The concept is rather simple. When you sell something for less than the amount that is owed, you are selling it short of the full amount.
Lenders became opportunists during the past few years and decided that they would irresponsibly lend the full value of homes to nearly anyone without proof of income. In some cases, lenders were giving homeowners more than 100% of the value of their home. They were giving away money without explaining to buyers that the reason their payments were so affordable was because the loans they were issuing were interest only adjustable rate loans; a perfect solution for a short term investment, but horrible for long-term homeownership.
John Doe in 2006 finds a home that he wants to buy. At his income level, he can afford to spend $2000.00 every month on a mortgage. The home that he wants to purchase, if financed conventionally on a 30-Year fixed interest mortgage would put him over his monthly mortgage payment budget. He could solve that problem by including a down payment to reduce the loan amount, but he doesn’t have any money in the bank. The lender, knowing they would make their money on closing costs and doc fees, decides to offer creative financing to John Doe Roofers Surrey so he can afford the home. They write an interest only, adjustable rate mortgage with a pre-payment penalty and more than likely a 5 year expiration period on the adjustment for the full amount of the home. The adjustable rate mortgage ensured that after 5 years, sometimes 3 years, the loan would come due to adjust up, which would bloat his payment way above what he would have been able to afford in the first place.
At this point, John Doe has zero equity in his home and a payment he can’t afford. With the declining market values, his situation is worsened by the fact that he won’t be able to sell the home for as much as he bought it. He owes more than the home is worth. Why is this a problem? Well, normally the homeowner could simply stay put in their home, make their monthly payment, and ride the market until the natural average increase in value caught up to them. The real problem is that John Doe couldn’t afford the home in the first place, and he’s out of cash. He has to sell.
In comes the Short Sale.
Since John Doe is in a position where he MUST sell, he would rather do that than file bankruptcy and walk on the property, so he appeals to the bank for approval to sell the home for less than what he owes. He must prove that he has a legitimate hardship before the bank will actually allow his chosen brokerage to sell the home. He can list the home for sale, but when it comes to actually selling the home, accepting an offer, he must obtain bank approval, and that may take up to 90 days, depending on who the lender is and how well they process Short Sales.
If the home that John Doe is living in doesn’t receive an offer quickly enough, the property may enter into foreclosure and the bank might have to give him the boot. When this happens, the bank puts the property on the auction block. If the property doesn’t sell at auction, the bank owns it.
As a result, the buyer believes that he/she is entitled to pay less than listing price on just about any property out there, whether short sale or not.