A short sale is one way out of a home you no longer wish to own. It can be an effective exit strategy, but does present some risks. You could end up owing your bank or mortgage company tens of thousands of dollars for the balance remaining after the short sale, and your credit score could drop if you missed payments waiting for the short sale to be approved. Despite that, many people consider a short sale preferable to foreclosure, and it should be considered if you must leave your home and have no other exit strategy available.
Definition
A short sale is the selling of a home for less than the balance remaining on the mortgage. People who owe more on their mortgage than the home is worth are considered to be "upside down" on their mortgage. Many people find themselves in this situation after home values decline because of an economic downturn or recession.
Negative Equity
It doesn't take much for a homeowner to become upside down. Some people start out with small down payments of as little as 3.5 percent for FHA-insured loans, and when values drop, they find themselves in a precarious situation. Other people drive down the equity of their homes by taking out home equity loans to finance everything from medical bills to vacations. They also become vulnerable when home values fall. Some people fall victim to simply having paid too much for their homes, and are shocked to see them lose a third or even half of their value when a housing bubble bursts.
Financial Problems
A decline in home values generally isn't an immediate problem if the homeowner can continue making the monthly payments. However, a job loss or an illness can create a catastrophe, making it impossible for the homeowner to continue paying the mortgage. That often leads to a short sale as an exit strategy.
Making Up the Difference
A short sale can be a perfectly fine exit strategy if you have the money to pay the shortfall at closing. The Washington Post reports that it is common for people to pay considerable sums of money out of their own pockets to sell a house through a short sale. Example: The balance on your mortgage is $240,000 but the house is appraised for just $215,000 -- and that is all your buyer is willing to pay. The bank reviews your financial situation and discovers that you have assets that can be turned into cash, such as retirement accounts. As a result, the bank refuses to allow the short sale to proceed unless you pay the $25,000 difference between the buyer's offer and the balance left on the mortgage. You then agree to take money from your 401K to make up the difference.
Foreclosure Threat
Some people who clearly cannot make up the difference in a short sale may settle for foreclosure -- if the bank isn't willing to make a deal. The Post reports that some banks may offer an arrangement rather than foreclose. The Post reports about one homeowner who was short by $30,000 in a short sale, but the deal was allowed by the bank with the former owner agreeing to make payments of $1,000 a month until the $30,000 was paid. In rare situations, the bank may forgive the remaining balance, or it may elect to allow the deal to proceed but file a lawsuit against the former owner later for the balance.
Written Agreement
If you feel a short sale is right for you, use a real estate attorney to negotiate the best deal that he can, and get all the details in writing. It's especially important to negotiate a deal that allows you to walk away without the threat of a future lawsuit.
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