A short sale occurs when a homeowner sells their property for less than the mortgage balance owed, and the lender agrees to accept the proceeds as full or partial satisfaction of the debt. It is an alternative to foreclosure for homeowners who are underwater on their mortgage and in financial hardship.
The term “short” refers to the proceeds falling short of the loan balance — not the length of the transaction (which is often long).
When Is a Short Sale Used?
Short sales happen when:
- The homeowner owes more than the home is worth (underwater/upside-down)
- The homeowner has a genuine financial hardship (job loss, divorce, medical crisis)
- The homeowner cannot afford to keep the home and wants to avoid foreclosure
Lenders prefer short sales over foreclosures because they avoid the cost and time of the foreclosure process and typically recover more of the loan balance.
Short Sale Process: Step by Step
| Step | Who Does It | Typical Timeline |
|---|---|---|
| 1. Homeowner contacts lender about hardship | Seller | Day 1 |
| 2. Lender reviews hardship package | Lender | 2–8 weeks |
| 3. Home listed for sale | Seller’s agent | Ongoing |
| 4. Buyer makes offer | Buyer | — |
| 5. Seller accepts offer, submits to lender | Seller + agent | 1–2 weeks |
| 6. Lender reviews, orders BPO/appraisal | Lender | 4–12 weeks |
| 7. Lender approves, counters, or rejects | Lender | — |
| 8. Closing | All parties | 2–4 weeks after approval |
Total typical timeline: 3–9 months. Bank approval is the biggest variable.
Short Sale vs. Foreclosure vs. Deed in Lieu
| Option | Who Controls Sale | Credit Impact | Deficiency Risk | Timeline |
|---|---|---|---|---|
| Short sale | Seller (with lender approval) | Moderate | Possible | 3–9 months |
| Foreclosure | Lender | Severe | Possible | 6–18 months |
| Deed in lieu | Lender takes title | Similar to foreclosure | Less likely | 2–6 months |
A deficiency is the gap between what the home sold for and what the borrower still owes. Whether the lender can pursue you for this depends on state law (some states have anti-deficiency statutes) and the specific agreement.
Tax Implications of a Short Sale
When a lender forgives debt in a short sale, the IRS may treat the forgiven amount as ordinary income under debt cancellation rules. However, there are important exclusions:
- Insolvency exclusion: If your debts exceed your assets at the time of the short sale, the forgiven amount is excluded from income
- Qualified principal residence exclusion: Tax relief has been periodically extended by Congress for mortgage debt forgiven on your primary residence — verify the current law at IRS.gov
The lender sends a 1099-C (Cancellation of Debt) for any forgiven amount. Work with a tax professional to determine how much, if any, is taxable.
Worked Example: Short Sale Math
David owes $320,000 on his mortgage. His home is worth $270,000. He is three months behind on payments after a job loss.
| Item | Amount |
|---|---|
| Mortgage balance | $320,000 |
| Short sale price | $270,000 |
| Lender’s net (after 6% commission) | $253,800 |
| Deficiency | $66,200 |
The lender may agree to forgive the $66,200 deficiency as part of the short sale approval. David must check state law and get the deficiency waiver in writing before agreeing.
Buying a Short Sale Property
Short sales can offer below-market prices, but buyers should understand the trade-offs:
Advantages for buyers:
- Price is often 5–15% below comparable properties
- Seller is motivated; property has been on market
- Title is clean (unlike some foreclosures)
Disadvantages for buyers:
- Sold “as-is” — no seller repairs or credits
- Slow process — months of waiting for lender approval
- Deal can fall through if lender rejects the offer price
- Multiple lenders (1st + 2nd mortgage) each must approve — even slower
Buyer tips:
- Get a thorough inspection before removing contingencies
- Build a long escrow period into the offer
- Have financing pre-approved and be prepared to extend if the bank delays
- Hire a buyer’s agent experienced in short sales
See the Homeownership Guide for how short sales compare to other distressed property purchases.
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