What Is a Short Sale?
A short sale is a home that is available at a purchase price that is less than the amount owed by its current owner.
The transaction benefits the bank by allowing it to avoid repossessing the home in foreclosure, which is expensive and time-consuming. The seller avoids the credit hit that comes with foreclosure and the bankruptcy that sometimes accompanies it.
How a Short Sale Works
A short sale is a financial option that is sometimes available to homeowners who are distressed borrowers. They are behind on their mortgage payments and have a home that is underwater. That is, the home is worth less than the outstanding balance on the mortgage.
Barring an unexpected cash windfall, the owner is forced to part with the home. There are really only two options: A short sale or foreclosure.
Experts disagree on whether short sales are a good deal. Proponents say that such homes are priced below market value. Opponents say that banks have no interest in doing fire sales.
Short sales are usually initiated by the homeowner when the value of a home drops by 20% or more. Before the process can begin, the lender who holds the mortgage must sign off on the decision. Additionally, the lender, typically a bank, needs documentation that explains why a short sale makes sense. After all, the lending institution could lose money in the process.
If approved for short sale, the buyer negotiates with the homeowner first and then seeks approval on the purchase from the bank second. It is important to note that no short sale may occur without lender approval.
Short sales tend to be lengthy and paperwork-intensive transactions, taking up to a full year to process. However, they are not as detrimental to a homeowner's credit rating as a foreclosure is. A short sale looks better to future lenders and creditors. It shows that the person took action before the bank moved to repossess the home. A homeowner who has gone through a short sale may even be eligible to purchase another home immediately.
How a Foreclosure Differs
In a foreclosure, the lender seizes the home after the borrower fails to make a certain number of payments. Unlike most short sales, foreclosures may take place after the homeowner has abandoned the home. If the occupants have not yet left, they are evicted by the lender in the foreclosure process.
Foreclosures do not normally take as long to complete as a short sale because the lender is concerned with liquidating the asset quickly. Foreclosed homes may also be auctioned off at a "trustee sale," where buyers bid on homes in a public process.
Homeowners who undergo foreclosure experience an immediate drop and precipitous drop in their credit ratings. In most circumstances, they must wait a minimum of five years to purchase another home or three years with an FHA loan. The foreclosure appears on a credit report for seven years.
Steps to a Short Sale
The short sale process varies from state to state, but the steps generally include:
- Short sale package - A financial package is submitted to the lender by the seller. It includes financial statements, a letter describing the seller's hardship, and copies of financial records.
- Short sale offer - If the seller accepts an offer from an interested buyer, the listing agent sends the lender the listing agreement, an executed purchase offer, the buyer's preapproval letter, and a copy of the earnest money check.
- Bank processing - The bank reviews the offer and either approves or denies the short sale. This can take several weeks to months.
In some ways, buying a short-sale property is just like any home purchase. However, in this case, the contract will specify that the terms are subject to the mortgage lender's approval.
The contract should also state that the property is being purchased "as-is." While the buyer may include language that allows the deal to be canceled if an inspection reveals considerable problems, it is unlikely a lower price can be negotiated. The bank is also unlikely to make any repairs, and the seller, being strapped for cash, is even less likely to help out.
Unlike with a foreclosure, the lending institution does not own the property in a short sale. However, because it must approve the sale and will receive the proceeds, the buyer will be dealing mostly with the bank rather than the homeowner.
Advantages and Disadvantages of a Short Sale
Short sale transactions can be much more time-consuming and patience-testing than regular real-estate transactions. 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.
Make sure the short sale is already lender-approved. If the seller has not yet negotiated the short sale with the bank, the buyer is in for a long wait, quite possibly for nothing.
Some experts recommend that you give the lender a deadline to reduce the wait time. Though it's hard to say whether this strategy will really spur the bank to action.
Pitfalls to Avoid
The buyer must make sure the short sale is already lender-approved. If the seller has not yet gone into default or negotiated a short sale with the bank, the buyer is in for a long wait, quite possibly for nothing. The bank may not be interested in a short sale if it thinks it can get more money by going into foreclosure.
Potential buyers also are wise to check in advance to make sure the mortgage lender has no problems with a short-sell property.
Best Agent for a Short Sale
Because of the complexity of the transaction, a buyer should work with an agent or realtor who is experienced with short sales and willing to work on one. Certain real estate agents specialize in short sales and may hold Short Sales and Foreclosure Resource (SFR) certification, a designation offered by the National Association of Realtors. Holders of this certification have undergone specialized training.
Haggling Over Prices
The buyer of a short sale property should be prepared to raise the offering price. Ultimately, the seller has no real authority to approve the selling price, only the bank does, and they may counteroffer.
On the other hand, the bank could reject the offer outright, especially if it's a significantly lower offer. In the worst-case scenario, they might not reply at all. Ever.
Keep the Search Going
Given how long it will probably take the bank to reply to your offer, a buyer should probably keep looking at other houses while waiting for a response. An agent can write a short sale purchase agreement in such a way that the buyer retains the flexibility to withdraw the offer.
Another reason to keep looking: Even if the buyer makes it to escrow, the bank may continue to collect offers. 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. But the bank is facing a losing transaction, and it wants to minimize its losses.
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.
Experts disagree on whether short sales are a good deal for buyers. Proponents say that short sale properties are priced below market value, creating the opportunity for buyers to get a great deal or for first-time homebuyers to get into a home they otherwise might not be able to afford. Opponents say that banks have no interest in doing fire sales, and will do a comparable market analysis before setting or accepting a price for a property.
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 have a deficiency judgment against him, which obligates him 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.
One advantage to both the bank and the buyer is that unlike a bank-owned property, a short sale property is less likely to be trashed or ransacked. While the property may be suffering from deferred maintenance because of the owner'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.
- For underwater homeowners, a short sale can be a way to avoid repossession, eviction, and black marks on their credit ratings.
- For a potential buyer, completing a short sale requires flexibility and a great deal of patience.
- A buyer must make sure the deal is worth the effort.