Part 1: Mortgage 101 – The Short Sale

August 1, 2016

A short sale is a type of real estate transaction in which you purchase a home from a distressed homeowner. It’s a very specific type of purchase, so much so that there are real estate agents who specialize in the category. If you’re interested in purchasing a short sale, you need to learn all that you can about the process before taking the plunge.

This is a complicated topic, and for that reason, we’re breaking it into two parts. Here in Part 1, we’re going to cover the basics of the short sale. But in Part 2, we’ll get into the mechanics of how to buy a short sale property. You’ll need to read both parts to get the full picture.

What is a Short Sale?

A short sale is a real estate transaction in which the mortgage lender on the property agrees to accept less than the full amount of the loan so that the sale can be completed. They’ll do this because the property owner is already in default on their mortgage, and a short sale is a last-ditch effort to avoid foreclosure.

It’s different from a foreclosure because the bank has not yet taken control of the property. For this reason, short sales are commonly referred to as pre-foreclosures.

From the lender’s perspective, short sales are often preferred to foreclosures. The lender will likely lose money in either case, but in a short sale, the job of selling the property is handled by the owner. And sometimes a short sale results in more money to the lender than a foreclosure will.

Lenders may allow the sale to go through, but many will also attempt to collect the deficiency balance on the mortgage from the previous owner, after the fact.

How a Short Sale Works

To conduct a short sale, the current owner must be in default on his mortgage. He must contact the mortgage lender and get their approval to proceed. That doesn’t guarantee that the lender will accept an offer or even any offers at all, but only that they’re open to it. This is one of the fundamental issues with a short sale; you can never know if the purchase will go through until the very end.

The owner puts the property up for sale, and any offers that are received must be presented to the lender. The lender will evaluate the offer, calculate realtor fees and other transaction costs, and determine the amount of proceeds that will be available to be applied to the mortgage. They may approve the offer, or decline it for insufficient proceeds.

If the initial offer is declined, you as the buyer are always free to counter offer. The process is very similar to any other real estate purchase transaction, except that you are indirectly negotiating with the bank.

The property seller can end up having offers rejected by the bank from multiple buyers. It will all depend on upon how much money the lender is willing to accept in settlement of the loan.

The Benefits of Doing a Short Sale

Despite the complications of trying to buy a short sale, there are some advantages:

Price. Since a short sale represents a distressed situation, the property will likely be offered for less than its fair market value. You may also feel more comfortable in making lowball offers than you might on an ordinary property. You can sometimes settle on a price that is many thousands of dollars below fair market value.

Property condition. Though the property may reflect a degree of neglect due to seller distress, it’s usually in better condition than an outright foreclosure. Properties that are sold in foreclosure are often severely damaged by the previous owners, sometimes intentionally. And if the property has been empty for many months, it may also reflect weather damage, vandalism, and general neglect. A short sale property will usually be at least maintained by the current owner.

Connecting with the owners. With a short sale, you can meet the owners of the property, and even get to know them a little bit. That can be more emotionally comforting than the human emptiness that’s a typical part of a foreclosure. At a minimum, you may be able to call the current owner after the sale, to find out specifics about the property.

The Drawbacks of Doing a Short Sale

Though the benefits of purchasing a short sale are compelling, it’s far from the easiest type of property purchase.

The price may not be a real bargain. Never assume that a property is lower-priced because it is a short sale. The lender is trying to get as much for the property as possible. If the owners are underwater due to market factors, the lender may not accept offers that are less than fair market value. They will know exactly what that value is.

You’re not dealing with the property owner. Though your negotiations will be with the property owner and the real estate agent, they’re just go-betweens. The real counterparty in the transaction is the lender. They will have the final say in accepting or rejecting your offer. They may not accept counteroffers, and there’s even a possibility that they won’t bother to consider your offer in the first place.

You must accept the property in “as is” condition. Since the owner is in distress, he probably has no money available to make any required repairs. But since the lender does not own the property, they won’t make repairs either. You will have to accept the property in the condition that it’s in, including imperfections and even code violations.

The process can drag on and on…and on. Because of the back-and-forth negotiations, as well as the lack of certainty regarding lender cooperation, it can take many months to complete a short sale.

The lender may continue soliciting offers. While the negotiations with the lender are dragging on, the lender may continue to solicit new offers. They are trying to get the best price possible for the property, and will have no loyalty whatsoever to you.

Two lenders are NOT better than one. If the property has both a first and second mortgage, the transaction will have to be approved by both lenders. If it’s difficult to get an acceptance from one lender, it will be close to impossible to get it from two.

You may have difficulty getting financing. If all of those obstacles weren’t enough, you might find it difficult getting your mortgage. Though mortgage lenders will make loans on short sales, property condition can be a problem. Your lender may require certain repairs of the property. But since neither the seller nor the current lender will make them, you may be unable to get a mortgage yourself.

If it looks like we’re trying to scare you with this list, it’s completely unintentional. The difficulties involved in purchasing a short sale must be fully understood before you even begin the process.

Should You Buy a Short Sale?

If in studying the housing market in your area you find that short sales do have a major price advantage compared to the general market, you may want to investigate further. Be sure that the property is in fact listed for sale at well below prevailing market values. And if you find a property that’s at least structurally sound, you may want to go ahead and make an offer.

Make sure that time is not a factor for you. Purchasing a short sale property is a long, tedious process that requires more than the ordinary amount of patience that people have.

In Part 2: The Process of Buying a Short Sale Property we’ll get into the specific steps involved in purchasing a short sale property.

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