If you’re looking to purchase a home at a discount, short sales can be an appealing option. Short sales are a safer alternative to foreclosures for both sellers and their lenders, which is why you often can find them priced just below market value. However, these transactions are far more complex than your average sale and can involve a lot more risk.
Before you decide to purchase a short sale, you must know precisely what you’re getting yourself into. Reading this guide will arm you with the knowledge you need to navigate a short sale and determine if it’s the right choice for your circumstances.
What Is A Short Sale?
A short sale is a type of real estate transaction that occurs when the proceeds from the sale of a property are lower than the total debt owed against it.
When Does A Home Go Into Short Sale?
A home goes into short sale when the homeowner realizes that they can no longer afford to keep up with their mortgage payments. Instead of waiting for the bank to foreclose on the home, the homeowner initiates the short sale process by submitting an application to the lender.
There are two critical factors that the lender will consider when deciding whether to approve a short sale:
- The home has to be worth less than what the homeowner owes on it. The lender will want to review recent sales of comparable properties to make sure this is the case.
- The seller must be able to prove financial hardship. They have to show that they don’t have the income or assets to pay back the rest of the mortgage.
Short sales and foreclosures were much more common during the financial recession of 2008. As the economy has improved and the housing market recovered, short sales have become less commonplace. However, they’re still an option.
Short Sale VS. Foreclosure
Short sales and foreclosures are both processes that help homeowners who are struggling to keep up on their mortgage payments or find that their mortgage is underwater. (Underwater mortgages occur when a borrower owes more money than the home is worth.) In both cases, the homeowner loses possession of their property, though the circumstances and repercussions are different.
The extent of the seller’s control is a significant difference between these two processes. In a short sale, a seller will decide to submit a financial package, seeking a lender’s approval to sell the property for less than the amount they owe on it. Therefore, the seller enters into this process voluntarily, which is not the case for foreclosures. Once a lender approves a short sale, a seller is in charge of selling the property. However, the lender is responsible for the negotiations and determines whether to accept or reject buyers’ offers – as it is the lender who is trying to recoup costs.
On the other hand, a foreclosure is a legal action taken by a lender to seize a seller’s property after they fall too far behind on their monthly payments. While the seller may live in their home rent-free during the foreclosure process, they’ll ultimately be evicted. The lender, then, takes on legal ownership of the property and is responsible for selling it to make up for as much of the seller’s debt as possible. Instead of listing them on the market, the lender sells foreclosed properties at auction.
Although both processes can negatively impact a seller’s credit, a foreclosure can have a far more damaging impact on a seller’s FICO® Score. Furthermore, the foreclosure process can be expensive for the seller (and lender) and ultimately force them to have to file for bankruptcy.
Foreclosures are time-consuming and costly for all parties, which is why they’re avoided whenever possible. They also can be seriously damaging to the real estate market. Since foreclosed homes tend to be sold for less at auction than short sales on the market, they can significantly lower the value of other homes in the neighborhood. When many homes in an area go into foreclosure, it can be crippling for the local housing market.
The Short Sale Process For Buyers: 6 Steps
Although the steps involved in a short sale are very similar to a traditional deal, the process is more complicated because of the bank’s involvement. The typical home buying process merely requires the seller to transfer their equity to the buyer in exchange for the agreed-upon purchasing price. However, in a short sale, the transaction is in the hands of the lender, so the process tends to be more time-consuming and convoluted. The following six steps illustrate the primary differences between a short sale and a traditional sale.
Step 1: Get Approved For Financing
As with any home purchase, the first step is getting approved. While it’s always beneficial for buyers to obtain preapproval before making an offer, it’s even more important in a short sale as the lender will want to ensure that the new buyer is actually capable of purchasing the property.
With Rocket Mortgage®,the process of securing approval is fast and convenient. It can be done online by filling out an application and providing us with permission to check your credit score. Based on your financials, we’ll recommend mortgage options and tell you how much you’re approved to borrow. After you choose a mortgage, we’ll give you a Prequalified Approval Letter that will demonstrate that you’re a qualified, serious buyer.
Step 2: Get A Real Estate Agent And Find A Home
Finding any home can take time, but it’s more challenging when your heart is set on scoring a short sale. Instead of searching through all the listings available in your desired area, focus on pre-foreclosure property listings online. You can also search through public records by getting in touch with the local county court.
Identifying and navigating a short sale can be tricky, but an experienced real estate agent can help you. An agent can assist with and explain all aspects of the home buying process, including locating short sales.
Step 3: Do Your Research
Before you make an offer, you want to gain all the information you can about the property. You’ll want to begin by reviewing comparable sales in the area to find out the actual value of the home. Real estate agents are an excellent resource for determining home value because they have access to the Multiple Listing Service, which provides information on the prices of homes currently on the market and recently sold.
Since short sales are transactions in which the seller owes more on the home than it’s worth, you’re going to want to find out exactly how much the seller owes the lender. Before you purchase a short sale, you must make sure that you know of every person or entity that has a claim to the property. So, you should also double-check that there are no other liens on the home. You can ask the seller, their agent or lender for this information. However, to be safe, you should also ask a title company to do a title search on the property.
Step 4: Make An Offer
When making an offer on the property, you must use your knowledge of local home values to consider what the lender will think of your offer. You might be looking at the short sale as a way to get a deal on the home, but keep in mind that the lender is still trying to recoup as much of the remaining mortgage balance as possible – and likely also has to meet investor guidelines to accept the offer. Your offer should be close to the market value of the home if you want it to be accepted.
When you’re looking at properties, beware of fraudulent activity. If the seller asks you to pay money under the table for the opportunity to apply for a short sale, refuse and report it.
Step 5: Have The Home Inspected
Short sale properties are sold “as-is,” which means you won’t be able to negotiate a lower purchase price if there are problems with the property. However, you should still know the condition of the home you’re buying before you decide to close on it. While the seller is required to disclose any known defects, sometimes this type of information falls through the cracks.
Be sure to get a home inspection so you know what you’re getting yourself into. If repairs are needed, research the cost or get estimates, so you can find out if the home will make financial sense for you in the long run.
Step 6: Close On The Property
Even after the lender has accepted the short sale, you need to ensure that the lender and any other lienholders are willing to release the collateral. The more lienholders there are, the longer this process can take.
For the sale to close, the seller must also provide the following documentation:
- Hardship letter: A letter that explains the seller’s financial burdens and exactly why they can’t afford to make further mortgage payments.
- Proof of income and assets: The seller must provide at least 2 years’ worth of bank statements and tax documents. This information must prove that the seller has no funds available to pay off their remaining debt.
- List of liens: While some sellers may only be in debt as a result of their primary mortgage, others may have multiple debts. The seller must provide an up-to-date list of all liens on the property.
- Comparative market analysis: A lender will insist upon seeing a list of comparable properties that are currently on the market and have sold in the last 6 months to prove that the seller owes more than the house is worth.
Assuming approval and documentation is in order, you will be able to close on the property, receive the keys and move in.
Benefits Of A Short Sale
Short sales can be beneficial for all parties involved. They provide greater investment opportunities for buyers and minimize the financial repercussions that both lenders and sellers would face if the properties went into foreclosure. Let’s take a closer look at the benefits for each party.
Short Sale Benefits For Buyers
- Discounted price: Although the property will be priced according to market value, the lender is highly motivated to sell in order to cut the bank’s losses. As a result, buyers can often get a better deal on the home than they would if it was purchased through a typical sale.
- Less competitive market: Given the lender’s entanglement in the deal, short sales are far more complicated than traditional sales. Since most buyers are not experienced in short sales, they tend to shy away from them. With fewer interested buyers, there is less competition and a better chance of getting an offer accepted.
Short Sale Benefits For Sellers
- Foreclosure prevention: A short sale will prevent a seller’s home from going into foreclosure, which can have a far more detrimental impact on their credit score.
- Debt absorption: The majority of a seller’s debt will be paid off by the home buyer.
- Savings on fees: In a typical sale, a seller would have to pay for agents’ commissions, but in a short sale, the lender pays these fees.
- Potential debt forgiveness: It is possible that the lender will accept the proceeds of the short sale and write off the remaining debt as a loss. In these cases, the seller is not held accountable for paying off whatever debt remains after the short sale.
- Housing market re-entry: A short sale enables the seller to reenter the market and obtain a new mortgage after two years (while a foreclosure makes getting another loan more difficult because it remains on credit reports for seven years).
Short Sale Benefits For Lenders
- Foreclosure avoidance: Foreclosures are costly for lenders due to the lengthy legal process and the fact that homes typically sell for less at auction than they do on the market. By avoiding foreclosure, a short sale enables the lender to recover more money faster.
- Delinquency judgment: In some states, the lender can sue the borrower to recoup the remaining mortgage balance (the “deficiency”).
Drawbacks Of A Short Sale
Despite the benefits involved, there are still quite a few drawbacks that come with short sales. The process is complex and drawn out, which can increase the riskiness of the transaction and negatively impact buyers, sellers and lenders financially. Here’s a list of some of the issues that each of these parties face when involved in a short sale.
Short Sale Drawbacks For Buyers
- Time-consuming: A short sale usually takes longer than a traditional sale because of the lender’s involvement. In an attempt to recoup as much money as possible, the primary lender and any junior lienholders involved will take their time negotiating and closing the deal. Remember, the more lienholders there are, the longer the process will take. Furthermore, there are times when the seller delays the sale because they either second-guess their decision or are unprepared with the necessary paperwork.
- Increased risk: Since short sales are sold “as-is” without typical disclosures, the condition of the home and the quality of the deal is not always clear to the buyer. Moreover, there is no guarantee that the deal will actually close, so the buyer may risk spending time and money on a home they’re unable to purchase in the end.
- More homework: A short sale requires the buyer to put in a lot more work upfront. Doing research to figure out the true value of the home, discover all liens on the property and identify any issues with the property’s condition is essential to determining whether the purchase is worthwhile.
- Property condition: Given the fact that short sale sellers are financially strapped, their properties tend to be in worse condition than average homes sold on the market. Therefore, the buyer often has to spend a lot more money on repairs and improvements.
Short Sale Drawbacks For Sellers
- No negotiation power: Although a seller plays an active role in the sale of the property, the lender is the only one who has the power to negotiate the purchasing price of the home.
- Lack of profits: Since a seller owes money to the lender, they will not receive any of the proceeds of the sale of their home.
- Credit Score Damage: A short sale can do real damage to a seller’s credit score. The higher your credit score, the larger the hit it will take. However, short sales tend to cause sellers’ credit scores to drop by fewer points than foreclosures.
- Delay in obtaining another mortgage: After a short sale, a seller must wait 2 years before qualifying for a new mortgage.
- Deficiency judgment: In some circumstances, the lender will sue the seller in an attempt to retrieve the remaining debt after the short sale. If a seller is sued, their credit score will receive a blow similar to a foreclosure. However, this process is not legal in all states.
Short Sale Drawbacks For Lenders
- Can’t recoup all costs: Since the lender is selling the property for less than what is owed on it, they typically are unable to recover the full balance on the loan. Therefore, the lender must either write off their losses or sue the seller for a deficiency judgment.
- Legal fees: If a lender chooses to sue the seller for a deficiency judgment, they will have to pay costly legal fees, which may not be worthwhile in the end.
- Junior lienholders: If there are other liens on the property, the primary lender must get all lienholders to approve the short sale. To do so, the primary lender must offer the junior lienholders a cut of the sale proceeds. Having to split the proceeds limits the amount of money the primary lender can recover from the sale and often leads to lengthy disagreements between the lienholders.
5 Buyer Tips For Navigating Short Sales
- Get estimates for repairs: The property may be sold “as-is,” but you should still have the home inspected and get estimates for any repairs that must be made. Having this information at hand will not only help you determine if the home is worth buying but it will also give you more power when it comes to negotiating with the lender. If you can prove that the property is in worse condition than it appears, you’ll be more likely to persuade the lender to sell at a lower price.
- Make sure your offer is serious and realistic: Though lenders are motivated to sell, they are also trying to make as much from the transaction as possible. If you submit a low-ball offer or try to ask for contingencies, it’s unlikely that your offer will be accepted.
- Provide as much cash as possible: After having lost money on a risky investment, lenders are looking for a sure thing. If you can pay in cash, lenders will be jumping at your offer. If not, the larger your down payment, the safer and more enticing your offer will appear. (Don’t forget: if you require financing, you must get preapproved before you make an offer.)
- Offer to pay seller’s fees: Although the lender typically pays the commission and any other fees the seller is responsible for, agreeing to pay them will make your offer more appealing. If there are other buyers interested in the property, this offer will give you a leg up against the competition, as it will enable the lender to recoup more money.
- Enlist the help of a real estate professional: Real estate agents are indispensable resources when it comes to short sales. Short sales are complicated transactions, and with lenders calling all the shots, it’s vital that you have representation. An agent who is knowledgeable about the process will be able to research the property, advise you on its value, negotiate a better deal and ensure that your interests are protected.
Is A Short Sale Right For You?
The answer is not necessarily a simple one. To decide if a short sale is right for you, you must consider your needs as well as the specifics of the property you are interested in. To begin, you must determine how flexible you are time-wise. If you’re selling a home and will need to close by a specific day, a short sale is probably not your best option. Since short sales require lenders’ approval each step of the way, they tend to be more drawn out and are often delayed without warning.
While a short sale may enable you to buy a property at a discount, you still must think about your finances. Since the lender is the one who will be accepting or rejecting your offer, you have to make sure that you can afford to pay the current market value for the property and make a larger down payment than you would otherwise.
More importantly, you must remember that short sales are sold as-is without disclosures, which means that you will have to do a significant amount of research to ensure that the property is actually worth buying. Looking into the public records and getting a home inspection are key to figuring out whether the deal beneficial to you. Make sure you know the condition that the home is in and how much repairs will cost. Saving money on the purchasing price will mean nothing if you ultimately have to spend more to make the home livable.
If you’re ready to start the process, don’t forget that getting preapproval for a loan is a necessary first step. Create an account through Rocket Mortgage® to learn about your options.
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