What is a short sale and how does it work? How many times have we heard these questions? Too many unfortunately, although fewer now that the main effects of the subprime derivative collapse have all but run their course. It can be a complex topic to explain fully, but here are the main aspects of this solution to owing money on a negative equity home.

What is a Short Sale on a Home: Short Sales Explained

Before going further, let’s explain what a short sale fundamentally is. At its most basic it the sale of property at a sum below the balance of the mortgage still owed on it. For example, if you still owed a bank $440,000 on your house, and it was currently valued and sold at $420,000, that would be a short sale.

It would have to be agreed between the owner of the property and the bank. It is generally used when the alternative would be a foreclosure. If the homeowner was broke, then the bank and lender might take the view that the cost of the foreclosure proceedings would make it easier and possibly even cheaper to cut their losses and mutually agree to a short sale.

Negative Equity Solution

A short sale on a home only makes sense if the home is in negative equity:  i.e. its current value is worth less than what is still owed on the mortgage. If it has positive equity, for example if its value in the above example was $480,000, then the owner could sell it to pay off the mortgage or the bank could foreclose.

However, house prices are not rising so fast these days, with many remaining fairly static, so some mortgagees are finding that the equity on their homes is not reducing as they maintain mortgage payments. When they get into difficulty, they often find that the equity has become negative.  This is particularly the case with low or even zero down payment mortgages that were popular when banks and building societies were keen to promote house purchase.

Is a Short Sale on a Home Easy to Arrange?

Absolutely not – they just as complex a procedure as a foreclosure. Short sales are not automatically offered, even if you are in the classic situation that warrants one. You have several things to prove before a bank or building society will even listen to you. The most important of these is documented evidence that you are broke. You must prove that you can no longer afford to make mortgage repayments, and that there is no other option available to you other than foreclosure.

The lender will have to be 100% convinced that they will lose money if they foreclose on you, and that is not a simple thing to convince a bank of. Even if the bank does agree, a short sale is not handled like a normal home sale. You, the bank, the real estate agent and the new buyer all have to cooperate.

This is not a preferred solution for the bank. It is a last resort for the lender and for you, and only when it realizes that it is a cheaper option than foreclosure will the bank agree to a short sale.

The Consequences of Short Sales

The main consequence is that you lose your home – period! You get nothing in return but to owe no mortgage. One benefit is that it looks better on your credit record than a foreclosure, and you will finish up with a better credit score because you will have cleared your mortgage. However, it might be better for you to consider some options before going straight for a short sale.

You might be able to rearrange your mortgage loan, or perhaps even refinance to pay off your arrears and get back on a level footing. Discuss these options with your bank first.  If you do, and they fail to be viable options for your circumstances, the bank might be more likely to offer a short sale because you have made an effort to find an alternative solution. So what is a short sale? It is not a first choice solution to a problem, but might be offered if you have negative equity and no other option.