Legal Definitions - Short sale

A short sale is a term with two distinct meanings, primarily used in real estate and financial markets, both referring to a situation where an asset is sold for less than its current value or expected future cost.

• In Real Estate: A real estate short sale occurs when a homeowner sells their property for an amount less than the outstanding balance of their mortgage. This typically happens when the homeowner is facing financial hardship and cannot afford their mortgage payments, and the property's market value has fallen below the amount owed. For a short sale to proceed, the mortgage lender must agree to accept less than the full amount of the loan, often waiving the remaining debt.

  • Example 1: The Rodriguez family purchased their home for $300,000 with a mortgage of $280,000. Due to an unexpected job loss and a downturn in the local housing market, their home is now only appraised at $250,000, and they can no longer afford the mortgage payments. To avoid foreclosure, they negotiate with their bank to sell the house for $250,000. The bank agrees to accept this amount, even though it is $30,000 less than what the Rodriguezes still owe, and waives the remaining debt. This transaction is a short sale because the sale price is less than the mortgage balance.

  • Example 2: Sarah owns a condominium with a mortgage balance of $180,000. She needs to relocate quickly for a new job opportunity in another state, but the condo market in her current city has softened, and comparable units are selling for around $165,000. Rather than waiting for the market to improve or facing foreclosure by abandoning the property, Sarah's lender agrees to a short sale, allowing her to sell the condo for $165,000 and release her from the remaining $15,000 mortgage obligation. This enables her to move without the burden of an unsold property or a lingering debt.

• In Stock Investment: A short sale in stock investment refers to a strategy where an investor borrows shares of a company's stock from a broker and immediately sells them on the open market. The investor does this with the expectation that the stock's price will fall. If the price does drop, the investor then buys back the same number of shares at the lower price and returns them to the broker, profiting from the difference between the initial selling price and the lower repurchase price (minus any fees). This is a high-risk strategy because if the stock price rises instead, the investor could incur significant losses.

  • Example 1: An investor, Mr. Lee, believes that shares of "Global Gadgets Corp." (GGC) are overvalued at $75 per share and anticipates a price decline after a competitor releases a new product. He borrows 200 shares of GGC from his broker and sells them for $75 each, receiving $15,000. A few weeks later, GGC's stock price drops to $60 per share. Mr. Lee then buys 200 shares at $60 each, costing him $12,000. He returns these shares to his broker, making a profit of $3,000 (before broker fees). This is a short sale because he sold shares he didn't own, hoping to buy them back cheaper.

  • Example 2: Ms. Patel, a financial analyst, predicts that "Energy Solutions Inc." (ESI) will report disappointing quarterly earnings, causing its stock price to fall. When ESI is trading at $120 per share, she executes a short sale by borrowing 100 shares and selling them for $12,000. After the earnings report is released, ESI's stock price drops to $105 per share. Ms. Patel then buys 100 shares at $105 each, spending $10,500, and returns them to her broker. Her profit from this short sale is $1,500 before any commissions.