A short sale occurs when a home is sold but the amount of the sale is not enough to cover what is owed on the seller’s mortgage loan, as well as closing costs, taxes and the commission owed to the real estate agent. In a short sale, the seller is not willing to make up the difference. Oftentimes, a short sale is happening because the owners are behind on their mortgage payments and are heading down the trail to foreclosure. Other reasons for a short sale could be because the home was bought at the peak of the market and has decreased in value, the homeowners used a large amount of their home equity toward a refinance, the owners are being relocated or they are getting a divorce.
If you are interested in purchasing a short sale, you will need to ask the seller how much is still owed on their debt. Then you can figure out the additional costs associated with the short sale. Many lenders will have their own forms to help calculate these costs. The lender and the title company will have exact figures that will be due at closing. You will also be able to find out if there are any other inspections that should be completed. When a seller decides that a short sale might be the best option, he or she will need to get the lender’s approval. Included in the approval request submission is the borrower’s W-2 forms from any employers, or if he or she is unemployed, a letter outlining the unemployment. It will also include bank statements, two years of tax returns and any other financial documents that show the amount of income and debt obligations. It is also a good idea to include a “hardship letter,” which explains the reasons why you are not able to pay the full amount of the loan. What kind of impact does a short sale have on credit reports? It is not unheard of for the lender to ask the seller to sign a promissory note. It can be for all or part of the difference between the short sale amount and the amount still owed on the debt. Overall, short sales show as negative activity on credit reports and can therefore lower credit scores tremendously. When looking to purchase a short sale property, it is important that you understand exactly what you are getting into and know that the process is a long one. Have your real estate agent walk you through each step of the short sale process.
How a Short Sale Works
In a real world, short-sale scenario, a home seller puts his or her property on the market, while formally designating the home for-sale as a potential “short sale/subject lender” deal to any potential buyers. Once a buyer agrees to make a short sale offer, the homeowner contacts his or her bank, and completes an application asking for short sale status on the home. There is no guarantee the bank will green light the application, but a short sale does eliminate many hassles associated with the mortgage loan, such as closing the books on the homeowner loan, and the bank or lender gets a portion of their loan repaid. Home sellers involved in short sales can expect to file several firms and documents to their mortgage lender. Those include a hardship letter stating why you can’t fully repay your mortgage loan, along with the filing of records like pay stubs and tax returns that back your case as being unable to repay the home loan. The bank will then review your application, send out an appraiser to estimate the full value of the property against the short sale offer, and then either approve or reject the short sale request.
Benefits of a Short Sale to a Home Seller
If the property seller is presented with a short sale opportunity, it’s a good idea to thoroughly vet all the options on the table, and calculate the risks and opportunities and look at other relative personal financial options, before making a decision. Nobody is saying a short sale is a perfect solution to a home seller who has suffered a financial setback and owns a home with where the mortgage exceeds the property’s value – but it might be the best option.
Benefits of a short sale
Credit score advantages
A short sale is highly preferable from a personal credit score point of view, especially when weighed against any potential home foreclosure. Credit scoring firms take a dim view of a foreclosure, and will issue a credit score much lower than when a home seller turns to a short sale instead. That not only protects the seller’s score, it keeps them “in the game” and better able to buy another home down the road, without the burden of a significant foreclosure-induced credit score decline.
Emotional advantages
In many instances, a home mortgage is the biggest financial event of a person’s life at least before retirement. The seller avoids a “worst case scenario” of foreclosure and can honestly say they sold their home and moved on with their life.
Saving on home sale fees
With a traditional home sale, the seller bears the burden of fees and charges, including real estate agent commissions, which can be 3%-to-6% of the total home sale. In a short sale, those fees and commission are paid by the bank.
Negatives of Short Sales to a Home Seller
Short sales can create issues for sellers such as:
• No cash-out: A short sale means they won’t earn any profit from the sale of the house the bank or mortgage lender gets all the sales proceeds.
• Dependence on the lender: Home sellers also need a green light from their lender on a short sale they can’t make that decision on their own.
• Less cash for a future home purchase: Since the seller earns no profit on a home short sale, they won’t be able to steer home sale assets toward the purchase of a new home. Instead, they’ll be starting from scratch.
Benefits of a Short Sale to a Home Buyer
Home buyers can take good advantage of a short sale, as well, with several advantages:
• Reduced price: Primarily, the big benefit is the increased odds of getting the home for a reduced price, knowing that the house is in short sale mode, and that the owners, and likely even the bank or lender in many cases, will want to sell the home and get out from under the home loan. As any real estate agent will say, a motivated seller is a seller who wants to cut a deal, so a low-ball offer has a better chance of being accepted in a short sale than in a traditional home sale negotiation.
• Less competition: Many home buyers, especially first-time buyers not used to the complexities of the process, may not want to get involved with a short sale. That opens up the field for home buyers with more patience for a short sale, and who’ll face less competition for the home.
Negatives of Short Sales to a Home Buyer
Short sales can have negative repercussions for buyers such as:
• A longer home-purchase timetable: For buyers, the paperwork process is significantly longer in a short sale (usually up to 120 days) than in a traditional home sale (usually up to 45 days) and that may be a deal-breaker for home buyers.
• Lender interference: Lenders may also get directly involved in the home price negotiations, often asking for a higher sales price than the home seller (including the insistence that the buyer make all or most of the closing fees), in order to recoup more money on the home loan.
• The property may be in disrepair: It’s also highly advisable for a short sale buyer to work with a real estate agent well-experienced in the short sale process. It’s also strongly advised that a short sale buyer hire a home inspection professional to thoroughly examine the property, as short sellers may not have the financial resources to keep up with home maintenance and repairs.
Disadvantages of Buying a Short Sale
Buying a short sale can be a great opportunity to get a property at a reduced price, but it can also have its disadvantages. Purchasing a short sale is a more complicated process than a typical home sale, so there are some unique risks involved when investing in this type of investment property.
Long Process
Short sales may not be the best choice for those wanting or needing to purchase a property quickly. Getting a short sale approved can be a long process. They can be completed in as little as a month or could take up to a year to be finalized. Many factors can influence this time table including a lender’s experience dealing with short sales, whether the seller has already been approved for a short sale and the number of lenders involved.
Subject to the Mortgage Lender’s Approval
In a typical property sale, the only one who has to approve the sale is the person who owns the property. In a short sale, this is not the case. The current owner is not the only one who must accept the offer. Since the owner is trying to get their mortgage lender to accept less than they are owed for the property, the lender must approve the sale. Lenders are not necessarily too eager to take a loss on their loan. This process is further complicated if there are multiple liens on the property, meaning you would have to get multiple lenders to agree to the short sale.
Lender Could Counter, Reject or Not Respond
Even if a seller has already been approved by their lender for a short sale, there is no guarantee that the lender will accept your offer. They may believe your offer is too low. If this is the case, the lender may counter your offer, flat out reject your offer or they may not even respond to it. This is a significant and real risk considering you could have already been waiting months to even get to this point. Even if the lender does counter, there is no guarantee that the price is a price you would be willing to pay based on your perceived value of the property. In addition, if there are multiple liens on the property, you will have to get the acceptance of all the lien holders. The first lien holder may accept the offer, but the second or third lien holder may reject it, so there will be more hurdles to getting the short sale approved.
Opportunity Cost
Short sales present another risk because the lengthy short sale process could cause you to miss out on other potential purchases. With all your time and resources tied up in short sale negotiations for months, you could miss out on an even better investment opportunity.
Property ‘As Is’
Sellers attempting to negotiate a short sale are usually experiencing some sort of financial hardship. Therefore, they may not have the money to do upkeep on their property. This inability to keep up with maintenance may be obvious, or it may lie deeper in structural, electrical or plumbing issues. When you buy a short sale, you are usually buying the property ‘as is.’ The bank is already losing money on the property, so they will not usually make concessions for these maintenance issues. It is therefore extremely important to get a home inspection so you can uncover any major issues the property may have.
Is the Seller Approved?
Just because someone advertises a property as a short sale does not mean they have been approved for one. They may think they qualify for a short sale, but unless they are actually approved by the bank or mortgage lender, this classification means nothing. Before getting involved in a short sale, you should always verify that the seller has been approved by their lender for one. If they have not, you could be wasting your time or could become involved in a process that will draw on for months or even a year.
Lenders Prefer All Cash or Large Down Payments
Another risk of a short sale is losing out on the property to an all-cash buyer or a buyer who is able to put down a large down payment. When agreeing to a short sale, banks and other lenders prefer to deal with these types of buyers. They see them as less risky than a buyer who needs to get a large mortgage in order to purchase the property.
Pros and Cons of Buying a Short Sale
Any buyer considering participating in a short sale should be aware of these issues:
Short sales can take a long time.: The term “short sale” is a bit misleading. The bank or lender holding the mortgage must approve the offer, instead of just the seller. The property can end up in escrow for months and months. In the meantime, a better property could come on the market and the hopeful buyer is tied up in red tape on the short sale. For that reason, it pays to have an experienced real estate agent on board.
They are sold as-is.: Unlike a traditional home purchase, the buyer of a short sale is unable to negotiate on price in exchange for needed improvements, repairs, or updates.
Make sure the lower price is really worth it: Many buyers are willing to ignore these points because they feel getting a home for a much lower price makes it worth it. However, they will need to factor in the local market conditions, such as inventory, home prices, appreciation rates and how fast homes are selling, aka “DOM” or days on market.
The good deal factor can be influenced by the market conditions: When properties are being sold well above the list prices and market value, those looking for short sale opportunities could end up on top. If short sale homes can only be purchased for prices in line with the current market value, then it may be better to focus on traditional listings.
Less competition: A definite plus with short sale listings is that there is not nearly as much competition. Because so many prospective buyers are also first timers, they tend to shy away from anything that’s not a standard transaction.
Don’t overlook needed repairs: Anyone thinking about a short sale should be aware that all too often; the disgruntled former homeowners have taken their frustrations out on the home. There have been numerous horror stories about sabotaged appliances and hidden damages left by angry parties. Another concern is that because of the owner’s financial problems, these types of homes are often in sad states of disrepair. Are you handy or have the extra funds to make things right?
Home inspections are a must: Banks are not required to reveal disclosure information like a seller in a traditional property sale would have to do. This includes legal and insurance information. Even though short sellers must complete a disclosure form, as already mentioned, they may not be up to speed on routine maintenance. It may not always be obvious that something costly to replace, such as a roof or furnace, is on its last legs. That’s why in a short sale, a home inspection should always be done. Anxious buyers should never skip this step even if they are experienced with the ins and outs of home ownership. A home inspection can reveal a lot of hidden problems such as, mold, mildew, termites, or electrical issues.
Research the community, get neighbors’ opinions if possible: It might be a good idea to chat with a few of the neighbors in order to cover all the bases towards finding out what type of situation you are getting into. They may have some extra insight or knowledge of the home’s condition, the neighborhood’s best/worst features, and so on.
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