If you cannot pay your mortgage or move because you’re “underwater”—that is, in negative equity, where you owe more on the mortgage than your home is worth—you may head toward foreclosure.

(This is where the mortgage lender repossesses your property to claw back some of its value.) 

 However, foreclosure is the last, and often a distressing, resort and there are other options for homeowners struggling with their bills.

One is a short sale.

A short sale is where someone other than the lender offers to buy your property at a reduced rate, for less than the amount that is left on the mortgage. The proceeds of the sale then go to the lender in full. Short sales were common following the 2008 financial crisis, though with a rising housing market have become less so.

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A short sale is a long process with plenty of paperwork, but it's much less damaging to an owner's credit than a foreclosure. Credit: Gerd Altmann/Pixabay

With foreclosure, the lender initiates the process and seizes the property themselves, and usually is set on selling or auctioning it off quickly in order to realize the value of the asset.

Short sales are initiated by the property owner, who has to persuade the lender to agree. This involves providing paperwork to make a case for why you need to sell for less than the value of your mortgage. 

The lender will have to accept receiving less money than would be due if the mortgage was repaid in full. They may issue a “deficiency judgment,” where you must pay the lender the difference between the sale price and the mortgage, but this outstanding amount is usually forgiven.

Some lenders will be happy to accept a short sale because the financial loss to them is often smaller than it is with foreclosure.

A short sale can be a long process, with plenty of paperwork, but they are usually much less damaging to a mortgage-holder’s credit file than foreclosure, which can make it very difficult to buy another property. 

With a short sale you may be able to buy a property again immediately, since your lender can report that the loan is paid in full to credit reference agencies. 

Short sales are not the only option before foreclosure, so you should always discuss with the lender the possibility of a payment plan or a change in the structure of the loan if it is not affordable. You may also be able to use your private mortgage insurance.

Buying a Short Sale

As a buyer, you could consider taking on someone else’s short sale, which can be an affordable way to invest in a property, as you will be buying at a much reduced price. 

There may be less competition from other buyers than on an ordinary property sale, too, so you may find a better deal. It is also less risky than buying a property sold during foreclosure,  because a short sale home is not usually empty and the owners may still be living there. Foreclosure occurs on vacated or abandoned properties that can also be in disrepair.

That said, buying a short sale can be a lengthy and bureaucratic process. You cannot buy until the seller’s mortgage lender has approved it. This can take several months.  They may also be involved in price negotiations, too.

Many short-sale properties still require fixing up. You may also need to pay additional closing costs that would usually be covered by the seller.

Find a buyer’s agent who is used to dealing with short sales for advice during the process.