Short sales are a small but significant segment of real estate sales, particularly in times of economic downturn. During prosperous times when the housing market is seeing healthy appreciation, short sale numbers are so inconsequential that they almost go without notice. But during the worst of the housing collapse and Great Recession, there were more than one million distressed home sales every year, with short sales making up a good number of those (along with foreclosures). In 2009 alone, there were 1.45 million distressed property sales in the US, adding up to 41 percent of all sales.
Just like the volatile number of short sales, peoples’ opinions of short sales run the gambit, too. Depending on who you ask, short sales are either incredible deals and lucrative for investors or a waste of valuable time or even money.
It’s hard to deny that they can be a little bit of “Fool’s Gold,” as the low prices you see for homes listed as short sales may not be close to what they actually sell for. Additionally, closing a short sale is a long process, even most optimistically.
While most traditional sales may close in 30 or 45 days, short sales often take months and months.
The reality is that short sales play an important role in our housing market, both for homeowners who are in financial strain and facing a foreclosure and investors, first-time buyers, or those looking for a great deal on their forever home.
But short sales also command a good deal of patience and understanding, as there are several aspects to the complex process that intertwine regular home buying along with a pre-foreclosure alternative.
The good news is that when you find the right short sale, work with the right agents or professional negotiators, and the bank finally approves the sale (we’ll talk about that more), the end product can be a great house at a great price.
Let's take a closer look at short sales and everything you should know, whether you're an investor, an eager buyer, or homeowner who rough financial waters ahead.
The definition of a short sale
Short sales are definitely widely misunderstood among consumers and the public, and that can lead to some wasted time, money, and other costly errors.
But the essence of a short sale is rather simple: the lender or mortgage company approves a sale of the property by accepting less than what is owed by the homeowner/mortgage holder. So, if the homeowner holds a mortgage for $200,000, for example, the lender might approve a sale for $150,000 in some cases. Obviously, the lender takes a big loss and absorbs the financial hit with a short sale.
So, why would they do it?
Essentially, the mortgage bank or lender would relinquish their lien on the property and allow their outstanding loan to be released for less than what’s owed because they determine it will cost them less money in the long-term.
That determination comes after careful consideration when the mortgage lender sees:
- The borrower/homeowner is delinquent on payments, having missed several monthly mortgage payments.
- And the borrower does not have a realistic plan to get caught up and current on payments, such as through a payment plan or paying off a large sum that’s in arrears.
- A traditional sale is not possible since the current market value of the home is less than the amount owed.
- A regular sale is also not feasible if the home value is approximately equal to the market value since the homeowner still wouldn't be able to come up with the funds needed for a sale, such as closing costs, Realtor fees, transfer taxes, etc.
Therefore, the mortgage lender sees that a short sale is the most efficient way to recoup the greatest sum possible.
Sure, the lender could just wait until it's possible to go through the foreclosure process, either receiving an adequate offer during the public foreclosure sale or eventually recouping the property. But that also means a whole lot of time – and time is money.
In fact, the foreclosure process could take three to six months in reality, or longer if the homeowner puts up a reasonable protest or the court is backed up. Some states have more restrictive and prohibitive legal requirements than others. Any court action takes an abundance of attorney and legal fees, of course, in addition to that wasted time when the homeowner is still not paying.
Even when the lender finally receives a foreclosure judgment in their favor, they will have to legally take back the property, which often means more time and money with the state’s foreclosure process.
Another key factor in the bank’s decision to go through a short sale is because they don't want to create an adversarial relationship with the homeowner, which is often the case with a foreclosure. Of course, that's just bad business for the lender because angry homeowners who are allowed to stay in their home for months and months often leave the home in disrepair. There are plenty of horror stories of malicious homeowners completely trashing properties during the foreclosure process. We’ve even seen unscrupulous owners seriously crippling the home’s value by purposely causing water damage or stripping every single fixture and appliance to sell!
That’s a huge risk for the bank, who then will need to also completely rehab and fix the property before it’s sold on the MLS, or incur another huge loss if it has to sell a trashed property as-is.
But with a short sale, the homeowner is working with the lender to make the best of a bad situation, and there are far more checks and balances to keep them engaged and working with the lender.
Why would a homeowner try to short sale their property?
The financial benefits to the bank or lender are now clear, but what’s in it for a homeowner?
After all, if they’re missing their payments already, then why wouldn’t they just throw up their hands and surrender trying to get caught up or reinstate their home loan?
Luckily, there are some clear advantages for a homeowner to try and short sale their property as they’re going through a difficult financial period.
The benefits of a short sale to homeowners include:
It’s better for your credit
Of course, missing mortgage payments, foreclosures, and bankruptcies are some of the most damaging negative items that can hit a consumer’s credit report. While a short sale won’t erase the missed payments with the credit bureaus, it will prevent a foreclosure from showing up on your credit report and acting as a wrecking ball to your score. It’s not perfect, but the credit bureaus reflect a short sale far more favorably than a foreclosure.
Buy again sooner
Whether you short sale or foreclosure, your credit score may “bottom out,” dropping 150-200 points for most people. As we noted above, a short sale may ease the damage to your credit score, but the reality is that if you were forced to miss payments and lose your home, you’re probably not in a position to buy another home right away. But that could change soon as you get back on track financially and save up to buy a home again.
However, when lenders look to approve your next home loan, they may have more stringent requirements for those who have gone through foreclosures than those who short sold their home. It usually takes three to four years minimum after a foreclosure before a lender will offer a mortgage again (and sometimes up to seven years), but we've seen consumers with a short sale buy a home again in 18-24 months!
Avoid deficiency judgment
This is a huge one, as in some states (like Florida), the lender can still go after you for money after you foreclose. That's right; even though you lost the house and aren't paying the mortgage anymore, the bank can look at the loss they took between what you owed and what they recouped, and go after you for some or all of that amount in the form of a deficiency judgment. That's especially true if it was an investment property, you had a second loan or HELOC, or you refinanced and took cash out of the property. If you're missing payments and losing your home, the best way you can reduce your risk of a deficiency judgment is by communicating with your lender(s), as they may sign off on any attempts to go after you for a deficiency judgment if you short sale the home.
Therefore, when you enlist a Realtor and/or real estate attorney to negotiate the short sale acceptance with the mortgage lender, you should always make sure the agreement includes a waiver of the lender’s right to come after the homeowner for any further funds or collection efforts.
Let’s get practical for a moment. If you’re going through some profound financial hardship and missing mortgage payments, you probably are looking to save every dollar you can. With a short sale (as opposed to a foreclosure), you’ll be communicating with the bank, looking for a solution that will protect the bank’s asset. For that reason, they usually don’t aggressively pursue foreclosure proceedings if a homeowner is trying to short sale their property. Of course, this isn’t a perfectly predictable process, but if the lender sees the home is on the market and in negotiations to approve the short sale, they usually will suspend aggressive legal action during that period.
So, just be trying to short sale your property, you may buy yourself extra months and months living in the property – all while you’re not paying your mortgage. An extra few months without a housing payment means you can save as much cash as possible, getting ready for what comes next.
Help a good buyer!
With a foreclosure, it’s a contentious relationship between the homeowner and the mortgage lender, who is going through a legal process to kick them out of the house and take back the property. But most people prefer the more civil, mutually-agreeable process of a short sale. You’re also in a position to pass on your home to a good family or buyer who will love to live in your home and take good care of it.
What are the steps to the short sale process?
A short sale is somewhat of a hybrid, with some elements and timelines of the pre-foreclosure process, but combined with some aspects of a traditional sale.
The homeowner misses their mortgage payment (or payments). When that happens, they're quickly in the pre-foreclosure process and at a crossroads. They can either try a foreclosure alternative like paying their past payments and fees, interest, etc. in full (which rarely happens); continue missing payments and just let the bank proceed to foreclosure; or, decide to engage in a short sale.
The homeowner will want to communicate with their lender early in the process, alerting them that they are interested in pursuing a short sale. The bank may give you some information/resources and even specific forms that will help later on.
Once the homeowner decides they want to go the short sale route, they should enlist the help of a few professionals. We recommend you talk to your CPA or tax planner, and possibly a real estate attorney. You also will need to find a good real estate agent to help you with the “sale” part of “short sale.” We highly recommend you utilize a Realtor who is proficient and experienced in short sales.
Remember that using this Realtor won’t cost you a dime out of pocket – so don’t try to go-it alone.
The Realtor will come by the house and survey its condition, take photos, and take a look at a detailed market analysis to determine fair market value. You, the homeowner, will also sign a listing agreement authorizing the Realtor to market and sell your home (and for them to earn a commission when that happens).
The Realtor will officially publish the home for sale on the local MLS, put their sign in the front yard, and start entertaining offers from buyers.
Those aspects are all just like with a traditional sale.
Next, the Realtor or short sale negotiator submits the purchase offer to your mortgage bank, along with other documentation like a market analysis, your documents displaying that you have a valid financial hardship, and more.
The lender will review the offer and your case and either approve it, deny it, or counteroffer in some cases.
That sounds like a simple step, but waiting for the bank to approve a short sale can take months and months and is often an arduous process. Remember that the buyer who submitted the offer is not "locked in" to the deal, and they are most likely out looking at other homes and submitting other offers. So, in many cases, the bank finally approves a short sale after six months, but by that time, the buyer is no longer interested.
The whole process has to start over again!
Once we get all parties aligned and the seller, buyer, and bank are ready to go forward, the home sale officially starts the normal selling process, with inspections, disclosures, and the buyers obtaining their home loan.
Once all of those steps are satisfied, the buyers close on their loan and the home sale can officially close and record. Your mortgage lender will receive any proceeds of the sale (not you) and will release you, the homeowner, from the mortgage loan.
When a lender WON'T allow a short sale:
Remember that there are no guarantees with short sales. Just because a homeowner wants to short sale their property, it doesn’t mean the bank will allow it. And just because you put your home on the market and found a willing buyer who submitted an offer, it doesn’t mean the bank will sign off on it.
In fact, a good number of short sales never get approved by the bank and end up in foreclosure. Additionally, even when a short sale is approved, the buyer may have moved on to making another offer with another home, which is often the case since buyers don’t want to wait endless months for the bank’s process to unfold.
In that case, the Realtor scrambles to put the short sale on the market again and looks to engage another buyer. At that point, they have to start the short sale approval process again.
However, it’s not all pessimism, as some banks and lenders have streamlined their internal processes to handle and approve short sales with improved efficiency. With a good Realtor, a good negotiator, and a good bank, a short sale has a reasonable chance of being approved and closing successfully.
But there still are some instances where the bank cannot and will not approve a short sale in any case. These are:
- The loan is current, and the homeowner hasn't missed any payments. Of course, the lender won't consider a short sale or any loss mitigation options if the mortgage borrower is paid-up and current. (Why would they?!)
- If the homeowner declares bankruptcy, a short sale is not allowed to proceed. Short sale negotiations are considered an extension of debt collection activities, which is not allowed to proceed during bankruptcy proceedings.
- If the homeowner owes less than the home is worth on the current housing market, the lender won’t consider or approve a short sale. In that case, a traditional sale will be the homeowner’s option because they can still sell with enough equity to end up with proceeds, or at least break even.
- If the buyer of your short sale is a family member or even close friend, the lender typically won’t approve the short sale for fear of fraud or any impropriety.
Remember to talk to your CPA or tax planner and possibly a real estate attorney about a short sale. There are some huge implications to selling a house as a short sale, including possible tax ramifications and even deficiency judgments or recourse debt in some states and situations. So, it behooves you to set an appointment with your tax and legal professional, so you understand the implications or your liability.
Tips for buying a short sale
- Make sure you understand the short sale process and timelines and know what to expect. It’s hard enough to complete and close a short sale, so you don’t want to have any unfortunate surprises based on gaps in knowledge along the way.
- That being said, you should also make sure to use a Realtor who really understands the short sale process and has some experience. They should have clear expectations that this transaction may take a lot longer than your normal 30-day escrow, and they’ll have to do additional work by communicating with the homeowner’s Realtor. The relationship between the buyer and seller’s Realtors goes a long way to successfully completing the short sale transaction!
- Understand that the seller’s lender will ultimately approve or disapprove the short sale. The decision doesn’t lie with the seller.
- For some buyers who are not knowledgeable about short sales, they think they’ll be able to swoop in and make a low-ball offer and end up with a steal. Let me dispel that myth right now: it’s not going to happen. The seller’s mortgage bank will carefully scrutinize any offer and will only approve fair offers at current market value. We all get a little opportunistic when home buying and want to pick up a home for a fraction of what it’s worth, but if you’re going to submit unreasonable offers or not be serious about buying a home for fair worth, don’t bother.
- As a buyer, you should always do a home inspection, whether it's a traditional sale or a short sale. The same is true of a pest inspection (which the buyer's lender will probably mandate, anyway).
- A short sale doesn’t mean you have to purchase the home As-Is every time. While the seller’s bank will prefer not to do repairs or spend money on contractors during the escrow process, they may agree to repair major issues you find in the home inspection, especially if they impact the health, safety, or livability of the structure. They may also negotiate a price discount for those fixes or set aside funds to go to a contractor out of escrow.
- Be patient and get ready for a longer process, since timelines for review and approval are up to the seller’s bank, as we mentioned.
- If you’re an investor or a home buyer who is serious about purchasing a short sale, consider putting offers down on properties who plan on using a professional short sale negotiator. Many Realtors try to negotiate these themselves, which may work fine in some cases (and with some Realtors) but has a much better chance of being successful if a professional short sale negotiator is handling that aspect of the deal.
Short sales aren’t a perfect process, but they hold some prominent benefits for home sellers, who may buy time, avoid foreclosure, possibly remove further debt collection, and gain the satisfaction of turning their keys over to an excited home buyer.
While these transactions take a higher level of understanding and professionalism, they can yield great results if you’re looking to buy and are willing to exercise patience, as you can end up with a great home at a great price.
Please contact us if you have any questions about short sales or would like to consider your foreclosure alternatives!
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