INSIDER: Don't Sell Short Sales Short

By Rachel Watson, JD, MBA Candidate

Due to the recent downturn in the economy, the use of short sales has risen in the real estate market. A short sale occurs when a property is sold and the lender agrees to accept less than the amount owed on the mortgage. Real estate professionals are increasingly using short sales to assist homeowners in selling their homes in order to prevent foreclosure or bankruptcy. In Real Estate Short Sales 2010 Step by Step (2010), Loren Keim gives a comprehensive overview of the short sale process, discussing the recent increase of short sales and the steps for using a short sale.

THINK POINT #1: The Rise Of Short Sales

During the 1990's and early 2000's, there was pressure on lenders to relax the qualifications of buyers in order to increase homeownership. Programs allowed potential buyers to purchase homes with no money down, and therefore, buyers lost little to no investment if they walked away. From 1993 to 2005, homeownership increased from approximately 63% to 69.2%, a sharp rise that represented an increase in first-time buyers (Keim, p. 13-14). As large numbers of unqualified buyers defaulted on their loans, the mortgage market collapsed. As a result, it became more difficult for buyers to obtain loans, creating fewer buyers and keeping real estate prices low. As many homeowners found themselves owing more money on their house than it was worth, short sales rose.

THINK POINT #2: Short Sales May Be Better For Your Credit Than Foreclosure or Bankruptcy

Many individuals in a negative equity situation consider either walking away from their home by means of foreclosure or filing bankruptcy. However, a short sale could be a better alternative to many in this situation. After an individual sells his/her home through a short sale, the individual will retain less debt, and she can begin the process of paying her bills on time and rebuilding her credit. Additionally, while a short sale does appear on a homeowner's credit report, Keim suggests that a short sale only costs the individual approximately 80-120 credit points vs. the 200-300 credit points that a foreclosure would reflect. Keim further proposes that the impact of a short sale on the credit report is significantly less than that of a bankruptcy (Keim, p. 46).

THINK POINT #3: A Short Sale Is A Good Option In Several Scenarios

The first situation in which a short sale might be a good option is when a homeowner owes more than the property is worth, is behind in making the mortgage payment, and the lender is about to foreclose on the property. In this scenario, a short sale is a far better alternative to foreclosure. The second situation in which a short sale may be beneficial is when a homeowner owes more than the property is worth and needs to sell the house because of a personal issue such as illness, job loss, or divorce. In this situation, the property is not at risk of immediate foreclosure, but the property cannot be sold on the market for the amount owed on the mortgage.

THINK POINT #4: Evaluate The Risks And Rewards Of A Short Sale

In examining the risks of a short sale, lenders may be uncooperative with the sellers and the short sale process may take longer than a traditional home sale. These risks may discourage a traditional home buyer on a time schedule from looking at a short sale property. Further, sellers do no not receive any of the sales proceeds at the time of the closing, as they do not have equity in the property. In considering the rewards of a short sale, homeowners can avoid foreclosure or bankruptcy, each of which can last on the credit report for up to seven to ten years (Keim, p. 35). As an additional benefit, the lender typically pays all closing costs in short sales.

THINK POINT #5: The Five Steps of a Traditional Short Sale

1. Contact the lender. Find out if you can pre-apply for a short sale or if the lender requires an offer to proceed. Request the lender's "short sale package," as starting the process early will save time when the seller receives an offer.
2. Place the property on the market and find a buyer. The home must be labeled as a short sale, which can deter time-sensitive buyers and attract those looking for a "deal."
3. Negotiate an agreement with the buyer. As short sales can take an extended amount of time to close, and some do not close at all, many traditional buyers will overlook using a short sale. Pricing can be an important factor in enticing buyers to consider a short sale property over a traditional property.
4. Put together the "short sale package." While requirements vary by lender, typical packages will include documents such as W-2s, bank statements, seller's net sheet, and (possibly) a preliminary HUD 1 settlement sheet.
5. Send the package to the lender. Regularly communicate with the lender regarding the status of the package, as the process is slow moving and can stall. While the lender may accept the original offer, often times the lender proposes a counter offer. In this situation, the real estate professional would need to ask the buyer for additional funds to close the transaction.

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Recommended Reading

Keim, Loren (2010), Real Estate Short Sales 2010 Step by Step, Bethlehem PA: Gideon Publications.

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About The Author

Rachel Watson, JD, MBA Candidate, May 2013, Baylor University
Graduate Assistant, Keller Center for Research

Rachel is a graduate student from Georgetown, Texas. She earned her BBA with a concentration in business and management from St. Edward's University and her JD from Texas Tech School of Law.