Short Sale Pros and Cons for Underwater Homeowners
A comprehensive guide for El Paso homeowners with little or no equity. Understand your options when you owe more than your home is worth and make the best decision for your financial future.
If you owe more on your mortgage than your home is currently worth, you're what the real estate industry calls "underwater" or "upside down" on your mortgage. This situation affects millions of American homeowners and can feel like being trapped with no good options. But there is a way out: the short sale.
A short sale occurs when a lender agrees to accept less than the full amount owed on a mortgage, allowing the homeowner to sell the property and move on without going through foreclosure. While it's not a perfect solution, for many underwater homeowners in El Paso, a short sale represents the best path forward when keeping the home is no longer financially viable.
In this comprehensive guide, we'll explore everything you need to know about short sales—the advantages, the drawbacks, the process, and whether it's the right choice for your specific situation. Whether you're facing financial hardship, need to relocate, or simply want to understand all your options, this guide will help you make an informed decision.
What Does "Underwater" Mean?
You're underwater when your mortgage balance exceeds your home's current market value. For example, if you owe $250,000 but your home would only sell for $200,000, you have $50,000 in negative equity. This situation often results from market downturns, buying at peak prices, or taking out home equity loans.
What Exactly Is a Short Sale?
A short sale is a real estate transaction where the lender agrees to accept a sale price that is less than the outstanding mortgage balance. The term "short" refers to the fact that the sale proceeds fall short of what's owed. Unlike a regular sale where the seller pays off the mortgage in full, a short sale requires the lender's explicit approval because they're agreeing to take a loss.
For example, imagine you purchased your El Paso home for $280,000 with a $260,000 mortgage. After several years of payments, you still owe $240,000. However, due to market conditions or property issues, your home is now only worth $190,000. In a short sale, your lender might agree to accept $185,000 (after closing costs) and forgive the remaining $55,000 difference.
Why Would a Lender Agree?
Lenders often prefer short sales over foreclosure because foreclosure is expensive, time-consuming, and typically results in even greater losses. A short sale allows them to recover more money faster while avoiding the costs of maintaining and selling a foreclosed property.
How the Short Sale Process Works
Understanding each step helps you navigate the process more effectively and set realistic expectations
Prove Financial Hardship
You must demonstrate to your lender that you cannot afford to continue making payments or cover the shortfall at closing. This typically requires a hardship letter explaining your situation (job loss, medical issues, divorce, etc.) along with financial documentation including tax returns, pay stubs, bank statements, and a detailed budget.
List the Property
Work with a real estate agent experienced in short sales to list your home at fair market value. The listing should clearly indicate it's a short sale, as buyers need to understand the process may take longer than a traditional sale. Your agent will help gather comparable sales data to justify the listing price to your lender.
Receive and Submit Offers
When you receive a purchase offer, you'll submit it to your lender along with your complete short sale package. The lender will review the offer, your financial situation, and the property's value to determine if the offer is acceptable. They may order their own appraisal or broker price opinion (BPO).
Lender Review and Negotiation
This is often the longest part of the process. The lender's loss mitigation department reviews everything and may counter the offer, request additional documentation, or approve as-is. If you have multiple liens (second mortgage, HELOC), each lienholder must approve. This stage can take 30-120 days or longer.
Approval and Closing
Once approved, you'll receive a short sale approval letter specifying the terms, including whether the remaining debt will be forgiven or if you'll owe a deficiency. The sale then proceeds like a normal transaction with inspections, title work, and closing. The lender releases the lien, and you transfer ownership to the buyer.
Post-Sale Considerations
After closing, review your approval letter carefully. If the lender forgave debt, you may receive a 1099-C for the forgiven amount, which could be taxable income. Consult a tax professional about potential exclusions under the Mortgage Forgiveness Debt Relief Act or insolvency rules that may reduce or eliminate tax liability.
The Advantages of a Short Sale
For underwater homeowners, short sales offer several significant benefits compared to foreclosure
Less Credit Damage Than Foreclosure
While a short sale does impact your credit score, the damage is typically 50-150 points less severe than a foreclosure. A foreclosure can drop your score by 150-240 points and stays on your credit report for seven years. A short sale, while also reported for seven years, is viewed more favorably by future lenders because it shows you took responsibility for resolving the situation.
Buy a Home Again Sooner
After a foreclosure, you typically must wait 3-7 years before qualifying for a new mortgage (depending on loan type). After a short sale, the waiting period is often just 2-4 years for most loan programs. With extenuating circumstances documented, some programs allow you to buy again even sooner.
Potential Debt Forgiveness
Many lenders agree to forgive the deficiency (the difference between sale price and mortgage balance) as part of the short sale approval. This means you walk away without owing additional money. Even when lenders reserve the right to pursue a deficiency, they rarely do so in practice, especially in Texas where anti-deficiency protections exist for certain loans.
Avoid the Stigma of Foreclosure
Foreclosure is a matter of public record and can affect employment opportunities, security clearances, and professional licenses. A short sale is a private transaction between you, your lender, and the buyer. While it appears on your credit report, it doesn't carry the same public stigma as a foreclosure auction.
Control Over Timeline
With a short sale, you have more control over when you move. You can negotiate the closing date and often stay in the home during the process. In foreclosure, you're at the mercy of the legal timeline and may face sudden eviction after the sale.
Possible Relocation Assistance
Some lenders offer cash incentives (typically $3,000-$10,000) to homeowners who complete short sales. This "cash for keys" or relocation assistance helps cover moving expenses and provides a financial cushion as you transition to new housing.
The Disadvantages of a Short Sale
Short sales aren't perfect solutions—understanding the drawbacks helps you make a fully informed decision
Lengthy and Uncertain Process
Short sales are notoriously slow. While a traditional sale closes in 30-45 days, short sales often take 90-120 days or longer—sometimes six months or more. During this time, buyers may walk away, lenders may reject offers, and you're left in limbo. The uncertainty can be emotionally and financially draining.
Credit Score Still Takes a Hit
While less damaging than foreclosure, a short sale still negatively impacts your credit. Expect a drop of 50-150 points, and the short sale notation remains on your credit report for seven years. If you were already behind on payments before the short sale, those late payments compound the damage.
Potential Tax Consequences
Forgiven debt may be considered taxable income by the IRS. If your lender forgives $50,000 in debt, you could receive a 1099-C and owe taxes on that amount. While exclusions exist (insolvency, qualified principal residence indebtedness), navigating the tax implications requires professional guidance.
Deficiency Judgment Risk
Not all lenders forgive the deficiency. Some reserve the right to pursue you for the difference between the sale price and what you owed. While Texas has some protections against deficiency judgments, they don't apply to all loan types. Always get the deficiency waiver in writing before closing.
Additional Drawbacks to Consider
- You must prove financial hardship—not everyone qualifies
- Multiple lienholders complicate and delay the process
- You walk away with no money from the sale
- Lender may reject offers they deem too low
- Buyers often prefer traditional sales, limiting your pool
Do You Qualify for a Short Sale?
Not every underwater homeowner qualifies for a short sale. Lenders have specific criteria they use to evaluate short sale requests. Understanding these requirements helps you determine if this option is viable for your situation.
Typical Qualification Requirements:
- Negative Equity: You must owe more than your home is worth, or at least more than you could net after selling costs.
- Financial Hardship: You must demonstrate a legitimate hardship—job loss, income reduction, medical expenses, divorce, military PCS, or other circumstances that make continued payments impossible.
- No Liquid Assets: Lenders want to see that you don't have significant savings or assets that could cover the shortfall. They may require you to contribute if you have substantial resources.
- Default or Imminent Default: Most lenders require you to be behind on payments or able to prove you'll soon be unable to pay. Some programs allow short sales even if you're current but facing hardship.
Important: Even if you qualify, approval isn't guaranteed. Each lender has different policies, and approval depends on factors like the offer amount, your documentation, and the lender's current loss mitigation priorities.
Short Sale vs. Foreclosure: A Comparison
Understanding how these options compare helps you see why many homeowners prefer short sales
| Factor | Short Sale | Foreclosure |
|---|---|---|
| Credit Score Impact | -50 to -150 points | -150 to -240 points |
| Time on Credit Report | 7 years | 7 years |
| Wait to Buy Again (FHA) | 3 years | 3 years (with extenuating circumstances) |
| Wait to Buy Again (Conventional) | 2-4 years | 7 years |
| Control Over Process | High - you manage the sale | None - lender controls everything |
| Public Record | Private transaction | Public auction, public record |
| Deficiency Risk | Often waived in approval | Lender may pursue deficiency |
| Relocation Assistance | Often available ($3K-$10K) | None |
| Employment Impact | Minimal | May affect security clearances, some jobs |
Alternatives to Short Sales
A short sale isn't your only option—consider these alternatives based on your specific situation
Loan Modification
If you want to keep your home, a loan modification changes your mortgage terms to make payments affordable. Lenders may reduce your interest rate, extend your term, or even reduce principal in some cases.
Best for: Homeowners who want to stay and can afford modified payments
Deed in Lieu of Foreclosure
You voluntarily transfer ownership to the lender, avoiding foreclosure. This is faster than a short sale but has similar credit impacts. Lenders typically require you to attempt a short sale first.
Best for: Homeowners who can't sell and want to avoid foreclosure quickly
Bring Cash to Closing
If you're only slightly underwater, you might cover the difference yourself. This avoids the short sale process entirely and protects your credit. Consider borrowing from family or using savings if the gap is small.
Best for: Homeowners with small negative equity and available funds
Rent the Property
If you need to move but can't sell, renting your home might cover the mortgage until values recover. This requires becoming a landlord and may need lender approval if you have an owner-occupied loan.
Best for: Homeowners who can cover costs and manage a rental
Bankruptcy
Chapter 7 may allow you to walk away from the mortgage debt, while Chapter 13 can help you catch up on payments over time. Bankruptcy has serious long-term consequences but may be appropriate in some situations.
Best for: Homeowners with multiple debts beyond just the mortgage
Wait It Out
If you can afford payments and don't need to move, staying put until values recover is an option. El Paso's market has shown steady appreciation, and time may restore your equity naturally.
Best for: Homeowners who can afford payments and aren't forced to sell
Short Sales in Texas: What You Need to Know
Texas has specific laws and market conditions that affect short sales. Understanding these factors helps you navigate the process more effectively and protect your interests.
Texas Anti-Deficiency Protections
Texas law provides some protection against deficiency judgments for purchase money mortgages on your primary residence. However, these protections don't apply to refinanced loans, HELOCs, or investment properties. Always get deficiency waiver language in your short sale approval letter.
Fast Foreclosure Timeline
Texas is a non-judicial foreclosure state with one of the fastest foreclosure timelines in the country. If you're considering a short sale, don't wait too long—the foreclosure process can move quickly, and you need time to complete the short sale before the auction date.
El Paso Market Conditions
El Paso's real estate market has been relatively stable compared to more volatile markets. While some homeowners are underwater due to buying at peak prices or taking out equity, the market's steady appreciation means many underwater situations may resolve naturally over time if you can wait.
Common Situations Leading to Short Sales
You're not alone—these are the most common reasons El Paso homeowners pursue short sales
Job Loss or Income Reduction
Losing a job or experiencing significant income reduction is the most common reason for short sales. When you can no longer afford your mortgage and have negative equity, a short sale may be your best path forward.
Medical Emergencies
Serious illness or injury can devastate finances through medical bills and lost income. When health issues make it impossible to maintain mortgage payments on an underwater home, a short sale provides relief.
Divorce or Separation
Divorce often means neither spouse can afford the home alone, and selling may be required to divide assets. When the home is underwater, a short sale allows both parties to move forward without ongoing financial ties.
Military PCS Orders
Military families at Fort Bliss often face PCS moves that require selling quickly. When orders come and the home is underwater, a short sale may be the only option to relocate without bringing cash to closing.
Property Value Decline
Sometimes market conditions, neighborhood changes, or property issues cause values to drop below what you owe. If you need to sell and can't wait for recovery, a short sale addresses the negative equity problem.
Unaffordable Repairs Needed
When a home needs major repairs you can't afford, and the property's distressed condition has reduced its value below your mortgage balance, a short sale to an investor who can handle repairs may be your solution.
Tips for a Successful Short Sale
If you decide a short sale is right for you, these strategies can help improve your chances of approval and a smoother process.
Work with Experienced Professionals
Hire a real estate agent who specializes in short sales and understands the lender negotiation process. Consider consulting with a real estate attorney, especially if you have multiple liens or complex circumstances.
Document Everything Thoroughly
Your hardship letter should be compelling and honest. Gather all financial documents before starting—tax returns, pay stubs, bank statements, expense records. Incomplete packages cause delays.
Price the Home Correctly
Price too high and you won't get offers. Price too low and the lender will reject offers. Work with your agent to find the sweet spot that attracts buyers while satisfying the lender's loss mitigation requirements.
Stay in Communication
Respond promptly to lender requests. Follow up regularly on your file's status. Keep records of all communications. Persistence and organization can significantly speed up the process.
Get the Deficiency Waiver in Writing
Before closing, ensure your approval letter explicitly states the lender waives the right to pursue a deficiency judgment. If it doesn't, negotiate for this protection or consult an attorney about your options.
Pro Tip: Consider Cash Buyers
Cash buyers like local real estate investors are often more willing to wait through the short sale process than traditional buyers who need financing. They understand the timeline and are less likely to walk away during the lengthy approval process.
Frequently Asked Questions
How long does a short sale take?
Most short sales take 90-120 days from listing to closing, though some can take six months or longer. The timeline depends on your lender's responsiveness, the completeness of your documentation, whether you have multiple liens, and how quickly you receive acceptable offers. Plan for a longer process than a traditional sale.
Will I owe money after a short sale?
It depends on your lender and the terms of your approval. Many lenders forgive the deficiency (the difference between sale price and mortgage balance) as part of the short sale. However, some reserve the right to pursue you for the difference. Always get deficiency waiver language in writing before closing. Texas law provides some protection for purchase money mortgages on primary residences.
Do I have to be behind on payments to do a short sale?
Not necessarily. While many lenders require you to be delinquent, some programs allow short sales for homeowners who are current but can demonstrate imminent default—meaning you can prove you'll soon be unable to make payments due to hardship. Contact your lender's loss mitigation department to understand their specific requirements.
How much will a short sale hurt my credit?
A short sale typically drops your credit score by 50-150 points, depending on your starting score and whether you were already behind on payments. While significant, this is less severe than foreclosure (150-240 points). The short sale notation stays on your credit report for seven years but becomes less impactful over time as you rebuild.
Can I buy another home after a short sale?
Yes, but you'll need to wait. For FHA loans, the waiting period is typically 3 years. For conventional loans, it's usually 2-4 years depending on circumstances. VA loans may have shorter waiting periods. With documented extenuating circumstances and rebuilt credit, some programs allow earlier purchases. The waiting period is generally shorter than after foreclosure.
Will I have to pay taxes on forgiven debt?
Potentially. The IRS generally considers forgiven debt as taxable income. If your lender forgives $50,000, you may receive a 1099-C and owe taxes on that amount. However, exclusions exist: the Mortgage Forgiveness Debt Relief Act (for qualified principal residence debt), insolvency exclusion, and bankruptcy exclusion may reduce or eliminate tax liability. Consult a tax professional for your specific situation.
What if I have a second mortgage or HELOC?
All lienholders must approve the short sale. Second mortgage holders and HELOC lenders often receive little or nothing from the sale, making them harder to negotiate with. They may demand a cash contribution from you or the first lienholder. Having multiple liens significantly complicates and lengthens the process.
Can my lender reject my short sale request?
Yes. Lenders may reject short sales if you don't demonstrate sufficient hardship, if you have assets that could cover the shortfall, if the offer is too low, or if they believe foreclosure would recover more money. Some lenders are simply more difficult to work with than others. If rejected, you may be able to reapply with additional documentation or a better offer.
Related Resources
Explore more guides to help you navigate your real estate situation
How to Avoid Foreclosure
Complete guide to foreclosure prevention options and strategies for El Paso homeowners.
What Happens If I Can't Pay My Mortgage
Understand the timeline, consequences, and options when you can't make mortgage payments.
How to Sell Your House Fast
Proven strategies to sell your El Paso home quickly, including cash buyer options.
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