The Short Sale Process in the USA

Cat Song is a second-year law student from Fordham University School of Law in New York, NY.  She is currently working at Housing Rights Service as a legal research intern studying comparative housing law in the different U.K. jurisdictions.   In this article, Cat looks at the process of "short selling" a property, an option that has become increasingly popular for overburdened homeowners in the US. 

A “short sale” occurs where a lender gives permission for a property to be sold at a lesser value than that of the debts currently owed on it.  To be eligible for this process:

• a homeowner must be unable to afford the regular mortgage payments and
• the property must be in negative equity. 

This option has becoming increasingly popular for indebted households in the US. 

A short sale must be approved by the lender and any shortfall between the approved selling price and the existing mortgage (deficiency) can be written off, although some lenders may choose to secure a deficiency judgment against the borrower.  Some states have legislation that prevents a lender who has approved a short sale from pursuing the borrower for the deficiency.

Options for homeowners in arrears

A homeowner in mortgage arrears with negative equity has three options:

1. Go through the judicial process of foreclosure (bank repossession).
2. Give the keys to the lender if the lender agrees to forgive the borrower’s mortgage (referred to as a “deed-in-lieu of foreclosure”). 
3. Sell their home for less than the mortgage amount (a short sale).

The short sale process

A short sale begins when the homeowner receives an offer from a prospective buyer. Both this buyer and the homeowners must sign a purchase agreement.  The homeowner must then get permission from the lender to sell the property at a low price.

The homeowner must provide the lender with the following:

• A copy of the purchase agreement;
• Detailed information about the current owners’ finances including assurances that they don’t have sufficient assets to cover the shortfall;
• Proof that the prospective buyer can afford to purchase the home, usually in the form of a “pre-approval letter” from the buyer’s bank;
• A listing agreement between the homeowner and the estate agent; this proves that the property has been marketed for sale and that this offer is the best achievable price.

The lender will also ask the homeowner to fill out a “hardship package” application.  On this, the homeowner will be asked to explain

• why the mortgage has fallen into arrears and
• why a short sale would be the bank’s best option in this case.

Banks will usually only allow a short sale if the seller is suffering extreme hardship

The lender will run a credit check on the seller, and then arrange to have the home appraised.  When all the information they need has been received, the lenders will present this information to their investors to try and get an approval for the short sale.  This approval process can take up to 4 months, and the entire short sale process can take up to 12 months.

What happens to the shortfall?

The “deficiency” or shortfall that remains after the short sale is completed can be charged to the seller.  This means that the lender can sue the seller in court to have a deficiency judgment attached.  This deficiency judgment is an unsecured debt that is personally guaranteed by the seller. 

The seller can repay the deficiency in installments as a new loan, or it may be subject to wage garnishment or a bank account lien. 

In some instances, the seller is not charged with the shortfall.  This can occur when the seller’s state laws prohibit deficiency judgments, or when the seller is able to successfully negotiate a “waiver of deficiency judgment” with the lender as one of the terms of the short sale.  Lenders issue this waiver in instances where the seller can prove that their financial situation is particularly dire.

Read Cat's other articles