Yesterday, a headline at The Wall Street Journal talked about “Why 2010 Could be the Year of the ‘Short Sale’”.  It outlined the reasons why short sales are becoming more common and talked about some of the challenges inherent in shorting a home.

Well, if something’s going to be the thing for the year, it makes sense to understand a bit about it, right?  That’s what I thought, anyway.  And I also know that there are many people who’ve heard the expression “short sale” without really knowing what it meant.  So, I thought I’d provide this little overview…

Let’s start by building a basic definition.  AOL Real Estate provides a good start, stating that “In a short sale, a seller facing potential foreclosure strikes a deal with their lender to accept less than they owe on the property in exchange for avoiding foreclosure.”

In other words, someone’s about to lose their home to foreclosure.  Instead, he or she finds a buyer who’s willing to pay less than full amount due.  The homeowner goes to the bank and says, “I know you want the whole enchilada, but I can’t pay on this note.  However, I found someone who’s willing to pay most of it.  Wanna sell to them and just forget about the difference?”

Well, hopefully he or she is a more eloquent, but you get the idea.

Now, let’s break that down into its component parts to understand the process a little better.

“…a seller facing potential foreclosure…”

Short sales are not something people can do just because they’d like to sell their home after making a poor investment decision.  There really is a need requirement.  Lenders won’t agree to take less than their owed just because a mortgage inconveniences the homeowner.  The homeowner needs to be up against the wall, facing foreclosure–and he or she will need to demonstrate that their situation warrants a break from the lender.  For instance, a lender will require a hardship letter outlining the circumstances leading to the request and explaining why it’s unrealistic to anticipate that the homeowner will be able to cure their mortgage default.  The homeowner will need to open his or her books to substantiate their claims, as well.

“…strikes a deal with their [sic] lender…”

A homeowner can’t just roll out of bed in the morning and decide to short sell his or home.  As intimated above, the lender needs to agree with the plan and that isn’t always a smooth process.  The lender may feel as though foreclosing on the property is a better deal for them than excepting less than the amount owed.  It’s also possible the lender may just be too bureaucratically impaired to make anything happen.  This is a major issue.  Even though banks are getting better at processing these requests, the process can be slow moving.  In fact, USA Today offered this rather sobering assessment of short sales and how lenders are handling them:

Just 23% of short-sale offers that homeowners receive from potential buyers actually close, according to a February study of 1,300 real estate agents by Campbell Communications. More than 90% of agents cited a slow response from the lender as the reason short sales were lost.

Just 23%!  However, the overall number of short sales continues to increase.  That “year of the short sale” article in the The Wall Street Journal noted that sales of bank owned homes is dropping with short sale numbers went up by 16% in December and January.  So, it is possible to get through the process.  If you’re interesting in doing it, be prepared to call you lender repeatedly and to keep pushing, all the while doing every little thing right.

“…avoiding foreclosure…”

That’s the whole reason behind a short sale, and it can work.  While the seller will usually get a big slam against his or her credit score, the ugliness of foreclosure is avoided.  And, occasionally, it’s possible to walk away from a short sale without even taking a hit to one’s credit score, if one can negotiate that with the lender.

The short sale is a case of everyone trying to get the most out of a lousy situation.  The seller gets out of an impossible mortgage and avoids foreclosure.  The bank avoids acquiring property it doesn’t want and the annoyance of going through the foreclosure process.  The buyer can pick up a home at a better-than-expected price.

Does everyone win?  No.  But two of the three parties lose less than they otherwise might.

Further Reading:

If you’re interested in some short sale advice from someone who’s been there, “Debt Kid”  has an interesting post.

Elizabeth Weintraub discusses the short sale process in some detail.