Short sales are less common today than during the 2008 housing crisis and recession, but they remain a viable option for homeowners. For sellers, a short sale provides a means to escape a property that is worth less than their mortgage balance. For buyers, it can offer the opportunity to purchase a home at a reduced price. Here’s what you need to know.

What is a short sale?

If you’re unable to secure a loan modification or refinance, selling your home may become necessary. If you owe more on your mortgage than your home is worth, a “short sale” could be your best option. In a short sale, the lender agrees to let you sell the property for less than the mortgage balance, thereby settling the debt and avoiding foreclosure. This situation often arises when property values decline or when arrears accumulate faster than the property’s value increases.

One reason to consider a short sale is the potential personal liability for the difference between the sale price and the loan balance, known as a deficiency. This is particularly important if you’re contemplating bankruptcy or if the borrower is deceased or judgment-proof. If no one is liable for the deficiency, pursuing a short sale or deed in lieu may not be worthwhile.

If you have multiple loans on the property, all lenders must approve the short sale. The second or third lien holders might receive nothing from the proceeds, so they may be reluctant to consent. Typically, subordinate lien holders receive a small portion of the loan proceeds, with the agreement of the primary lien holder, to incentivize their approval.

If the short sale is approved, you will not owe anything further on the loan. However, you may need to pay taxes on the forgiven portion of the debt. The IRS may consider the forgiven amount as taxable income, though there are rules that might allow you to exclude some or all of the forgiven debt from taxation. It’s advisable to consult a tax attorney or accountant to determine if you are eligible for any tax relief on the forgiven debt.

Short sale vs. foreclosure

Both foreclosure and short sales negatively impact your credit, but they differ in process. Foreclosure occurs when a lender repossesses a home from a borrower who has ceased making mortgage payments. If the borrower does not reinstate the loan, the lender may sell the home, often through an auction, to recover its losses. Some borrowers facing foreclosure attempt to negotiate a short sale or other relief options with their lender first, while others may abandon the property and mortgage, leading the lender to proceed with foreclosure.

Who benefits from a short sale?

Short sales offer both benefits and drawbacks for buyers, sellers, and lenders or servicers:

Seller: A short sale helps the seller avoid foreclosure and eviction, but it negatively impacts their credit score, and they won’t receive any proceeds from the sale for a new home.

Buyer: Buyers may obtain the property at a lower price, but they should be prepared for potential issues with the home and a more complicated transaction process compared to a typical real estate deal.

Lender/Servicer: The lender or servicer does not recover the full mortgage amount but benefits by avoiding the costs and delays associated with foreclosure proceedings.

How does a short sale work for sellers?

Here’s an overview of the short sale process for homeowners:

Provide a Hardship Letter The initial step in the short sale process involves negotiating with your mortgage lender or servicer. Draft a hardship letter detailing your financial difficulties that make it impossible for you to continue paying your mortgage. This could include circumstances such as job loss, disability, a serious health issue, divorce, or the death of a partner.

Along with the letter, your servicer may request supporting documentation to verify your hardship, such as bank statements and copies of bills.

List Your Home with Disclosures If you’re not handling the sale yourself, you’ll need a real estate agent to price and list your home. Be aware that not all agents are familiar with the complexities of short sales. Before signing a listing agreement, interview at least three agents to evaluate their expertise, skills, and marketing strategies.

When listing the property, clearly state that it is a short sale. Your agent will then market the home to potential buyers similarly to a traditional sale. If the property requires significant repairs, your agent might focus on attracting house-flippers or investors.

Submit the Offer to Your Lender After you accept an offer, submit it to your lender or servicer for review and approval. This process can be lengthy, and the lender may not accept the initial offer price. Be prepared for further negotiations between the lender, the buyer, and yourself as the seller. There is no guarantee that the lender will approve the offer.

The Bottom Line

Short sales can provide an opportunity for buyers to purchase a home at a bargain price. However, the approval process with the seller’s mortgage lender can be complicated, and the home might need considerable repair work.

If you’re looking for a short sale on your property, reach out to Illinois Real Estate Buyers to get your no obligation cash offer today.