What is a Short Sale and How Does it Connect to the Foreclosure Process?

The term short sale has been brought up more and more in the real estate world as the property market has corrected to a more sustainable growth level. Depreciation of home values over the last few years has led to homes that are worth less than the mortgages that were used to finance the purchase. This situation coupled with a nationwide recession that has created the need for people to sell their homes despite being “underwater” has led to the recent popularity of short sales.

What Is an Underwater Loan?

A home loan or mortgage that is higher than the actual value of the home is said to be underwater. Over the last few years this situation has become a common occurrence as homeowners who bought at the peak of housing prices with little or no money down have seen their property values decrease, sometimes dramatically. They began with a $300,000 loan on a home that appraised around that value, and now their mortgage amount is around the same, but that same house appraises for less than $250,000.

With the rise in unemployment, many homeowners who have found themselves in this difficult situation have been forced to sell their home because they can no longer afford the mortgage. The problem that occurs is that even if the homeowner sold their home for $250,000, they would still owe the bank the additional $50,000, which holds up the sales process. This hurts everyone involved because the original owners cannot pay the mortgage, so they default on the loan. The new buyers who are excited about the home are not allowed to buy it at the new market price. Finally, the bank that holds the mortgage will not let the original owner sell, does not receive a payment each month for the mortgage, and must now go through an expensive and time consuming foreclosure process to get possession of a home they will only be able to sell for less anyways.

Buying and Selling a Home with a Short Sale

This is where short sale comes into play. In a short sale the original homeowner who is underwater will get an agreement from the bank to complete a short sale and put their home on the market at the current local price. When a buyer decides to purchase the home, the bank agrees to let the sale take place and take a loss on the original mortgage. Ultimately, this type of legal settlement allows the homeowner and bank to avoid a costly and credit damaging foreclosure process. The owner will still take a hit on their credit score and the bank will lose some money on the transaction, but the overall solution is much better than foreclosing on the home.

Foreclosures and Short Sales

Short sales are becoming more common with our current correction in home prices and high unemployment, but many bands still make the process very difficult for the owners because they do not want to take a loss on the loan. For this reason, many banks will not consider the option of a short sale until the homeowners are already several months behind on their mortgage. In addition, banks reserve the right to not accept the price the new buyer offers for the home if they think it is too low. This creates tension between all parties involved, and if unresolved leads to the eventual foreclosure of the home.