How Do You Do a Short Sale to Avoid Foreclosure? Here’s a Step-By-Step Walkthrough

You bought a home with every intention of building wealth, securing stability for your family, and paying the bills on time. But as one of the largest debt vehicles, mortgages carry equal opportunity and risk. Somehow, you’ve found yourself too far underwater on your current loan with a stack of final notices that read “Mortgage Past Due!”

Rather than face foreclosure, pursuing a short sale can offer financial solace. But real estate estate and distressed sales experts warn: it’s far from a perfect solution or easy out. So how do you do a short sale if your back’s against the wall? With patience, close attention to the rules, and an agent who’s on your side.

Here we’ll walk you through each step, including:

1. Determining whether a short sale is right for you.
2. Finding a real estate professional to guide you through the process.
3. Submitting your hardship letter.
4. Sending in your other required documentation to prove financial instability.
5. Selling your home “as is” on the open market.
6. Pro tips to get to closing and move on.

Why the need for short sales? Understanding the math behind these transactions

A short sale is when your lender agrees to let you sell your home for less than you owe on your mortgage.

Short sales long precede the U.S. subprime mortgage crisis, but before the housing market crash, few people even knew what a short sale was.

That changed drastically when in 2008, short sales made up a whopping 11% of home sales and real estate agents were called upon to better understand these transactions and develop the skills to navigate these deals.

As the result of strong home price growth and the economic comeback over the past several years, short sales have now shrunk to pre-crisis levels in many parts of the country and make up only 1% of total home sales in 2018.

But in any market, some homeowners face financial hardship and may need to execute a short sale to get out of a bind.

The most common types of short sales happen when a homeowner is underwater, meaning the owe more on their mortgage than the home is worth.

Let’s walk through an example.

Say you bought a house in 2016 for $300,000. You put down 5% or $15,000, and took out a mortgage for $285,000.

At an interest rate of 4%, you’ve paid off $33,000 of your mortgage over the past two years.

But during that time, home values in your neighborhood have gone down, and now your home is only worth $200,000. Unfortunately, you lost your job and can no longer afford your mortgage payments.

If you sold your home, your lender would say, “Hey, thanks for the $200,000, but you still owe me $52,000 on this loan. A deal’s a deal.”

If you in no way, shape, or form have the extra $52,000 to bring to the table, and your mortgage payments are seriously delinquent, that’s when you might be able to negotiate a short sale.

Note that a short sale can arise even when the home is worth more than the mortgage. In some rare cases, a seller may be inches away from paying off the mortgage but still owe more than they can afford to pay in closing costs.

Why is it called a short sale?

The word “short” in short sale refers to how the lender is “shorted” the original loan amount. It has nothing to do with the length of the deal.

In fact, selling your home using the short sale process takes much longer than a traditional brokered deal—we’re talking 4-6 months or even years. Compare that to traditional listings, which were only on the market an average of 32 days as of September 2018.

If you are considering a short sale, what is on the line?

Although a short sale will allow you to walk away from your mortgage without penalties, a short sale still carries implications compared to a traditional sale.

First, the IRS treats forgiven debt as taxable income. Even if you don’t owe a lender for the shorted mortgage, you may owe the government.

Your lender will report your forgiven debt on a 1099-C form so it is important to plan ahead by setting aside money to cover the increased income tax obligation.

Second, if you plan on using a short sale to protect your credit history, keep in mind that lenders are under no legal obligation to not report a short sale to credit reporting bureaus.

The lender may report your mortgage as a line of credit “not paid as agreed” which can follow you for as long as 7 years. Any delinquent mortgage payments leading up to and during the short sale process can also appear on your credit history and impact your credit score.

Lastly, your outstanding debt may be sold off to a collection agency that can pursue you.

How are short sales different than other transactions?

During a short sale, the lender isn’t getting all of its money back as promised. So unlike a traditional sale or even a foreclosure, every short sale is a unique experience directed by the lender, who holds all the cards.

In a traditional transaction, the new home buyer can assume the current mortgage from the seller, the seller can settle the loan with the money from the deal, or in rare cases, perform a 1031 exchange or transfer the loan to a new property.

In a foreclosure scenario, the lender is seizing the real property from the borrower due to delinquency. Foreclosures are costly and lenders follow strict guidelines to remain compliant with the law. After posting all the requisite notices and a Notice of Default in the county records, the Notice of Sale and auction occurs. This pre-auction process can take upwards of four months. On average, a foreclosure can take a year to complete.

Lenders agree to a short sale for a few reasons. As foreclosures are often costly for lenders, a short sale can offer a compromise for both parties: lenders can minimize their losses and borrowers can protect themselves from ruined credit.

Lenders do not want to initiate a foreclosure as they assume the risk and legal costs of holding an REO for over a year with the addition of the shorted loan amount.

In essence, a short sale is a compromise for both parties.

Now, let’s jump into the steps involved in the short sale process.

Step 1: Determine if a short sale is right for you.

Although short sales appear like a good deal on the surface, they are not without their own unique drawbacks and hurdles.

In fact, not all borrowers who are simply upside down on their mortgage can qualify for a short sale. If you are considering a short sale, speak to a real estate attorney to understand how your state lending laws may affect your chances.

Short sales are ideal for borrowers who are:

• Underwater on their loan
• Behind on their mortgage payments
• Unable to refinance or modify their mortgage
• Facing foreseeable long-term financial hardship
• Listing their homes in unfavorable market conditions which will not satisfy their debt obligation
• No longer able to afford the costs of homeownership and need to leave

Before you launch into short sale mode, note that lenders are willing to work with borrowers who are behind on payments or are unable to make timely, complete payments. Before considering a short sale, speak to your lender first to find out about any temporary mortgage relief options.

Step 2: Assemble a dream team to get you through this tough process.

Distressed sales and traditional sales are widely different. The bank now stands between you and the buyer of your home, and your agent needs to know how to handle the extra layer of unpredictability.

That’s why before you initiate a short sale, you need to hire a real estate agent (or broker depending on your state) with hands-on experience navigating these types of transactions.

Not sure where to start? Consult our comprehensive guide to finding the best short sales Realtor for your needs.

Above all, make sure you ask any candidates you’re considering one critical question: How many short sales have you handled to date? You need someone who does at least a handful of these deals every year.

It’s also a good idea to find out if your agent candidates have completed the National Association of Realtors Short Sales and Foreclosures Resource Certification program, or if they are a Certified Distressed Property Expert.

To expedite this process, work with a HomeLight concierge to get matched with top real estate agents in your area who have a successful track record of short sale closings.

Step 3: Submit the hardship letter.

“The hardship letter is going to be the most pertinent document that you’re going to end up having to submit,” says Brent Wilk, a foreclosure specialist and top-selling agent in Chicago.

“Unfortunately, you’re apologizing to the bank for not being able to meet the requirements you signed to at the closing.”

You’ll submit your hardship letter to the bank along with a number of documents in order to prove your financial instability. When writing the letter, it’s important to be specific, direct, and clear as to why you are unable to make your mortgage payments on time and/or in full each month.

If you lost your job, or are losing your house to other means, the hardship letter is where you need to explain how you got into this situation. That doesn’t mean your letter needs to be the length of a novel. Three to 10 lines may suffice, so long as you are precise in your explanation.

“Times are changing with the nation,” says Wilk. “Unemployment is much lower than it was. At the same time, ultimately, there are hardships.”

Step 4: Send in your supporting documents.

With the hardship letter drafted under the guidance of your agent—which can be handwritten for an added bonus—your bank will need additional documentation to fully understand your financial situation before a short sale can begin.

The Letter of Authorization will grant your bank permission to disclose personal information to your agent, title companies, or any other parties that will be involved in the short sale. Make sure to include the loan reference number, the real property address, your agent’s contact information, as well as your contact information.

The Preliminary Net Sheet is a personal finance audit which shows how much you are expected to owe once the sale closes. This spreadsheet should outline in detail all the fees, commissions, and other outstanding payments, including the expected closing price on the home.

Handing over Proof of Income, Assets, and Bank Statements should feel familiar: this information was once requested by your lender when you were pre-approved for the loan. In this case, your lender will need to see if you hold any instruments, other real property, money market accounts, or any other investment vehicles which could help satisfy your obligation. Your lender will want full transparency to know you are truly facing financial hardship.

Your agent will put together a Comparative Market Analysis (CMA) which will demonstrate that your home’s value is unable to satisfy the loan obligation. (Your lender will also perform an appraisal followed by one or more broker price opinions throughout the short sale process.)

Optionally, an Offer to Purchase from a prospective buyer can help speed the process along.

Your agent will include the listing agreement, the copy of the offer, as well as any contingencies.

Your lender will want to know what the buyer will be paying for and what can be negotiated.

Keep in mind that the buyer may not qualify for their own loan, so having a pre-approved buyer for the loan amount beforehand is paramount.

Step 5: The short sale begins.

Once the lender approves you for the short sale process, your agent will handle the negotiations between the bank, the buyer, and yourself (when applicable).

If you don’t have a buyer lined up, the short sale process will be similar to a traditional sale: your agent will market your home to prospective buyers and field offers.

Unlike a traditional sale, your lender will want to negotiate with the buyer’s agent to discuss fees and specific contingencies.

Buyers are wary of short sales, and for good reason. When a seller lists a home, the listing agent prepares a disclosure packet which is required by law. The disclosure packet outlines every single defect with the home so the buyer knows what is at stake. However, lenders are not required by law to prepare a disclosure packet, so buyers are approaching the short sale “as is.”

That means if by any chance you have a buyer lined up to snatch up your home, that will surely expedite the whole process. If not, expect delays.

Next, your agent will collect financial information and negotiate with other lien holders to see who has priority. Your agent will be responsible for working with the buyer’s agent and your lender to finalize the sale.

During the short sale process, make sure to keep up with your utilities, HOA dues, and insurance. After all, you will still be living at home unless you have other arrangements.

Neglecting chores such as landscaping or general maintenance can attract unwanted headaches such as fines from the city.

Step 6: You close the deal, and face the financial consequences.

Once the buyer of your home and the lender come to terms, the deal closes much like a normal home sale.

Now, even though a short sale will allow you to walk away from your mortgage without penalties, a short sale still carries implications different from a traditional sale.

First, you’re not making any money on the sale, and the IRS treats forgiven debt as taxable income.

Even if you don’t owe a lender for the shorted mortgage, you may owe the government. Your lender will report your forgiven debt on a 1099-C form so plan ahead by setting aside money to cover the increased income tax obligation.

Second, if you plan on using a short sale to protect your credit history, keep in mind that lenders are under no legal obligation to not report a short sale to credit reporting bureaus.

The lender may report your mortgage as a line of credit “not paid as agreed” which can follow you for as long as seven years. Any delinquent mortgage payments leading up to and during the short sale process can also appear on your credit history and impact your credit score.

Lastly, your outstanding debt may be sold off to a collection agency that can pursue you.

Tips for how to get through a short sale

• Be patient.
  It can take anywhere between 3 and 10 months for the bank to respond to your hardship letter and initial documentation to let you know if you qualify for a short sale and the terms for the sale. Then, there’s the course of the home sale itself to navigate. Short sales take longer than traditional sales because the lender needs to find a buyer who will purchase the home “as is.” The bank is not going take on the costs of any additional repairs to make the home sell faster.
• Be proactive.
  The best time to give the lender their requested documents was yesterday. Technically, they are doing you a favor.
• Hand write your hardship letter for a personal touch.
  But only if you have good handwriting! If you’re on the fence about it, typing is a safer bet. Most importantly, the lender needs to be able to read the letter clearly. If they’re squinting or trying to make sense of a mess, you might ruin your chances for qualification.
• Select a battle-hardened agent.
  You want someone who’s done this before, and will stick with you through the long process!
• Communicate frequently.
  “Don’t become an ostrich and bury your head in the sand,” says Wilk. “When a bank is going to try and reach out with you communicate, the less you communicate with the bank, the faster the transaction is going to end up moving forward toward the foreclosure status.”
• Keep up with your other obligations throughout the entire process.
  Pay your utilities, HOA dues, and insurance. “If you fall back on the HOA dues, it could be another mess,” explains Wilk.
• Do not neglect your home!
  Even though you are separating from your home, make sure to keep up with landscaping and general maintenance, or you’ll risk getting a city violation—as if you need any extra debts right now. Emotionally, that can be tough because your heart’s no longer in this place. But if your electric gets cut off and your sump pump backs up, now you’re also dealing with a flooded basement.

Short sale, long road

When a borrower owes more on a mortgage than the home is worth, and if the proceeds from selling the home fall short of the mortgage obligation, a short sale offers borrowers an exit that avoids the penalties of a foreclosure.

Indeed, a successful short sale can feel like a new lease on life. But it takes a long time to get there, and this road is not without its risks and trials.

If anything, think of a short sale as an opportunity to become a smarter shopper. Play your next mortgage as safe as you can (thankfully, it will be easier to get one than if you’d foreclosed), and stay within your means. Never max out on your loan limit, no matter how hard you fall in love with your next dream house.