When shopping for a home, you may notice that certain listings are labeled as short sales, short pays or pre-foreclosures. All of these terms mean the same thing: the seller is upside-down on his or her mortgage and is attempting to negotiate a deal with the lender in the hope of avoiding foreclosure.

In this type of sale, the bank (lender) agrees to accept less than the amount owed on the mortgage. The transaction benefits the bank by allowing it to avoid repossessing the home in foreclosure, which is expensive and time-consuming, and it benefits the seller by allowing him or her to avoid the negative credit ramifications of foreclosure (and the bankruptcy that sometimes accompanies it). (For more on foreclosures, see Foreclosure Investing Not A Get-Rich-Quick Venture and Foreclosure Opens Windows For Investors.)

If you're interested in buying a property that's listed as a short sale, here's what you need to know.

How It Works
Unlike in a foreclosure, the bank does not own the property in a short sale. However, because the bank must approve the sale (because it is the lender, not the seller, who will be taking a loss on the property) it will seem like the buyer is purchasing the property from the bank. Short sale transactions, however, can be much more time-consuming and patience-testing than foreclosure transactions. (Keep reading about this in Short Sell Your Home To Avoid Foreclosure.)


In some ways, buying a short-sale property is just like a traditional purchase. However, there are a couple of ways in which the purchase agreement you and your agent draw up are different. The contract will specify that the terms are subject to the mortgage lender's approval. In a normal transaction, the only party who would need to approve the sale is the seller.

The contract should also state that the property is being purchased "as-is". While it is acceptable to include language in the contract that allows you to back out of the deal if an inspection reveals considerable problems, in general, you should not expect the bank to lower the price to account for repairs if any problems are revealed. The bank is also unlikely to make any repairs, and the seller, being strapped for cash, is probably even less likely to help out. Given the situation, you'll likely also need to have enough money for closing costs. (Keep reading about the closing process in Understanding The Escrow Process.)

A Waiting Game
If you make an offer on a short sale property, be prepared to wait. Banks are notorious for taking as long as several months to respond to short sale offers. Some experts recommend that you give the lender a deadline to reduce the wait time. It's hard to say whether this strategy will really spur the bank to action, but it may be worth it from your perspective if you can't handle the stress of waiting months for a response. However, if the bank hasn't actually approved the short sale yet at the time of your offer, implementing a deadline will be useless as it may take several months just for the seller to reach a short sale agreement with the lender. And even if such an agreement is struck, there is no guarantee that the short sale will go through.


Weighing the Pros and Cons
Experts disagree on whether short sales are a good deal for buyers. Some say that short sales are priced below market values, creating the opportunity for buyers to get a great deal or for first-time homebuyers to get into a home when they otherwise might not be able to afford one.


Others say that banks have no interest in selling properties below market value and will do a comparable market analysis before setting or accepting a price for a short sale. Further, the listing price of a short sale may be an amount the seller's agent thinks the bank might accept - rather than the amount the bank has actually agreed to accept. The bank might find the price too low, or the seller might list the property below market with the intention of generating a bidding war. In some states, the seller will be obligated to pay the bank back the difference between the mortgage amount and the sale price of the home, so it's in the seller's best interest to get as much money as possible for the home even though he or she will see no cash from the sale.

Better Living Conditions
One advantage to both the bank and the seller is that unlike a bank-owned property, a short sale property is less likely to be trashed or ransacked. The owner will still be living in the home and while the property may be suffering from deferred maintenance because of the seller's financial situation, the seller is not likely to destroy the place when he or she still lives in it. By contrast, homeowners who lose their properties to foreclosure often take out their frustration on the house as a way of getting back at the bank. If the property is damaged, the bank won't be able to get as much money when it resells the home.


Along the same lines, because short sale properties are still occupied, they won't have suffered at the hands of unscrupulous people who have chosen to squat in or vandalize the property. Vandalism can be a common problem with foreclosure properties, especially in lower-income neighborhoods.

Don't assume the property is a great deal just because it is a short sale, though. Do your own comparable market analysis. The bank is facing a losing transaction, so it will want to minimize its losses and sell the property as close to fair market value as possible. If you can buy a similarly priced property directly from the seller, do it. It will be easier than dealing with a short sale. Also, if you make it to escrow, don't skip a thorough home inspection.

Precautions and Pitfalls
As you've probably gathered by now, short sale transactions are fraught with pitfalls and don't have many compensating advantages. If you still want to proceed in an attempt to snag a bargain or simply because the property that's perfect for you happens to be listed as a short sale, here are some precautions you should take and situations to be wary of.


Experience
Make sure your agent is experienced with short sales. Because of the complexity of this type of transaction, you don't want to work with someone who is unfamiliar with the process. Also, make sure your agent is willing to work with you on a short sale. Some agents won't want to get involved due to bad past experiences or the poor reputation of short sales. Not only are short sales more work for agents, they sometimes offer less of a commission. The bank may not be willing to pay the listing agent the usual 5-6% commission because it is already taking a loss, and because the buyer's agent gets a percentage of that percentage, he or she will see even less money.


In addition, try to find out if the listing agent is experienced with short sales. Although the bank is ultimately in control, a listing agent who knows the ropes may be able to facilitate or expedite the transaction.

Keep the Search Going
Given how long it will probably take the bank to reply to your offer, you should probably keep looking at other houses while you wait for a response, and you should probably proceed with the purchase of another property if you find an easier buy. Have your agent write the short sale purchase agreement in such a way that you'll retain this flexibility. And if you're buying on a deadline, don't even bother with a short sale.


Haggling Over Prices
Be prepared to raise your offering price. For the seller to increase the odds of the bank going through with the short sale, he or she may try to convince you to up your purchase price. Ultimately, though, the seller has no real authority to approve the selling price. The bank may also counteroffer as it tries to cut its losses.


What's worse, the bank may continue to collect offers even if you make it to escrow. Most people would consider this unethical because the potential purchaser is likely to have shelled out a few thousand dollars on inspections, title searches and the like, at this point. Getting dropped from the deal so late in the game is a huge waste of time and money for the buyer, not to mention enormously frustrating. For all of these reasons, the listing price of a short sale must be taken with a healthy dose of skepticism.

On the other hand, the bank might not counteroffer. They might just reject your offer outright, especially if you've written a significantly lower priced offer. Or, in the worst case scenario, they might not reply at all. Ever.

Seller Must Be in Official Default
Make sure the short sale is already lender approved. If the seller has not actually gone into default yet, the bank may not be interested in doing a short sale. The bank may also not be interested in a short sale if it thinks it can get more money by going into foreclosure.


Short sales are already difficult because of the involvement of the original lender. If there are two lenders, you double the difficulties of completing the transaction. It takes a considerable amount of time and convincing to get a bank to agree to a short sale, so if it hasn't agreed already, don't waste your time. Many homes are listed as a short sale by the listing agent, but there is no guarantee that the transaction will ever be completed as such.

Bottom Line
Potential buyers of short-sale properties should proceed with a hefty dose of caution and a pound of patience. Even with a thorough understanding of the process, the best agent in the world and a willingness to wait, the bank will not always cooperate. However, short sales can be a good deal for some buyers and will occasionally close successfully.


To learn more about buying a home, see our First-Time Homebuyer Guide.




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