How does a short sale work?

A short sale happens when a borrower sells their property for less then what is owed on the mortgage, does not have the means to pay the difference, and the lender agrees to accept less then the amount owed to settle the debt. In order to be eligible for a short sale the homeowner must be able to demonstrate a financial hardship that is causing the mortgage to be unaffordable.
For example, if your outstanding mortgage debt is $300,000 and the property is now only worth $150,000, this property is considered to be “underwater.” If you are looking to sell your property for less than you outstanding balance, you will have to supply all of your financial information to your lender so they can determine whether or not they want to sign off and settle the debt for less than the amount owed.
Please keep in mind that the servicer of the loan will be in control of the sale at all times. Even if you have a offer on the table ready to go, your application must be completely processed before they will accept the deal. In many cases the buyer will drop out because of how long this process can take. The realtor on the transaction (or yourself) are required to submit a written purchase agreements with estimated closing costs (estimated HUD) to the mortgage servicer.
Obviously a short sale is not the best solution for a homeowner or the lender. No one wants to have to sell their home for less than what they owe, especially those who have been working hard for years to build up equity. However, this option is much better than allowing the property to go into foreclosure. A foreclosure will completely destroy your credit rating and will remain on your credit property for up to seven years. For most people s foreclosure will make financing extremely difficult for years to come.
How will this affect your credit?
One of the main disadvantages of a short sale is the damage it will do to the seller’s credit score. Not only will this negative mark remain on your credit report for a few years, but a short sale may lead to higher interest rates on future purchases or make financing anything else very difficult for years to come.

When you sale your home as a short sale it seems your credit will be damaged approximately 60-200 points, especially if you were delinquent on your mortgage prior to the closing of the sale. While this may not seem very attractive, it is far better than letting the property go into foreclosure which may damage your credit anywhere from 200-300+ points for up to 7 years. Unlike a foreclosure, the short sale will not remain on your report even close to 7 years and if you work on rebuilding your credit after the sale goes through, it could be as if the short sale never even took place.
However, for those who are able to short sale their property without missing a payment, the damages of this event will lessen a significant amount. Here on LoanSafe.org we have seen quite a few homeowners over the years achieve a short sale while current and their payments only dropped about 25-75 points.
Can you obtain a new mortgage after a short sale?
Fannie Mae allows new financing for a home loan after twenty four months from the date of closing. However, the qualifications when getting a new mortgage will be more strict. For example, to get a new mortgage within two years you must be able to provide a 20% down payment for the home you are trying to purchase. If you can only manage a 10% down payment, the waiting period to purchase can be up to four years. But for those who can demonstrate the sale was due to “extenuating circumstances” such as a divorce, health problems, job loss, etc, then Fannie Mae will allow financing immediately after the two year waiting period is up.
For sellers who were able to maintain their mortgage payment until the time of sale, have a decent debt to income ratio, and a excellent credit score, then those borrowers may qualify for a new home loan right away.
You will want to make sure you manage your credit wisely over the next few years as your slowly rebuild your credit wisely. Open a couple small credit accounts where you maintain about 40% balance and pay on time monthly. In addition, you do not want to make an emotional decision when you decide to buy more real estate. You need to get educated and make sure that you do not get into another bad investment that had just caused you to short sale because in the real world, it is not always a good time to buy a home and sometimes it is better to just rent.
Also, after a short sale it can be quite difficult trying to secure another mortgage.  Because you had to short sell your current property you will be seen as a high risk candidate for any future loans you seek as long as that short sale mark is on your credit report.
It would be very wise to first go out and consult with a couple real estate lawyers in your state to determine whether or not a short sale is right for you. The lawyer can also help explain all of the consequences that come along with this event and the specific laws in your state.