What Is a Short Sale?

By: , Contributor

Published on: Oct 13, 2019 | Updated on: Feb 03, 2020

Many properties go on the market as short sales. Here’s what you need to know about them.

Sometimes homeowners fall behind on their mortgages and need a way out. Lenders can foreclose on homeowners who don't make their mortgage payments, but there's often another solution -- a short sale.

Short sales can be beneficial to struggling homeowners and prospective buyers alike. That said, there are risks involved in buying a short sale property, so it's important to know what the process entails.

How does a short sale work?

A short sale occurs when a homeowner owes more on his or her mortgage than the property in question would sell for. The lender agrees to accept the proceeds of the sale of that home rather than go after the homeowner for the remaining mortgage balance.

Imagine Bob owes $250,000 on his mortgage, and he can sell his home for $200,000 in a short sale. In doing so, he fulfills his obligations to his mortgage lender, and that lender, in turn, accepts a smaller amount than what it's owed. The lender, however, is short $50,000 -- hence the name.

Keep in mind that a short sale isn't the same as a foreclosure. A foreclosure occurs when a homeowner falls behind on his or her mortgage payments and the lender reclaims the property. Usually against the owner's will.

As an owner, there are benefits of going through a short sale. It doesn't have the same repercussions as a foreclosure from a credit score perspective. Often, homeowners who go through the short sale process can buy another home shortly thereafter.

Foreclosures, meanwhile, stay on owners' credit records for seven years, and there’s a minimum three-year waiting period to get a new mortgage. You'll also get a 10% down payment requirement for conventional loans.

Buying a short sale property

If you're looking to buy a home, the benefit of pursuing a short sale is that you'll typically get a good deal. In a short sale, the mortgage lender isn't repaid by the owner of that property on a monthly basis. So that lender is motivated to sell the home and recoup some of its money. As such, it might agree to a lower amount than what a similar home on the market would go for.

However, you may need to jump through some hoops to close that deal.

For one thing, short sales aren't quick. They can easily take four months or longer. When you buy a short sale, the original homeowner's lender has to approve the sale, including the price at hand, which can lead to lengthy negotiations and delays.

Furthermore, short sale properties tend to not be in great shape. Remember, short sales arise when homeowners can't afford their properties -- so many short sale homes are put on the market in a state of neglect. You might snag a good deal on a short sale home, but those savings could be offset by the repairs you'll need to make.

If the buyer uncovers issues with the property in a traditional sale, they can ask the seller for a price reduction to compensate. But lenders are already losing money in a short sale. So your chances of getting them to make concessions are slim.

If you're interested in a short sale, get a thorough home inspection first. That will alert you to major red flags and you'll be better equipped to decide if you're willing to take on the added expense.

A short sale can be a win-win

If you’re a homeowner and can't afford your property, think of a short sale as a bailout of sorts. And if you’re looking to purchase a new home, a short sale could be a great opportunity to snag a good deal. Just be aware of the pitfalls involved in buying a short sale property, especially if you’re a first-time homebuyer.

Become A Mogul Today

Real estate is one of the most reliable and powerful ways to grow your wealth - but deciding where to start can be paralyzing.

That's why we launched Mogul, a breakthrough service designed to help you take advantage of this critical asset class. Mogul members receive investing alerts, tax optimization strategies, and access to exclusive events and webinars. Past alerts have included investments with projected IRRs (internal rates of return) of 16.1%, 19.4%, even 23.9%.

Join the waitlist for Mogul here and receive a complimentary 40-page guide on a NEW way to build wealth. Join waitlist now.

The Motley Fool has a disclosure policy.