When Short Sales Make Sense
Underwater mortgage
Underwater mortgage
Property value has dropped below loan balance. Cannot sell without bringing cash to closing or lender approval for short sale.
Financial hardship
Financial hardship
Owner can no longer afford payments due to job loss, medical issues, divorce, or other circumstances.
Foreclosure looming
Foreclosure looming
Short sale may be better than foreclosure for credit impact and potential deficiency liability.
No equity to sell traditionally
No equity to sell traditionally
Selling costs (agent commission, closing costs) would exceed any equity. Lender must approve sale below payoff amount.
Short Sale vs Foreclosure
| Factor | Short Sale | Foreclosure |
|---|---|---|
| Credit impact | Less severe | More severe |
| Time on credit report | 7 years | 7 years |
| Future mortgage waiting period | 2-4 years typically | 3-7 years typically |
| Control over process | More control | No control |
| Timeline | 3-12 months | 2-24 months |
| Deficiency judgment risk | Varies (may be waived) | Higher risk |
Short sales generally cause less credit damage than foreclosure because the account shows as settled rather than defaulted. However, both remain on credit reports for 7 years.
The Short Sale Process
1
Contact lender
Notify mortgage servicer about hardship and interest in short sale. Request short sale package or application.
2
Document hardship
Gather required documentation: hardship letter, financial statements, tax returns, pay stubs, bank statements.
3
List property
Work with real estate agent experienced in short sales. Price based on market value, not loan balance.
4
Receive offer
Buyer makes offer. Seller accepts subject to lender approval. Multiple offers may be submitted to lender.
5
Submit to lender
Complete short sale package submitted to lender’s loss mitigation department. Includes offer, buyer qualifications, and seller documentation.
6
Lender review
Lender evaluates whether short sale nets more than foreclosure. May order appraisal or BPO (broker price opinion).
7
Approval or counter
Lender approves, rejects, or counters with different terms. May take weeks to months.
8
Close sale
Once approved, transaction closes like regular sale. Lender receives proceeds; remaining balance handled per approval terms.
Lender Approval Requirements
Lenders evaluate short sales based on whether they’ll recover more than through foreclosure.What lenders consider
What lenders consider
- Property value vs loan balance
- Foreclosure costs and timeline
- Borrower’s financial situation
- Whether hardship is legitimate
- Net proceeds from short sale vs foreclosure auction
Common requirements
Common requirements
- Legitimate financial hardship
- Property listed at fair market value
- No fraud or misrepresentation
- Arms-length transaction (no sale to family or related parties)
- Borrower has made good faith effort to pay
Multiple lien holders
Multiple lien holders
If second mortgage or HELOC exists, all lien holders must approve. Each wants maximum recovery. Negotiations can be complex.Second lien holders may require payment to release their lien, even from short sale proceeds.
Hardship Documentation
Hardship letter
Hardship letter
Written explanation of circumstances causing inability to pay. Include timeline of events, current situation, and why short sale is necessary.Be honest and specific. Generic letters are less effective.
Financial documents
Financial documents
Typically required:
- Last 2 years tax returns
- Recent pay stubs (last 30-60 days)
- Last 2-3 months bank statements
- List of monthly expenses
- List of assets and liabilities
Qualifying hardships
Qualifying hardships
Common accepted hardships:
- Job loss or reduced income
- Medical expenses or disability
- Divorce or separation
- Death of income earner
- Military deployment or PCS
- Business failure
- Unaffordable payment increase (ARM reset)
Deficiency Balance
The deficiency is the difference between what’s owed and what the property sells for. Example: Owe $300,000. Property sells for $250,000. Deficiency is $50,000.Lender options
Lender options
Lender may:
- Waive deficiency entirely (full release)
- Reserve right to collect deficiency
- Accept partial payment of deficiency
- Sell deficiency to collection agency
Getting deficiency waived
Getting deficiency waived
Negotiate deficiency waiver as part of short sale approval. Get waiver in writing before closing.Approval letter should state “full satisfaction” or “waiver of deficiency” explicitly.
State law protections
State law protections
Some states prohibit or limit deficiency judgments on primary residences. Others allow lenders to pursue full amount.Know your state’s rules before proceeding.
Tax Implications
Forgiven debt as income
Forgiven debt as income
IRS generally treats forgiven debt as taxable income. If lender forgives 50,000, that could be reported as income.Lender sends Form 1099-C for cancelled debt.
Exclusions
Exclusions
Forgiven debt may be excluded from income if:
- Debt was on primary residence (check current law)
- Borrower was insolvent (liabilities exceeded assets)
- Debt was discharged in bankruptcy
Consult tax professional
Consult tax professional
Tax treatment is complex and law changes. Get professional advice before closing short sale to understand potential liability.
Timeline Expectations
Short sales are slow. Lender review creates delays. Typical timeline:- Listing to offer: 1-3 months
- Lender review: 1-4 months
- Approval to closing: 30-45 days
- Total: 3-12 months
- Lender staffing and backlog
- Completeness of documentation
- Number of lien holders
- Property value disputes
- Buyer patience
Buyers often walk away during long approval processes. Short sale agents should set expectations with buyers about timeline uncertainty.
For Buyers
Buying a short sale can offer below-market prices but comes with challenges.Advantages
Advantages
- Potentially below-market price
- Better condition than foreclosures (owner-occupied)
- Less competition than traditional sales
Disadvantages
Disadvantages
- Long, uncertain timeline
- Lender may reject or counter offer
- Sold as-is in most cases
- Seller cannot make repairs
- Deposit tied up during approval
Tips for buyers
Tips for buyers
- Be patient and flexible
- Don’t count on closing by specific date
- Get property inspected before lender approval (or accept risk)
- Have backup options
- Work with agent experienced in short sales