What Is a Short Sale, and When Does It Make Sense for an Investor?

What is a short sale?

Picture an owner who bought at a high point, then lost income or watched the neighborhood values slip. The mortgage balance is now larger than what the house would bring on the market. That is the situation where you hear the term short sale.

A short sale is a sale that falls short of the loan balance. The buyer pays less than the owner owes, and the lender agrees in writing to accept that smaller amount to release its lien. Without that approval, the sale cannot close, because the lender is still owed the difference.

The key point is that the lender, not the owner, controls the outcome. The owner finds a buyer and submits the offer, and the lender decides whether the numbers beat its other options.

Short sale compared with other ways out of default

Rules vary by state. General information, not legal advice.

How a short sale works from offer to closing

The process is a negotiation with a third party that holds the power to say no. While the details differ by lender, loan type and state, the general path looks like this:

1. The owner shows the lender a hardship, such as job loss, illness, divorce or a payment they can no longer afford.
2. The owner provides financial documents so the lender can judge whether a sale really is the better option.
3. A buyer makes an offer, usually contingent on lender approval.
4. The lender reviews the offer against the home's value and its expected outcome from foreclosure.
5. The lender approves, counters or declines. If it approves, the approval letter spells out the terms, including what happens to any remaining balance.

Expect it to take time. Lenders can be slow, and the review can restart if the buyer's offer changes or paperwork goes stale. Build that uncertainty into your plans before you commit money or other deals to it.

When a short sale makes sense

A short sale is not for every distressed owner. It generally fits when several things are true at once.

• The home is worth less than the total debt against it.
• The owner has a real hardship and cannot realistically catch up on payments.
• A loan modification or repayment plan is not workable.
• The owner wants to avoid a completed foreclosure and the lender would rather avoid the cost and delay of one.

If the owner has equity, a short sale is the wrong tool. A traditional sale will pay off the loan and may leave money for the owner. In that case the conversation is about a regular purchase, not a lender negotiation.

For the lender, the math is simple in concept. If an approved sale likely returns about as much as foreclosing, with less cost, time and risk of property damage, approval becomes more likely.

Short sale, foreclosure and the other exits compared

Owners in default usually have more than one way out. Knowing the differences helps you explain options honestly and see where a short sale fits. The table below gives the general picture, though terms vary by lender and state.

What a pre-foreclosure filing tells you about a short sale

When a lender starts a foreclosure, a filing is typically made in the county where the property sits. The form of that filing and the steps that follow depend on the state, and some states go through the courts while others use a non-judicial process. What the filing tells you is that the loan is in serious default and the lender has begun enforcing its rights.

That is often the window when a short sale becomes realistic. The owner still holds title and can still choose to sell, but the pressure of a looming sale date can push them to act. These filings are public records. If you want them delivered with the owner and property already matched, Keystone's pre-foreclosure leads do that.

Remember that a filing does not mean the owner wants a short sale, or that one is possible. Some owners have equity, some will reinstate the loan, and some will do nothing. Treat each as an individual situation.

Risks and details to check before you pursue one

Other liens matter. A second mortgage, a home equity line, a judgment or unpaid property taxes can all stand in the way. Each holder may need to agree to release its claim, and some will want a payment to do so.

Ask about the remaining balance. In some states a lender can pursue the owner for the difference after a short sale, which is called a deficiency. Whether that is allowed depends on state law and on what the approval letter says, so the owner should get any waiver in writing and speak with an attorney.

Taxes can come into play. Forgiven debt can sometimes count as taxable income, though exceptions exist. Owners should talk to a tax professional, and you should not offer tax advice yourself.

Lenders also commonly require that the sale be between unrelated parties at arm's length, and they may limit quick resales. If you plan to resell or assign a contract, read the lender's conditions and have an attorney review your approach before you sign anything.

How to treat owners facing a short sale

The person you are talking to may be dealing with job loss, illness, divorce or a death in the family. A calm, plain explanation of what you can and cannot do goes much further than urgency. Be clear that the lender must approve the sale, that the timeline is uncertain, and that you cannot promise an outcome.

Prefer a respectful letter or an in-person visit that is easy to decline. If you phone, check the National Do Not Call Registry and your state's telemarketing rules first, and honor any request to stop contacting them. Encourage owners to speak with a HUD-approved housing counselor or an attorney before they decide.