What is a Bank Short Sale?

K. Kinsella

A bank short sale involves a homeowner with an outstanding mortgage and the bank holding the loan, who agree to sell the house for less than the balance currently owed on the mortgage. Falling property values sometimes result in mortgage balances exceeding property values. Homeowners who wish to sell can only do so by arranging a bank short sale and selling for an amount equal to current market value as opposed to the original purchase price.

In a short sale, a homeowner sells his house for less than he owes on it.
In a short sale, a homeowner sells his house for less than he owes on it.

Mortgages are legal contracts, and homeowners are obliged to settle the debt even if the property securing the debt loses value over time. In most instances, a homeowner who cannot sell a home for a price sufficient to cover the mortgage debt is expected to cover the shortfall with separate funds. Many homeowners who are unable to sell but have to relocate end up converting their homes in rental properties. Homeowners who usually end up becoming involved in short sales are people who are struggling to make their mortgage payments due to a loss of income or a payment increase caused by an interest rate change.

Prior to agreeing to a bank short sale, a homeowner must first list their home for sale on the local real estate market for a price sufficient to cover the outstanding mortgage debt. Banks typically expect a homeowner to list the property for several months before considering a price reduction. Homeowners usually work with local real estate agents who provide advice on recent home sales and help to establish a fair market value for the home.

A homeowner can lower the listing price of the property and entertain bids from prospective buyers. If the homeowner agrees to accept a bid, a sale contract cannot be agreed upon until the lender has also agreed to the terms being offered. Lenders sometimes take months to approve or decline bids on properties. When an agreement is reached between all parties, the sale occurs and proceeds go towards covering the mortgage. The homeowner receives none of the proceeds from the sale.

When homeowners default on mortgage payments, lenders typically foreclose on the property and sell it at auction. Most properties sold at auctions are bought by cash buyers who are prepared to only pay a fraction of the market value of a home. Consequently, lenders can recoup more money by agreeing to a bank short sale rather than foreclosing on a home.

A bank short sale does not always relieve the homeowner of the obligation to settle the remainder of the debt. Laws in many places enable lenders to pursue homeowners for the remainder of the debt years after the sale of the property. Short sales also have a negative impact on people's credit scores and remain on credit reports for a period of seven years.

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