What is a Short Sale in Real Estate?
A short sale is when a property is sold for less than the remaining principal on the owner’s mortgage. When a homeowner defaults on a mortgage, the bank will give them a grace period to make up the payments or risk foreclosure. If the homeowner cannot make up the missed payments, then the bank may allow them to short sell the property to a buyer so they don’t do as much damage to their credit. Otherwise, they will foreclose on the property and short sale it themselves at auction or keep it on their books until they find a buyer. So, short sales present the opportunity for investors to get a decent property at a discount.
When Does a Home Go into Short Sale?
Short sales typically happen during the pre-foreclosure period. This means that the homeowner has already missed payments on the mortgage but hasn’t officially gone into the foreclosure process yet (which typically starts about 3-6 months from the first missed payment).
It’s only considered a short sale if the amount owed on the mortgage is less than what the home is worth, which means the lender must agree to the sale. The only time they will agree to take a loss is if it’s clear the seller will not be able to repay the loan. So, they’ll want to recoup as much as possible without going through the foreclosure process.
Short Sale Process For Buyers
1. Get Approved for Financing
Before you begin scouting for short sales, it’s essential to have your financing in order. Sellers will be looking to move quickly, so if you are still in the loan approval process, you may miss out on a great deal. Hard money loans are great for buying short sales because they offer investors a fast approval process and favorable terms.
2. Hire a Real Estate Agent and Find a Home
Once you have your financing in order, you can start looking for properties. Short sales are often listed on the MLS, so it may be wise to enlist the help of a real estate agent to help you scout for properties.
3. Do Your Research
Next, it’s essential to do your research to know if it’s a good deal and how much to offer. Research the neighborhood and try to determine a rough after-repair value. Also, look at the property and assess how much work it needs and what it will cost to repair.
4. Make an Offer
Once you’ve done your research and feel confident it’s a wise investment, you should make an offer. Make sure you crunch the numbers, determine your ideal price, and the most you can pay and still turn a profit. That way, you can start at the former but avoid going over the latter if you have to negotiate.
5. Have the Home Inspected
If you have the ability, you should have the home inspected before you sign the contracts. This is possible if you buy the property directly from the seller before it’s officially been foreclosed on (if you buy it from the bank at auction or as an REO property, you won’t have this option).
6. Close on the Property
After the inspection, all that’s left to do is close on the sale. Be sure to do a title search for any liens and verify with the bank that the price you’re paying will satisfy the outstanding debt. Don’t just take the seller’s word for it, or you may be hit with unexpected costs.
Short Sale Pros for Buyers
The biggest advantage of buying a short sale is that you can scoop them up at a significantly reduced price. While these houses aren’t always in the best condition, a short sale doesn’t automatically imply that there’s something wrong with the property. So, it’s possible to get a near market-ready property at a discount just because the seller needs to move quickly.
Less Competitive Market
There is often less competition from other buyers when you purchase a short sale because they aren’t usually being marketed in the same way as a regular home. The seller may not even be actively fielding offers but may be convinced if you come with the right price and a smart approach.
Short Sale Pros for Sellers
The main benefit of a short sale for a seller is avoiding foreclosure and the damage it will do to your credit. If you know you won’t be able to afford the payments in time to prevent foreclosure, a short sale gives you the ability to cut your losses and mitigate the damage.
In a short sale, the buyer will typically absorb all the debts related to the property. It allows you to get a fresh start and focus on getting back on your feet, which can be a massive relief to many who have gotten in over their heads with debt.
Savings on Fees
Late fees can add up quickly and get you even deeper in debt than when you began. A short sale allows you to get in front of the problem before it snowballs out of control and you get yourself into a hole that is difficult to escape.
Short Sale Cons For Buyers
Finding a short sale is a bit more time-consuming than purchasing a regular home. It requires additional research to find a short sale, and there are no guarantees that the seller will be receptive to your offer. So, you may be rejected a few times before you find a deal.
Buying a short sale often brings added risks. They are typically sold “as-is,” which means that if the inspection reveals something unexpected, you won’t have the opportunity to back out of the sale (unlike a regular home purchase). So, hope for the best but prepare for the worst if you purchase a short sale.
More variables are involved in purchasing a short sale, so you’ll need to do more research to ensure it’s a good deal. You’ll have to estimate its potential value if brought to market standards and get a rough estimate of the rehabbing costs. You’ll also have to do a title search and contend with any structural issues, which can get complicated.
Short Sale Cons for Sellers
No Negotiating Power
When you short sell your home, you have almost no room to negotiate. You don’t have the same bargaining power as a regular seller because you need to move quickly. So, you’ll have to accept whatever offer comes your way to avoid foreclosure.
Lack of Profits
All the money the buyer pays will go toward wiping out your debt. So, you may be very disappointed if you expect to use the money as the down payment on your next home or pay off any other debts.
Credit Score Damage
A short sale will still impact your credit score. It won’t be quite as bad as a foreclosure, but ultimately the bank is accepting a loss on the loan they gave you. So, they will report that to the credit bureaus, which will cause a dip in your score.
Delay in Obtaining Another Mortgage
When you short sell a home, you won’t be approved for another mortgage immediately. You typically must wait 2 to 7 years to apply for another mortgage (although some government-sponsored loans are laxer). So be sure that you have somewhere else to live in the meantime.
Short Sale vs Foreclosure
A short sale and a foreclosure are related topics often used interchangeably but refer to different processes. Foreclosure is when a lender repossesses a property because the owner has failed to make payments for an extended period. A short sale is when a property is sold for less than the outstanding balance because the owner is behind on payments.
Short sales help prevent the lender and borrower from going through foreclosure, which can be expensive and time-consuming for both sides. While a short sale will still impact the borrower’s credit, it won’t be as devastating as a foreclosure, which is why many choose that option.
Short Sale Bottom Line
Short sales present exciting opportunities for real estate investors, however, you must know what you’re getting yourself into. It’s a more complex process than buying a regular market property. However, that’s why there is often more profitable for those who know what to look for. So, if you’re going to buy a short sale, be sure to do your research and understand the risks.