How does a short sale work?
A short sale is similar to a foreclosure, but the two aren’t the same.
In a short sale, the bank or mortgage lender does not remove the homeowner. Instead, they agree to let the current owner sell the house for less than the mortgage owed.
What’s the benefit of buying a short sale home? There’s just one: You might pay an exceptionally low price for the house.
But the process can often be frustrating and has unique perils.
This article covers the process of buying a short sale home as well as the pros and cons.
Explore your mortgage options (Mar 6th, 2020)In this article (Skip to…)
- What is a short sale?
- The short sale process
- How long does a short sale take?
- Obstacles during the short sale process
- Who should buy a short sale?
- Pros and cons of buying a short sale
What is a short sale?
The concept of a short sale home is fairly simple. It happens when a homeowner owes more on their home than it’s worth. The home’s market value falls of the balance owed on the mortgage. This is also called being “underwater” or in “negative equity.”
In a short sale, the homeowner needs to sell their underwater home — and the mortgage lender gives permission for the property to be sold for less than the outstanding balance.
The lender calculates that it will make a smaller loss that way than after a foreclosure. So in a way, a short sale can help both the lender and the homeowner.
And it also helps you, the buyer, if you can get a below-market deal on the home.
The short sale process
The short sale process is a lot like buying a home off the market. You’ll find a place and get pre-approved for financing (unless you’re paying in cash). Then you’ll make an offer, negotiate the sale, and close. But at any of these stages, there are unique challenges for short sale homes. Here’s what you need to know.
Step 1: Find a short sale home
Given the complexity and risk associated with short sales, we don’t recommend going it alone unless you have plenty of prior experience.
Although you could search for properties on your own using a Multiple Listing Service (MLS), it’s to hire a real estate agent experienced in short sales.
A good agent will check the title, learn whether a foreclosure notice has been filed, and determine how much is owed to the lender(s). This data will help you prepare a competitive offer.
In addition, the agent will help you negotiate the best deal and overcome any roadblocks to a successful close.
Step 2: Get pre-approved for financing
Unless you’re paying for a short sale property with cash, your first step is to get pre-approved for a mortgage.
This is a must. Without financing in place, a bank is likely to dismiss your offer out of hand.
Luckily, getting pre-approved is relatively fast and easy.
Many lenders can verify your credit and financials in just one day. Then they’ll write you a pre-approval letter and you’re armed to make a credible offer on a home.
Start your pre-approval today (Mar 6th, 2020)Step 3: Make an offer on a short sale home
Your third step to buying a short sale home is to make a competitive offer. Although you may be able to below sticker price, don’t count on it. Instead, make a reasonable offer based on the home’s value.
A good offer package for a short sale will include:
- A purchase contract for you and the seller to sign.
- An earnest money deposit. A substantial deposit shows the bank that you are a serious buyer. (If the deal closes, the deposit becomes part of your down payment)
- A pre-approval letter to prove that you have the ability to purchase the property at the offered price
- Information on recent sale prices for similar properties in the area – “comps” – to prove that your proposed price is reality-based
- Proof of funds — This may be needed if a pre-approval letter doesn’t convince the seller that you have enough money. Proof of funds can include copies of bank and money market account statements, as well as equity lines of credit and certified financial statements
Launching the negotiations with a low-ball offer is not likely to work in your favor.
This tactic might have worked during the last recession when lenders were desperate to mitigate their losses. But sellers are able to be more discerning now.
In fact, underpricing is the number one reason banks reject short sale offers.
Another common reason for rejection is an incomplete offer — one that doesn’t contain all the necessary documents.
So make sure you have your paperwork in order before attempting to buy a short sale home, just like you would for any other home purchase.
Step 4: Negotiate the short sale and contingencies
You and your agent should also prepare a short sale addendum with certain contingencies.
“Contingencies” are conditions that have to be met before the home sale will go through.
For example, you probably want your offer to be contingent on the lenders’ approval of the sale, the length of time you’re willing to wait for short sale approval, and the amount you will pay in closing costs.
You probably also want a short sale to be contingent on the results of a home inspection.
Whatever you do, don’t buy a short sale home without having the place inspected first.
In fact, you may want to hire specialized inspectors to look for pricey problems such as termites, mold and structural damage.
Note: Short sale homes are sold “as is”
Keep in mind that short sales are “as is” purchases.
Unlike regular home sales, you should expect the seller to lower the asking price if any problems are uncovered. It rarely happens.
But an inspection can still uncover deal-breaker issues that might make it “not worth it” to buy the home.
If you’re a smart and determined buyer, it’s possible to find short sale bargains. Once you find one, a successful outcome can definitely be worth the effort.
How long does a short sale take?
One California-based agent recently estimated that it takes on average about 60 to 90 days for a lender to approve a short sale deal — and that’s after receiving the full offer.
However, that’s just one agent’s estimate. The actual time frame for a short sale can vary a lot.
The time to close can also depend on where you live. It could be way longer if multiple lenders are involved. And that’s just an average, meaning by definition that some take less time and others more.
The variables are just so wide and complex that a real estate agent who specializes in short sales could only guesstimate the time from offer to closing — even if he were in full possession of the facts of your case.
Obstacles to expect during the short sale process
There are three common obstacles that can make a short sale take longer than a traditional home sale — or prevent the transaction altogether.
- Multiple debts are owed. If the homeowner borrowed from multiple lenders, the “junior” lien holders might block the sale. These lenders often receive little (or no) money from short sales. An example would be a home equity lender that secured debt against the home after the original mortgage was taken out
- The seller could cancel the deal. This sometimes happens when the primary lender asks the seller to contribute to the closing costs and the seller balks
- The banks accept a competing offer. This can happen even after you make an earnest money deposit and pay for a title search, home inspection, etc.
Because of these unique pitfalls, it’s especially important to know what you’re getting into when you start the short sale process. And you’ll most likely want an expert (like an experienced real estate agent) on your side).
Who should buy a short sale home?
There are often challenges and delays when buying a short sale home — which is why a disproportionate number of short sales are taken up by professional property developers and house-flippers.
They’re not emotionally invested in the transaction and can shrug off delays right up until they pay the purchase price and take possession. They may not care much even if the deal falls apart if they’ve multiple others in the pipeline.
It’s different for individual buyers, who are looking for somewhere to live and could be in a sticky situation if the sale falls through.
Maybe you’re well-situated to wait out a short sale, and these things wouldn’t pose a challenge for you. But there’s a good reason so many private buyers leave short sales to the pros.
Pros and cons of buying a short sale home
Here’s an overview of the pros and cons of buying a short sale home:
| Short Sale Pros | Short Sale Cons |
| You may get a house at a low priceThe house may be in better shape than a foreclosure | Short sale houses can be hard to find There may be long delays There’s a higher failure rate for short sales |
The biggest benefit to buying a short sale home is that you might get a great deal.
And unlike with a foreclosure, a short sale home you’re buying is likely to be in good condition.
Often, the current owner will be still in residence and keeping up basic maintenance. A foreclosure, by contrast, might be in disrepair.
That said, there are lots of potential pitfalls during the short sale process.
Part of the reason there are more issues is that the decision maker on the selling side isn’t the homeowner. It’s the mortgage lender that holds the mortgage. There could even be multiple lenders, if the current owner has a second mortgage, such as a home equity loan or home equity line of credit (HELOC).
Some people choose to put up with short sale complications because they’re likely to be buying at a bargain price.
But you should know the potential issues before considering a short sale purchase.
Short sale homes can be hard to find
In order to need a short sale, a homeowner must have negative equity — meaning their mortgage balance is higher than the property’s value.
But that situation has changed dramatically since the financial crisis of 2008, with many fewer underwater homes now than a decade ago.
Dr. Frank Nothaft is chief economist for CoreLogic, a company that tracks property markets and mortgages. Summing up the position at the end of the third quarter of 2019, he observed:
“…underwater owners have been slashed to just 2 million, or less than 4% of mortgaged homes.” –Dr. Frank Nothaft, Chief economist, CoreLogic
“Ten years ago, during the depths of the Great Recession, more than 11 million homeowners had negative equity or 25% of mortgaged homes.
“After more than eight years of rising home prices and employment growth, underwater owners have been slashed to just 2 million, or less than 4% of mortgaged homes.”
So today there are way fewer opportunities than there once were for savvy buyers to take advantage of short sales.
Still, those opportunities haven’t dried up completely. And more will inevitably arise during the next recession, whenever that will be.
The short sale process can have long delays
Short sales are often given lower priority than traditional home sales. That’s because the paperwork is being processed by a lender that knows it’s already made a loss on the home.
Sometimes it takes weeks or even months for a short sale offer to be accepted or rejected. Or the lender may make a counteroffer, in which case you can refuse, accept or counter back — which involves restarting the process from square one.
And if more than one lender is involved, delays may be stretched beyond endurance as they each need to buy into the deal.
The National Association of Realtors describes some of its members’ experiences with short sales:
“As a result of these challenges our members have reported difficulties with: unresponsive lenders; lost documents that require multiple submissions, inaccurate or unrealistic home value assessments, and long processing delays, which cause buyers to walk away.”
That’s not to say everyone will have such a painful experience buying a short sale.
But it is important to set your expectations realistically — buying a short sale may likely be more difficult than buying a house off the market would be.
What to the original homeowner after a short sale is closed?
Sometimes the debt is forgiven. And other times the lender pursues the borrower through the courts for the shortfall.
Either way, the homeowner’s credit will be wrecked for a time, but will typically recover more quickly after a short sale than after a foreclosure.
Is buying a short sale worth it?
For now, the days of easy pickings from short sales are over.
True, you can still find very profitable deals. But you have to work harder and smarter to hunt them down. And it’s strongly recommended that you work with a professional who has plenty of short sale experience.
If you’re interested in buying a short sale home, you still need to get pre-approved for financing. That step, at least, you can start right here for free.
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