clients are appropriately treated with honesty and integrity. His insights and advice have been published in numerous blogs beyond FlipSplit, and he keeps a close eye on market trends and statistics, which are updated weekly on his social media pages. Outside work, you can find him participating and serving at church, cycling, mountain biking, surfing around Orange County and beyond, and enjoying time with his wife and two daughters.

Sources:

Ramsey Solutions. What Is a Short Sale? https://www.ramseysolutions.com/real-estate/what-is-a-short-sale
Experian. Short Sale vs. Foreclosure: What’s the Difference? https://www.experian.com/blogs/ask-experian/short-sale-vs-foreclosure/
Kaplan Real Estate Education. What Is a Short Sale in Real Estate and How Do They Work? https://www.kapre.com/resources/real-estate/short-sales
Advantage Legal Group. How Low Will My Credit Drop After a Short Sale or Foreclosure? https://advantagelegalgroup.com/foreclosure-defense/how-low-will-my-credit-drop-after-a-short-sale-or-foreclosure/
Upsolve. Foreclosure 101: Your Guide to Navigating the Process. https://upsolve.org/learn/foreclosure/