What is a short sale, and should you buy a home through one?

A short sale is when a property is sold for less than the amount owed on the mortgage. Short sales aren’t as common as they were during the decade following the 2008 housing crash. That’s because with housing prices rising quickly over the last few years, homeowners have built considerably more equity, decreasing the likelihood they’ll need to do a short sale.

The National Association of Realtors (NAR) reports the median existing home price rose 3.5%, from $358,200 to $370,700, from November 2021 to November 2022. This increase made it 129 consecutive months of year-over-year increases, "the longest-running streak on record," according to the NAR.

That said, the NAR reports that existing home sales dipped 7.7% from October 2022 to November 2022. With housing demand slowing down, it's possible prices could decrease too in the coming months and years, forcing more homeowners into short sales.

Read on to learn what a short sale is, how this type of sale works and why you may want to take advantage of it in the future.

Key insights

• A short sale takes place when a property is sold for less than the amount owed on the mortgage.
• Short sales are for homeowners experiencing financial hardship who can’t sell their homes to break even or turn a profit.
• Buyers who want to purchase a home through a short sale face several hurdles, such as longer timelines and the property being sold "as is.”

What is a short sale?

A short sale is a type of home sale that takes place when a mortgage lender agrees to accept an amount lower than what the seller owes on the mortgage.

Homeowners in financial distress may decide to pursue a short sale for several reasons. They may be struggling to keep up with their mortgage payments and want to avoid foreclosure, or they may want to sell the home but know they owe more than they can reasonably get for it.

While it may seem strange for a lender to accept a mortgage payoff for less than the loan amount, short sales tend to be less costly than letting a home fall into foreclosure. Ultimately, this type of sale lets the lender get most of its money back while minimizing losses for both parties.

How does a short sale work?

According to Derek Bauer, a real estate broker at Real Estate One in Michigan, the short sale process varies by state, since each state has its own statutory periods and guidelines for short sales.

According to the NAR, short sales typically work best when sellers have an extreme hardship that makes it "impossible or extremely impractical" for them to keep the home, and they’re willing to work with other parties for a successful transaction.

For a short sale to move forward, the lender must agree to sell the home for less than the amount owed on it.

Sellers typically must craft a hardship letter to their lender that explains their financial situation and their desire for a short sale. They also must list any other liens against the property, such as home equity loans or home equity lines of credit (HELOCs). Homeowners may also need to supply a list of assets, since having available funds to pay the mortgage will likely make them ineligible for a short sale.

Sellers must disclose to potential buyers if they’re selling the home via short sale. The home must also be priced according to local market conditions.

In some states, sellers who go through a short sale are required to make up for the deficiency between the sale amount and the amount owed on the mortgage. Other states, like California and Oregon, don’t allow such deficiency judgments.

How is a short sale different from a foreclosure?

There are several differences between a short sale and a foreclosure, starting with who owns the property during the sale process. In a short sale, the borrower still has ownership and legal rights to sell the property. They can also request a short sale from their lender without having missed any payments on their mortgage.

In a foreclosure, on the other hand, ownership is transferred to the lender, and the bank is selling its own asset directly. The foreclosure process typically begins after a homeowner has failed to keep up with the payments on their mortgage for at least three to six months.

What are the obstacles when buying a short sale?

Short-sale homes may have an appealing price tag, but there are several drawbacks to consider.

The process can be slow

Bauer, the real estate broker in Michigan, said that when he's working with a buyer to secure a short sale, the largest obstacle is time. It can take many weeks to months for a short sale to be approved or denied.

In the meantime, the buyer is often required to commit to a minimum period while the seller goes through this process. This time could be precious to a buyer, who may miss out on other properties while they wait.

The home may be sold “as is”

Most short sales are sold "as is," meaning the seller won’t make any required repairs or negotiate on repairs before closing. The buyer is responsible for making repairs to get the property move-in ready — which can chip away at the savings they hoped to get by purchasing a short-sale home in the first place.

The short sale may not be approved

Another problem with short sales is that buyers may incur the cost of inspections and appraisals, only for the sale to be denied by the lender. In this case, the buyer loses several months waiting for the sale to go through, as well as the money they spent on these items.

They may be hard to find

A final obstacle in buying a home through a short sale is that it may be difficult to find such properties in areas where home prices have risen dramatically in the last few years.

Should I buy a home through a short sale?

Only you can decide if buying a home through a short sale is worth it for you, but there are important considerations to keep in mind. Not only are short sales typically offered "as is,” but they also can take months to process and have a higher likelihood of being denied by the lender.

That said, short-sale homes may come with attractive pricing that can make the extra time, risk and hassle worth it.

Bottom line

At the end of the day, homes sold through a short sale come with an added layer of risk. Buyers may be able to secure a short sale for a price that's lower than they would pay on a similar home, but they'll face more red tape and waiting time along the way.

Ultimately, a short sale may be best for a buyer who has time to wait it out and won't experience problems if the deal falls through — that typically means someone who has a stable place to live, some extra cash they can afford to lose and a willingness to wait for a good deal.