Getting behind on your mortgage payments has to be one of the most stressful moments a homeowner goes through. The sleepless nights, dodging phone calls from your bank, and additional stress can take their toll. Thankfully, homeowners have options to get out from under that debt, thanks to a thing known as a short sale. However, going through a short sale isn’t something to be taken lightly as there are consequences that must be considered. But are those consequences worth the payoff? What are the pros and cons of a short sale, anyhow?
A short sale may give you, as the homeowner, the option of walking away from your obligation to your bank. While your credit score will take a hit due to the late payments and short sale, it’s still better than a foreclosure. The biggest thing you’ll need to consider is whether or not your bank takes the short sale payment in full for your debt or if they’ll still require you to pay the outstanding balance. This will be laid out in your payoff letter and will determine whether or not a short sale is suitable for your situation.
But I’ll get into all of that in a minute. First, let’s talk about what a short sale actually is, the process that goes on during a short sale, and what you’ll need to keep an eye out for to ensure you can walk away to a fresh start.
What is a Short Sale?
A short sale is a method of selling a house for less than what’s owed to the bank. Typically this happens when the homeowner has fallen behind on their mortgage payments and cannot get back on track. It’s a preventative measure to prevent the foreclosure process from happening.
How Does a Short Sale Work?
A homeowner will work with a real estate agent to find a potential buyer to take ownership of the home. To see how this works, let’s say Joe owns a house with a $150,000 mortgage. Unfortunately, due to market conditions, the home is now worth only $100,000. On top of that, Joe recently lost his job and is having trouble making ends meet. He’s started to receive letters in the mail from the bank asking what’s going on.
Joe sees that he’s staring down the barrel of a foreclosure, so to stop that from happening, he and his agent work together to list the house for $100,000 with the stipulation that it’s a short sale. Jane and her agent see the house and are interested in making an offer of $100,000. Joe takes Jane’s offer to the bank to say, “I’m not going to be able to pay off my debt to you, but Jane here has $100,000. Would you be willing to take that and give her the house?”
The bank will then crunch their numbers to see if it’s better to accept the $100,000 and transfer ownership to Jane or to deny it and foreclose on Joe. They’ll need to determine whether it’s worth the hassle to go through the long, expensive foreclosure process or if they should cut their losses and accept the short sale proposal. You might think they’d be silly not to take an open offer for the majority of their money, but banks know down to the penny which path is more profitable.
I can’t give you any odds for which way a bank will lean as it will depend on their internal cost-benefit analysis. But once the short sale offer is placed, the bank will have two options: accept or reject.
What Happens if the Bank Accepts the Short Sale
If the bank agrees to sell the home to Jane, they’ll issue what’s called a Payoff Letter. The payoff letter will either say:
- We’ll take the short sale price as payment in full of your (Joe’s) obligation or
- We’ll sell the house to Jane, but Joe is still on the hook for the remainder of the balance due.
The goal for Joe is to get that first option which releases him from the remaining $50,000 owed. If the bank doesn’t accept the short sale as payment in full, they can come after Joe or sell the debt to a collections agency as unsecured debt.
If the bank only provides Option B, that doesn’t mean Joe is required to accept that. He can try to negotiate with the bank or reject their payoff letter offer altogether. Rejecting it removes the option of a short sale happening, though.
What Happens if the Bank Does Not Accept the Short Sale
If the bank calculates that it’s better to recoup their costs through foreclosure, then they’ll issue a notice saying the short sale has been denied. Joe should then expect to receive notices that the foreclosure process is now in effect.
What are the Pros of a Short Sale?
If you’re able to get your payoff letter to state that your obligation to the bank is paid in full, then that removes the burden of your outstanding mortgage debt. In addition, while the short sale and your late payment history will show up on your credit history, it’s still better than the hit you’d take if it were a foreclosure instead.
Also, for what it’s worth, there’s something to be said for being able to, in a way, vet the new owner of the home. During foreclosure, any ability you had as the homeowner is completely revoked. Knowing that you’ve found a buyer interested in caring for your home the same way you would might soften the blow.
What are the Cons of a Short Sale?
The cons of a short sale are the gamble that you might still be on the hook for the balance of your mortgage. Also, you’ll lose the house and any equity you’ve put into it.
Your credit history will also take a hit. Not only will there be a short sale notated, but your history of late payments will add a double hit to your score. Keep in mind that these are temporary, though, and you can work your way back up.
Whether you decide to put your house on the market as a short sale is not an easy decision to make. Having a short sale may be more pragmatic than going through the foreclosure process, but giving up your home still hurts. If you get into a spot where you’re weighing your options, it’s important to first reach out to your bank to see if there’s a way you can work out a payment arrangement. While they’re a business, it’s still much easier for them to keep you in the home on a strict payment plan than having to go through eviction and foreclosure. Don’t be intimidated or ashamed; your bank has seen (and worked with) worse. The sooner you confront the issue head-on, the better likelihood you’ll be able to keep your house.
But if you can’t make an arrangement work, there’s no shame in considering a short sale. Consider the pros and cons listed here and talk with your real estate agent to see what options there may be.
Do you have any tips for someone who’s considering a short sale?