Definition
A short sale in real estate occurs when a homeowner in financial distress sells their property for less than the amount due on the mortgage. The buyer of the property is a third party (not the bank), and all proceeds from the sale go to the lender. The lender either forgives the difference or gets a deficiency judgment against the borrower requiring them to pay the lender all or part of the difference between the sale price and the original mortgage amount.
Key Takeaways
- A short sale in real estate refers to selling a property for less than the amount the current owner owes on the mortgage. This usually occurs when the mortgagee is unable to continue making their loan payments, leading to a potential foreclosure.
- Short sales need the lender’s approval because they involve letting the owner sell the property for less than the outstanding loan amount. The lender typically agrees to this to avoid the time and costs associated with foreclosure proceedings.
- While short sales can have a negative impact on the sellers’ credit report, they are typically less damaging than a foreclosure. However, they can be a complex and lengthy process, as it requires deep understanding of real estate market conditions, lender policies, and potential tax implications. It’s crucial to rely on experienced real estate professionals when carrying out a short sale.
Importance
A short sale in real estate is important because it is an alternative to foreclosure when a homeowner needs to sell and can no longer afford to make their mortgage payments.
The lender agrees to accept a sale of the property for less than the amount owed on the mortgage.
This allows the borrower to pay off the loan at a price that the market will bear, potentially avoiding dire consequence such as a significant hit to their credit score that comes with foreclosure.
This financial arrangement can also benefit the lender, as it often results in a smaller financial loss than a foreclosure would lead to.
Therefore, understanding the concept of a short sale is crucial for both buyers and sellers in the real estate market.
Explanation
In the real estate market, a short sale serves a distinct, yet significant purpose, primarily aiming to prevent foreclosure for homeowners unable to keep up with mortgage payments. Typically, this occurs when a homeowner owes more on their home mortgage than the current value of the property in the market.
Pursuing a short sale allows the homeowner to sell their property for less than the outstanding mortgage balance, thereby providing a certain level of financial relief, and mitigating additional credit damage that a foreclosure may result in. The primary use of a short sale is not just circumscribed to benefit the homeowner, but it also aids the lender and potential buyer.
From the lender’s perspective, they agree to a short sale to recover a portion of the mortgage loan that they have a lien on, though not the total amount. While it may seem counterintuitive, lenders are often in favor of short sales as they stand to lose more money through the foreclosure process.
On the buyer’s side, short sales can present opportunities to purchase properties at a price below the market value, offering potential for profit should they decide to sell when the market value improves.
Examples of Short Sale in Real Estate
Homeowner Distress: Consider a homeowner who has recently lost his job and can no longer afford his mortgage payments. He owes $300,000 on his mortgage, but the current market value of his house is only $250,
If the homeowner can prove his financial hardship to the lender, the lender might agree to a short sale, wherein the house is sold for the lesser market value and the lender writes off the remaining debt.
Decrease in Market Value: Suppose a person bought a home in a booming real estate market for $500,000, and now due to a downturn in the market, the home’s value has dropped to $450,000, but the homeowner still owes $480,000 on the mortgage. The homeowner could contact the lender and propose a short sale. The lender could agree, the home could be sold at the current market value, and the lender forgives the outstanding debt.
Homeowner Relocation: Imagine a person who purchased a home for $350,000, and a few years later, he gets a job offer in another city and needs to move. If the current market value of the home is less than what he owes on the mortgage, he may opt for a short sale. This will allow him to sell the house quickly, avoid foreclosure, and minimize potential damage to his credit score. Despite the lender losing money on the short sale, they may also benefit by avoiding costly foreclosure proceedings.
FAQs about Short Sale in Real Estate
1. What is a short sale in real estate?
A short sale in real estate occurs when a property is sold for less than the amount owed on the mortgage. This usually happens when the homeowner is in financial distress and the market value of the property has decreased. The lender may agree to this arrangement to avoid the potentially costly and lengthy foreclosure process.
2. How does a short sale work?
In a short sale, the homeowner sells the property and turns over the proceeds to the lender. The homeowner must first get the lender’s permission to do a short sale. If the lender agrees, and a buyer makes an acceptable offer, the lender will often release the homeowner from any further liability relating to the mortgage.
3. How does a short sale affect my credit?
A short sale can negatively impact your credit score. It typically appears on your credit report as a “settled”, “paid in full for less than the full balance” or similar notation. The effect on your credit score can vary depending on your individual credit history and the scoring model used by the lender.
4. Who benefits from a short sale?
Both the lender and the homeowner can benefit from a short sale. The lender avoids the potential loss and costs associated with foreclosure, while the homeowner is able to avoid foreclosure and limit the damage to their credit.
5. What are the risks of a short sale?
The main risks of a short sale include a potential negative impact on the seller’s credit score, potential tax implications, and the possibility of the lender seeking a deficiency judgment for the unpaid balance of the mortgage. It’s important for sellers to seek professional advice to understand the implications before proceeding with a short sale.
Related Entrepreneurship Terms
- Mortgage Lender
- Deficiency Judgement
- Negative Equity
- Pre-foreclosure
- Real Estate Owned (REO)
Sources for More Information
- Investopedia: This site offers comprehensive definitions and descriptions of financial terms, including ‘Short Sale in Real Estate’. It’s a reliable source for financial and investment information.
- Realtor.com: This site provides insights into various aspects of real estate, including short sales. It is backed by the National Association of Realtors.
- Zillow: Zillow is a widely used resource for real estate and rental marketplace. Here you can find information about the short sale process and what it means for buyers and sellers.
- Bankrate: Bankrate provides a plethora of resources on financial matters. They explain the implications of a short sale and who it can benefit.
