How Short Sales Work

The Short Sale Process

To simplify things, let's walk through the short sale process from the prospective of the buyer. As a buyer, the first step is to find short sale listings. Short sales are rarely listed as such, because they can't be approved until there's an offer on the table. Instead, sellers use euphemisms like "pre-foreclosure," "third-party review required" or "subject to bank approval" [source: Freddie Mac]. A good place to start is the pre-foreclosure section of a Web site like RealtyTrac, which carries listings in all 50 states.

Once you have a few listings in mind, compare the prices of similar homes in the area, especially those that recently sold. That gives you a better idea of the fair market value. With a price range in mind, the next move is to get a mortgage preapproval letter from your lender. As a buyer, this will not only lock in an interest rate for homes in your price range, but also show the seller's bank that you are a serious buyer.

When you find the home you want, the next step is to make an offer. As a buyer, you will sign a purchase contract for what you and your real estate agent believe is a fair market price. You will also be asked to supply earnest money, a refundable cash deposit that once again shows your commitment to buy.

In a traditional home purchase, this is where buyer and seller negotiate and arrive at a final purchase price. But that's not the case in a short sale. In a short sale, it's the seller's mortgage lender that needs to approve the sale price.

For that to happen, the seller first needs to prove that he or she cannot afford to pay the mortgage and that a short sale is the only option to avoid foreclosure. Required documents include:

  • Hardship letter with income statements and monthly expenses
  • Any foreclosure notices received
  • Proof that other loan modification efforts have been denied

The mortgage lender will then take weeks or months to consider the short sale [source: Toy]. During this time, it will seek approval from investors who bought the mortgage debt and conduct its own appraisal of the property value [source: Bank of America]. The bank might respond with a counteroffer or deny the short sale for a variety of reasons, including [source: Freddie Mac]:

  • It believes the seller can afford pay the mortgage.
  • It decides that it can recuperate more money from the seller's private mortgage insurance.
  • The offer is below the fair market value of the home.

If approved, the short sale will continue like a traditional home purchase with a closing. Keep in mind, though, if the home has a second mortgage, a home equity loan, or other liens on the property, this process will have to be repeated for each lender. Yikes.