What Is a Short Sale on a House? Process, Alternatives, and Mistakes to Avoid

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A short sale on a house is a home sale in which the mortgage lender agrees to accept less than the amount still owed on the loan. The sale price falls “short” of the payoff, and the lender, not the seller, receives the sale proceeds. Because the lender is taking a loss, it must approve the deal in advance. Without that approval, the lien on the property cannot be released and the sale cannot close.

Short sales usually happen when a homeowner is in financial distress, owes more than the home is worth, or both. For the seller, a short sale is a way to leave the home without a foreclosure. For a buyer, it can be a way to purchase below market value, but it comes with a slow approval process, as-is condition and the risk that the bank says no.

What a Short Sale Means in Real Estate

In real estate, a short sale is an offer of a property at a price below what the current owner owes on the mortgage. The word “short” describes the gap between the sale price and the loan payoff. It has nothing to do with short selling a stock, where an investor sells borrowed shares and hopes to buy them back cheaper. The two terms share a word and nothing else.

A mortgage has two parts, and a short sale treats them differently:

1. The lien. The lien is the lender’s security interest in the property. It gives the lender the right to sell the home to recover what it is owed if the borrower stops paying. In a short sale, the lender agrees to release the lien even though it is not being paid in full, so the buyer can take clean title.
2. The promise to repay. The borrower signed a promissory note promising to repay the loan. Releasing the lien does not automatically cancel that promise. The lender may forgive the remaining balance, or it may try to collect it through a deficiency judgment or a new note, unless state law or the approval letter prevents that.

This split explains much of what confuses people about short sales. The house can be gone while the debt question is still open. A seller who assumes “the bank took the house, so we’re even” can be surprised later.

Short sales are sometimes called pre-foreclosure sales, because they typically occur after a homeowner has fallen behind on payments and before the lender completes a foreclosure. They become more common when home prices fall. During the 2007 to 2009 financial crisis, home values dropped sharply in many regions, sales slowed, and many owners found themselves “underwater,” owing more than their homes were worth. A homeowner in that position cannot pay off the mortgage with an ordinary sale, so the only way to sell is with the lender’s agreement to take less.

How a Short Sale on a House Works

A conventional home sale is a two-party negotiation between buyer and seller, with the mortgage simply paid off at closing. A short sale adds a third party that controls the outcome: the lender. The seller and buyer can agree on price and terms, but nothing closes until the lender accepts the net payoff.

Lender approval

No short sale can occur without the lender’s prior approval. The mortgage lender, usually a bank, credit union or the company servicing the loan, reviews the seller’s finances and the buyer’s offer and decides whether accepting a loss now is better than its alternatives. The main alternative is foreclosure. If the lender believes it will recover more by foreclosing and reselling the home itself, it can reject the short sale.

Lenders typically want to see:

• A genuine hardship. The financial trouble should be new since the loan was made, such as a job loss, a serious health problem, a divorce or a death in the family. A problem the borrower concealed when applying for the mortgage will not earn sympathy.
• Inability to pay. If the borrower is current on the mortgage or still has substantial cash assets, the lender may refuse, or it may expect those assets to be used to keep paying or to cover part of the shortfall.
• A price close to market value. The lender will usually order its own valuation of the home, such as an appraisal or broker price opinion, and compare it with the offer.
• An arm’s-length buyer. Lenders generally require that the buyer and seller have no hidden relationship or side agreement, so that the seller cannot sell cheaply to a friend and buy the home back later. This is often confirmed with a signed affidavit.

If someone cosigned the mortgage, the lender may pursue the cosigner for payment before it considers a short sale at all, since the cosigner is equally responsible for the debt.

Who else has to agree

“The bank” is often more than one party. Many mortgages are serviced by one company and owned by another, such as an investor that bought the loan. The servicer handles the paperwork, but the loan owner’s guidelines govern what the servicer can accept, so a short sale may need approval up the chain. This is why sellers sometimes hear that a decision is waiting on “the investor.”

If the home has a second mortgage or home equity line of credit, that lender holds its own lien and must also agree to release it. Junior lienholders often receive little from a short sale, so negotiating their release can add time. A private mortgage insurance company, if one insures the loan, may also be involved because it shares in the loss.

How long it takes

Short sales are paperwork-heavy and slow. Lender review commonly takes weeks to months, and the full process can stretch from a few months to as long as a year, depending on how complete the file is and how many parties must sign off. Buyers often walk away during the wait, and a missing document, whether the seller’s omission or a filing error at the bank, can restart part of the review.

Example: The Numbers Behind a Short Sale

The following is a hypothetical example to show the mechanics. It does not represent any lender’s terms or typical market figures.

A homeowner owes $175,000 on a mortgage. Home values in the area have fallen, and the best offer the home receives is $150,000. Selling costs, including agent commissions and closing costs, come to $12,000 in this example.

The headline difference between the loan and the price is $25,000, but the lender’s actual shortfall is larger because selling costs come out of the proceeds before the lender is paid. If the borrower also owes missed payments, late fees or interest that the lender adds to the payoff, the deficiency grows further.

Deficiency = loan payoff amount (including any arrears and fees the lender includes) − net sale proceeds

The lender’s decision in this example comes down to whether $138,000 now is better than what it expects from foreclosure after legal costs, months of carrying the property, possible deterioration and a resale that may bring a lower price. The seller’s question is what happens to the $37,000: forgiven in writing, partly repaid, or left open for collection.

The Deficiency, Debt Forgiveness and Taxes

Will the seller still owe money?

After a short sale, the lender has two broad options for the deficiency:

• Forgive it. The approval letter or a separate agreement states that the lender waives the remaining balance. This is often called a deficiency waiver.
• Pursue it. The lender may seek a deficiency judgment in court, or it may ask the seller to sign a promissory note for part of the shortfall as a condition of approval.

State law can limit the second option. Some states have anti-deficiency rules that bar or restrict collection after a short sale on certain residential loans. California, for example, has a statute that prevents a lender from collecting a deficiency after it approves a short sale of a one-to-four-unit residence. Other states allow lenders to pursue the balance. Whether the loan is recourse or nonrecourse under state law also matters.

Because outcomes vary so much, a seller should read the approval letter closely. If the lender agrees to waive the deficiency, that waiver should be in writing and should say clearly that the debt is satisfied, not merely that the lien is released.

Taxes on forgiven debt

When a lender forgives debt, the forgiven amount can count as taxable income under federal tax law, called cancellation of debt income. A lender that cancels a debt may report it to the IRS on Form 1099-C. In the example above, a $37,000 waiver could create a tax question even though the seller received no cash from the sale.

There are exceptions. The Mortgage Forgiveness Debt Relief Act of 2007 created an exclusion for forgiven debt on a principal residence, and Congress extended it several times with changing limits. The tax code also excludes canceled debt to the extent the taxpayer is insolvent (total liabilities exceed total assets immediately before the cancellation), which ties directly to net worth at that moment. Which exclusion applies depends on the year of the sale and the seller’s finances, so a tax professional should review the situation once the short sale is approved.

How a Short Sale Affects Your Credit

A short sale hurts a credit score less than a foreclosure, but it is still a negative mark. Credit scoring treats any loan that was not paid as agreed as a derogatory event, and short sales, foreclosures and deeds in lieu of foreclosure all lower a score to some degree.

Much of the credit damage often comes from the months of missed payments before the sale, not from the sale itself. Those late payments are reported as delinquencies. The lender decides how to report the account, so a seller can ask the lender to report the account favorably as part of the negotiation. Lenders may be more open to that request when the homeowner raised the hardship early, before falling far behind. A free monitoring service such as Credit Karma can show how the account appears once it is reported.

A foreclosure stays on a credit report for seven years. The time before a seller can qualify for a new mortgage after either event depends on the loan program and the circumstances. After a foreclosure, waiting periods can run from two to seven years. After a short sale, some borrowers may qualify sooner, and in limited cases immediately, subject to restrictions.

Short Sale vs. Foreclosure

A short sale and a foreclosure are the two common endings for a homeowner who is behind on payments and owes more than the home is worth. In both cases the owner loses the home, but the process and consequences differ.

How a foreclosure works

In a foreclosure, the lender takes the property after the borrower fails to make payments. It is the lender’s last resort, used to recover what it can of the loan. Many foreclosures happen after the owner has already moved out. If occupants remain, the lender can have them evicted once it has the right to possession. The lender then orders a valuation and sells the home, sometimes at a public trustee sale or auction. Because the lender wants to turn the property back into cash, foreclosure sales tend to move quickly.

How a short sale works by comparison

In a short sale, the homeowner keeps more control. The owner usually lives in the home during the process, lists it with an agent, accepts an offer and negotiates with the lender. It takes more effort than letting a foreclosure run its course, but that work can mean less credit damage, a negotiated outcome on the deficiency and a potentially shorter wait before buying again.

Deed in lieu of foreclosure

A third exit is a deed in lieu of foreclosure, in which the homeowner signs the property over to the lender directly and the lender handles the sale. It avoids finding a buyer but still requires lender approval and still affects credit. A deed in lieu usually works best when the home has no second lien, since the lender takes the property subject to any other liens.

Alternatives to a Short Sale

A short sale ends with the owner leaving the home. Before choosing it, homeowners who want to stay should ask the lender about options that keep the loan in place:

• Repayment plan. The missed payments are spread over future months on top of the regular payment.
• Forbearance. Payments are reduced or paused for a set period, with a plan to repay later.
• Loan modification. The lender permanently changes the loan terms, such as the interest rate, term or balance, to make payments affordable. A modification may temporarily lower a credit score, as can any new credit application.
• Private mortgage insurance claim advance. Many borrowers who put less than 20% down were required to buy PMI. If the PMI company thinks the borrower can recover, it may advance funds to the lender to bring the loan current. That advance must eventually be repaid.
• A traditional sale. If the home is worth more than the loan, an ordinary sale pays off the mortgage in full and needs no lender approval. A short sale only makes sense when the owner is underwater.

These alternatives work best for a temporary hardship. When the hardship is permanent and the home is worth less than the loan, a short sale is often the more realistic path.

The Short Sale Process for Homeowners

Step 1: Assess whether the lender is likely to agree

The lender is not required to accept a short sale. A borrower with a new, documented hardship, who is behind or about to fall behind, and who owes more than the home is worth, is the kind of case lenders consider. A borrower who is current and has savings may be refused. If the borrower believes the loan itself came from predatory lending practices, that can also be part of the case.

Call the lender and ask for the loss mitigation department, not general customer service. That department handles short sales and other workout options and can explain the lender’s requirements and forms.

Step 2: Bring in professionals

Short sales involve legal, tax and negotiation issues that ordinary sales do not. Many sellers use:

• A real estate agent experienced with short sales. Agents can hold the Short Sales and Foreclosure Resource (SFR) certification from the National Association of Realtors, which covers qualifying sellers, negotiating with lenders and protecting buyers.
• A real estate attorney, especially to review deficiency language and state anti-deficiency rules.
• A tax professional, to assess the treatment of any forgiven debt.

These services cost money, but in many short sales the agent’s commission and certain closing costs are paid out of the sale proceeds with the lender’s approval, rather than by the seller in cash. Professionals who handle short sales regularly can explain how their fees will be paid. NAR rules that took effect on August 17, 2024 changed how buyer-agent compensation is offered and require written agreements between brokers and their buyer clients, which affects how commissions are negotiated in any sale.

Step 3: Set a realistic price

The asking price has to attract a buyer and satisfy the lender’s valuation. Pricing far below market makes the lender less likely to approve; pricing above market leaves the home unsold. Factor in selling costs when estimating the shortfall, as in the example above, so the seller understands how large the deficiency will be.

Step 4: Gather documents and find a buyer

The seller prepares a short sale package proving hardship. It usually includes:

• A hardship letter explaining what happened and why the payments cannot continue
• Recent pay stubs, or proof of job loss such as a termination notice
• Bank statements
• Tax returns and W-2s
• Supporting records such as medical bills or a divorce decree
• A financial statement listing income, expenses, assets and debts

Finding a buyer is the seller’s job, usually through an agent listing the home on the multiple listing service with a note that the sale is subject to lender approval.

Step 5: Submit the offer and the proposal to the lender

Once the seller accepts an offer, the listing agent sends the lender the listing agreement, the signed purchase contract, the buyer’s pre-approval letter, a copy of the earnest money check and the seller’s short sale package. The lender then reviews the file, values the property and responds with an approval, a denial or a counteroffer, for example a demand for a higher price or a contribution from the seller.

Be careful with what you disclose. If the lender rejects the short sale, it can use the financial information in the package to pursue the borrower in foreclosure or for a deficiency. An attorney can help decide what must be disclosed and how.

Step 6: Close, and confirm the debt outcome in writing

If the lender approves, the approval letter sets the terms: the minimum net proceeds, permitted costs, the closing deadline and what happens to the deficiency. Closing must usually happen before the approval expires. After closing, keep the approval letter, the closing statement and any deficiency waiver, and watch for a Form 1099-C.

Can a short sale be expedited?

There is no shortcut around lender review, but avoidable delays can be reduced. A complete, organized package at the start, prompt responses to document requests, a realistic price that matches the lender’s valuation, and early contact with any second lienholder all help. An agent or attorney who works regularly with the specific lender’s loss mitigation department may also know its process and forms.

Buying a Short Sale Home

Short sales can give buyers access to homes at a reduced price from a lender that is motivated to settle. They also demand patience and more homework than a typical purchase.

How to find short sale listings

Most short sale properties are listed by real estate agents and appear on real estate websites. Some are not labeled “short sale,” so look for clues such as “subject to lender approval” or “subject to third-party approval.” A buyer’s agent who knows the local market, ideally one familiar with short sales, can identify these listings and manage the negotiation.

What “contingent short sale” means

A listing marked contingent short sale (or “short sale contingent”) generally means the seller has accepted an offer, and the sale is waiting on lender approval. The home is under contract but not yet approved. Some listings in this status still accept backup offers. A buyer under contract on a short sale home is bound by the purchase agreement’s terms, but the deal cannot close until the lender signs off, and the contract usually allows either side to cancel if approval does not arrive by a set date.

Prepare to wait

The buyer’s offer is only the beginning. The lender may take weeks or months to answer, and it may counter at a higher price or reject the offer if it expects more from foreclosure. Meanwhile, the buyer’s mortgage rate lock, financing approval and moving plans can expire. Before signing:

• Ask how long the seller has been working with the lender and whether the package is complete.
• Make sure your financing and rate lock can be extended, or that you can afford to wait.
• Understand your earnest money terms if the lender rejects the deal.

Condition and disclosures

Short sale homes are usually sold as-is. The seller, who has no equity to protect and may lack the money for repairs, often provides fewer disclosures and will rarely agree to fix problems. The lender, which did not live in the home, typically will not make repairs either. That shifts the burden to the buyer: a thorough inspection before the contingency period ends is the main protection against surprises such as a cracked foundation, faulty wiring or termite damage. A short sale home may be in better shape than a foreclosure, since the owner usually still lives there, but that is not guaranteed.

Running the Numbers as an Investor

Investors often say the money in real estate is made when you buy. A good purchase price leaves room to cover repairs, holding costs and the discount you may need to offer to resell quickly. A high price erodes the margin. For a short sale, the purchase price is only one of four numbers an investor needs. (For a broader look at how property investing works, see our guide to real estate.)

Repair and renovation costs

Repair costs depend on the property’s condition and your plans. A realistic budget includes materials, labor, permits, inspection fees, trash removal, dumpster rental and storage. Since short sales come with limited disclosures, the pre-purchase inspection is where large hidden expenses are caught.

After repair value (ARV)

ARV is an estimate of the home’s fair market value after repairs and renovations. It is usually based on comparable sales (comps): similar homes that sold recently nearby, typically within about a mile, with similar square footage and numbers of bedrooms and bathrooms.

Carrying costs

Carrying costs are what you spend to hold the property until it sells. The longer the hold, including any delay waiting for lender approval and the renovation period, the more they add up. They include:

• Mortgage payments, including interest
• Property taxes
• Homeowners insurance
• Condo or association fees
• Utilities such as electricity, gas, water, sewer and trash

Estimating profit

Profit = ARV − purchase price − repair and renovation costs − carrying costs

If total costs are close to or above the ARV, there is little or no room for profit, especially after selling costs on the resale.

Some investors aim for at least a 20% profit and use rules of thumb that cap total investment (purchase, repairs and carrying costs) as a share of ARV, with lower caps in weaker markets:

• About 80% of ARV in a market with high demand and low inventory
• About 75% of ARV in a slightly rising market
• About 70% of ARV in a flat or cool market
• About 60% to 65% of ARV in a wholesaler’s market

These are guidelines some investors use, not rules any lender sets. The logic is that a rising market makes it more likely you’ll sell at or above ARV, while a falling market makes it more likely you’ll sell below it, so you risk less.

Hypothetical example. An investor estimates a home’s ARV at $200,000 in a flat market. Using the 70% guideline, total investment should stay near $140,000. If repairs are estimated at $25,000 and carrying costs at $8,000 for the expected holding period, the maximum purchase price is about $107,000 ($140,000 − $25,000 − $8,000). If the lender’s valuation and counteroffer push the price to $125,000, the deal no longer meets the investor’s target, even though it is still “below market.”

Advantages and Disadvantages of a Short Sale

For the homeowner

Advantages

• Disposes of a property and a debt the owner is unlikely to repay
• Avoids foreclosure, which is generally more damaging to credit
• The lender may write off the remaining balance as a loss, reducing the owner’s debt
• Selling costs are typically paid from the sale proceeds rather than by the seller in cash
• The owner can usually remain in the home during the process
• Possible shorter wait before qualifying for another mortgage than after a foreclosure

Disadvantages

• Still a negative credit event, along with the missed payments that preceded it
• Heavy paperwork and a slow, uncertain approval
• The deficiency may not be forgiven where state law allows collection
• Forgiven debt can create a tax liability
• The lender can reject the deal and foreclose anyway

For the buyer

Advantages

• Potential to buy below market value
• A lender that is motivated to resolve a nonperforming loan
• The home may be in better condition than a foreclosure if the owner has been living in it

Disadvantages

• Long, unpredictable timelines that can outlast financing approvals
• Fewer disclosures and as-is condition
• The lender may counter at a higher price or reject the offer
• Multiple lienholders can complicate and delay closing

Mistakes to Avoid

For sellers

• Assuming the debt disappears. Releasing the lien is not the same as forgiving the loan. Get any deficiency waiver in writing, with clear language.
• Waiting too long. Contacting the lender early gives more time to negotiate and may make the lender more flexible on credit reporting. A foreclosure sale date that arrives before approval can end the short sale.
• Overlooking second liens. A home equity loan or line of credit lender must also agree, and ignoring it until late in the process can sink a deal.
• Submitting an incomplete package. Missing documents are a common source of delay.
• Ignoring taxes. A forgiven balance can be reportable income unless an exclusion applies.

For buyers

• Skipping or rushing the inspection. With limited disclosures, the inspection is the buyer’s main source of information about the home’s condition.
• Not leaving enough time. Short sales often take longer to close than ordinary sales. Make sure your financing, rate lock and lease or moving plans can stretch.
• Treating the list price as the final price. The seller’s acceptance is only one approval. The lender decides what it will accept.
• Underestimating costs as an investor. Long approval waits add carrying costs before renovation even begins.

Mortgage lending discrimination is illegal. A borrower who believes a lender has treated them differently based on race, religion, sex, marital status, national origin, disability, age or receipt of public assistance can file a complaint with the Consumer Financial Protection Bureau or the U.S. Department of Housing and Urban Development.

FAQs

The Bottom Line

Short sales matter most to underwater homeowners facing a lasting hardship and to buyers willing to wait for a discount. Sellers should contact the loss mitigation department early, account for every lienholder, and get any deficiency waiver in writing. Buyers should plan for long approval times, as-is condition and a thorough inspection, and investors should count carrying costs before making an offer.