What is a Short Sale?

What is a Short Sale?

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Photographer: Helloquence | Source: Unsplash

Mortgage default rates in the U.S. have been dropping for the last ten years. According to the Consumer Financial Protection Bureau, mortgage delinquency rates have decreased by half since 2009. However, there are still plenty of Americans under the threat of foreclosure. Many are opting to make a short sale on their home.

Foreclosing on your home can have a number of downsides, including credit damage, the inability to get relocation assistance, and difficulty renting a property. This is why alternatives should be considered before you go through with it.

Now, it's important to note that a short sale isn't the right move for everyone. You need to be in a unique position for it to be beneficial. That's why educating yourself should be your first move.

Let's break down the basics of a short sale and go over some pros and cons.

The Fundamentals of a Short Sale

Sometimes homeowners end up in a situation where the value of their home is less than the remaining balance on their mortgage. Maybe they've been unable to make necessary repairs and maintain the value of the home. In many of these instances, the homeowner has suffered financial setbacks that have caused them to miss mortgage payments.

These scenarios often end in a foreclosure, but this isn't the only route. Another alternative is a short sale, in which the home goes on the market for less than the remaining mortgage balance. Homebuyers can negotiate with the sellers on a price and then seek approval from the lender.

This may not seem like a logical move for the mortgage lender, which is usually a bank. Why would they want to take less than what is owed by the current owner? It turns out there are some reasons why a lender would want to move forward with a short sale.

It's important to note this transaction can't happen without approval from the lender first. After all, they're the ones taking on more risk. However, sometimes a foreclosure is more costly and time-consuming for the bank. If the conditions are right, approving a short sale would be in their better interest.

Understanding the Process

The requirements for carrying out a short sale vary from state to state. However, the steps are generally the same. If you're considering this type of home sale, you need to make sure you understand the process and seek professional real estate advice if you have questions.

The first step involves submitting several documents to the lender. These include financial records and an explanation as to why the short sale is occurring. Once the seller gets an offer from a buyer, the real estate agent involved will need to send some items on behalf of the buyer. These include the offer, pre-approval letter, and a copy of the check for the earnest money. The bank will then review everything and either approve or deny the short sale.

If the sale is approved, it proceeds very similarly to a normal home purchase, with a few small differences. For example, the contract will state that the terms of the sale depend on approval from the bank. The home will also need to be purchased "as-is." While the buyer can still have the home inspected, negotiating for a lower purchase price based on the outcome of the inspection isn't an option.

Buyers should understand that even though they're paying the lender, the bank probably won't make any repairs. Plus, because the current owner is most likely in financial distress, they won't either.

Benefits of a Short Sale

On the surface, a short sale may not seem like the best idea. However, there are a number of advantages for both the seller, buyer, and lender. Granted, it's not the best scenario for the sale of a home, but we don't live in a perfect world.

For the seller, the biggest benefit is avoiding foreclosure. The foreclosure process can be stressful, costly, and ruin a person's credit. While a short sale won't look good on the seller's financial record, it's much less damaging than a foreclosure. Plus, the seller is absolved of further mortgage payments.

For the buyer, the main benefit is the ability to purchase a home at a lower price. Yes, they're buying a house that most likely has issues. However, if they have the means to perform renovations and they love the property, it's a good move. The buyer in a short sale may also be able to negotiate financing terms with the lender. Finally, because the seller is motivated, the process typically goes over smoothly.

Lenders can benefit from a short sale as well. The main advantage is that they're at least getting some of the remaining mortgage balance. This is better than nothing. Plus, the foreclosure process is a huge burden many lenders want to avoid.

Disadvantages to Consider

While a seller may be out of the woods when it comes to the threat of foreclosure, they'll still experience some drawbacks after a short sale. That's why it's important to weigh all options if you're considering moving forward with one.

There's a chance the lender will report the seller to the credit bureaus. This can damage the seller's credit score. However, this can take a while to happen and it's hard to gauge the extent of the damage.

Another disadvantage is that there's no way to know whether the short sale will be approved by the bank. It also may take a while for the bank to make a decision. This can be a stressful time, especially if the seller is experiencing major financial hardships. Plus, the bank will most likely go through all the seller's personal finance information, including tax documents, assets, and bank accounts.

Finally, a lender may opt to file a deficiency judgment due to the difference between the price of the home and the outstanding mortgage debt. This could result in the deficient amount going to collections or a lawsuit being brought against the seller by the lender. These things could happen even after the short sale has gone through.




How do I know a Short Sale is Right for Me?

How do I know a Short Sale is Right for Me?

Photographer: Eric Muhr | Source: Unsplash

Is a short sale a good idea? Well, that depends. As with any kind of investment, there are many points to consider before making a final decision.

For instance, are you selling or buying the house? What is your financial situation? These are all relevant points. In order to decide, you need to understand what a short sale is, its advantages, possible mistakes that you may commit and how it all applies to your specific situation.

What Is a Short Sale?

Life is full of ups and downs. Sometimes you commit to huge investments and then something happens. You can lose your job, for instance, and only find another one that pays considerably less. If your investment was a house and you've still got a mortgage to pay, then you can face a real problem.

The failure to pay the mortgage will damage your credit score and it can lead to a foreclosure. Fortunately, most banks never want to go down that road because everybody loses. So, in order to avoid trouble, several lenders can agree to have a short sale.

What is a short sale, then? It’s when someone decides to sell a residence for less money than what the person owes to the lender. The rest of the payment is forgiven.

Let’s look at this example. Someone still owes $200,000 to the bank for a house that originally cost $300,000. With a short sale, the person can sell the house for $175,000 and the bank will forgive the other $25,000.

Why would a lender do that? Wouldn’t it be losing money? Actually, no. Short sales can only happen during very specific situations that protect the lender.

In order to participate in a short sale, some rules have to be followed. The first one is that the house needs to be valued at less than the amount of money that the person paying the mortgage owes to the lender. This means that its value needs to have decreased considerably before now and the current owner has negative equity.

In the example from before, the house, which was bought for $300,000, would need to be valued at less than $200,000 now.

The other rule is that the lender needs to give permission in order for the deal to move forward. Without this agreement, nothing happens.

The Advantages Of A Short Sale

Short sales can present several advantages for both the buyer and the seller. Most of all, though, they present a huge advantage to lenders: they lose less money this way. The main reason for them to accept these deals is that they know that they have already lost the money anyway.

As the value of the house has gone down and the person who bought it is not even paying it anyway, any profit is profit.

The buyer can also benefit, because he/she has already lost money in this investment. For both the seller and the lender, a short sale can be great because it is really a way out of a huge mess.

That said, there are additional advantages to the seller. Your credit score will probably recover quickly after the sale is done. You can also avoid foreclosure, which is always a huge headache. The main advantage, obviously, is to go mortgage-free and finally have some peace of mind without owing a huge amount of money.

If you are a potential buyer, though, you should be asking yourself: don’t I get any advantages? Well, you certainly do, although they are not as big as theseller's.

Short sales are a great way to buy houses way below their market value. You can get huge discounts if the prices are considerably low and the house has no problems. This, however, is when most investors make a mistake. They do not know all the pitfalls that a short sale can bring if they are not careful.

The Most Common Mistakes During a Short Sale

If you are a buyer, this advice is for you: take care. Buying a house during a short sale means that there are considerably more chances that it may have issues. The last owner probably had financial troubles, so many things about the property may not be in order.

For instance, utility bills may be unpaid. Repairs may need to be done. Be sure to make an inspection before closing the deal. Sometimes that great investment is not really good when you see how much money you will spend later to fix it. Buying a house that does not need a lot of repairs is the best idea if you really don’t want to spend a lot of money.

Another good idea is to always visit the house accompanied by professionals. They are trained and will help you to spot any problems that may turn into inconveniences in the future.

It is also very important to consider is that there is a long wait before a short sale. The timeline for waiting for an answer can be a real pain for you if you are not willing to wait a lot. Offering a big payment can help you, but there are no guarantees.

You should know that other people may be interested in the house as well and that they may be the ones who will get to buy it. There is not much you can do about that, unfortunately.

Do Your Homework: Research Before The Short Sale

While a short sale can seem like a great idea at first, being prepared is essential. Whether you want to sell or buy the house, researching a lot is a necessity.

If you want to sell the property, you should do the math and determine if getting rid of this problem by losing the house is worth it. Sometimes, if you can pay the rest, it can still be a decent investment. However, in some situations (such as not having the money to pay at all) selling the house is the best outcome.

In case you are looking to buy a new home, you should check your priorities, follow all tips about the most common pitfalls and really do a lot of research about the property and its condition before deciding.