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Key Takeaways

  • A short sale in real estate is one in which a house is sold for a price that is less than the amount still owed on the mortgage.
  • It is up to the mortgage lender to approve a short sale.
  • Sometimes the difference between the sale price and the mortgage amount is forgiven by the lender, but not always.
  • For the seller, the financial consequences of a short sale are less severe than those of a foreclosure.
  • For the buyer, it’s important to calculate costs and be sure that there is room for profit when the house is resold.

What Is a Short Sale (Real Estate)?

A short sale in real estate is when a financially distressed homeowner 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 value of the mortgage. In some states, this difference must legally be forgiven in a short sale.

Understanding a Short Sale

The term "short sale" refers to the fact that the home is being sold for less than the balance remaining on the mortgage—for example, a person selling a home for $150,000 when there is still $175,000 remaining on the mortgage. In this example, the difference of $25,000, minus closing costs, and other costs of selling, is considered the deficiency.

Before the process can begin, the lender holding the mortgage must sign off on the decision to execute a short sale, also known as a “pre-foreclosure” sale. Additionally, the lender, typically a bank, needs documentation that explains why a short sale makes sense; after all, the lending institution could lose a lot of money in the process. No short sale may occur without lender approval.

Short sales tend to be lengthy and paperwork-intensive transactions, sometimes taking up to a full year to process. However, short sales are not as detrimental to a homeowner’s credit rating as a foreclosure.

A real estate short sale is unlike a short sale in investing. An investing short sale is a transaction in which an investor sells borrowed securities in anticipation of a price decline and is required to return an equal number of shares at some point in the future.

Special Considerations

Even though a short sale hurts a person’s credit score less than a foreclosure, it is still a negative credit mark. Any type of property sale that is denoted by a credit company as “not paid as agreed” is a ding on a credit score. Therefore, short sales, foreclosures, and deeds-in-lieu of foreclosure all negatively impact a person’s credit.

What's more, short sales don’t always negate the remaining mortgage debt after a property is sold. This is because there are two parts to all mortgages: a promise to repay the lender and a lien against the property used to secure the loan. The lien protects the lender in case a borrower can’t repay the loan. It gives the lending institution the right to sell the property for repayment. This part of the mortgage is waived in a short sale.

The second part of the mortgage is the promise to repay, and lenders can still enforce this portion, either through a new note or the collection of the deficiency. Whatever happens, lending institutions must approve the short sale, and borrowers are sometimes at their whim.