There are two main outcomes for a homeowner who can no longer afford their home, and whose home is worth less than the amount they owe on their mortgage. This is also known as being “underwater.” Both outcomes aren’t really ideal, unfortunately.
The first option is to stop making mortgage payments and simply walk away, leaving the bank to foreclose on the property. In this scenario, the homeowner not only loses their home, but the foreclosure also remains on their credit report for up to seven years. For many homeowners during the Great Recession, foreclosure often resulted in bankruptcy.
The second option for homeowners who find their home’s value is less than what they owe is to work with the bank and sell their home in a short sale. In this scenario, the bank doesn’t have to repossess and foreclose, and while there is still damage to the homeowner’s credit, it may not be as bad as in a foreclosure situation.
The Short Sale Process
- The homeowner recognizes that the value of their home has dropped by 20% or more and they are unable, or no longer wish to make monthly mortgage payments.
- The homeowner weighs their options. They can let the bank repossess their home, evict them and sell their home in a foreclosure sale, or ask the lender to approve a short sale of the property.
- The homeowner provides the bank with copies of financial records along with a letter detailing why they feel a short sale makes sense in their situation.
- The lender signs off on the homeowner’s plan to sell for less than the remaining balance on their mortgage.
- A prospective buyer negotiates a price with the seller and signs a contract with the lender agreeing to purchase the property “as is” and giving the lender final approval of the terms of the sale. The buyer can include a provision in the contract to allow them to opt-out of the deal if a home inspection reveals considerable work would be needed.
- Processing paperwork and getting final approval on a short sale from the lender can sometimes take several months, with the whole process taking as long as a year to complete.
The benefits of buying a home in a short sale are obvious. Not only is the buyer getting a deal, but they may even be purchasing a home for less than the fair market value. But, purchasing a home through a short sale can be a long and arduous process, requiring the buyer to be patient and open-minded as they haggle with the lender and compete against possible counteroffers. Because the lender ultimately receives the funds at closing, as opposed to the homeowner, they have the advantage when it comes to negotiating a final sale price.
Sellers should be aware that in some states, a “deficiency judgment” may be made against them requiring them to pay the difference between what they owed on their mortgage and the selling price of the home. Buyers should look for a real estate agent who specializes in short sales and foreclosures and has experience negotiating price with lenders. Buyers should also be certain that a short sale has been approved by the lender before making an offer to the sellers.