Undoubtedly, you’ve heard about “short sales” in the news and you may be wondering what that means and why most commentators and real estate professionals say to stay away from them. But before we can discuss whether or not that is sound advice, let’s first run through what they are, why you may want to chase one if you are planning to buy property in the near future, and how to do the most important thing — buy a good home, one way or another.
What exactly is a short sale? For starters, a short sale begins when an owner’s house is worth less than the outstanding mortgage balance. For example, the house is worth $150,000, but there is a mortgage on it with a balance of $200,000, which is commonly called “underwater" or "upside down." If the owner wants to sell the house, they'll have to apply to the bank to approve a sale where the net amount from the sale is going to be less than that $200,000 outstanding balance. Then, if the bank approves, the sale goes on as a normal sale and the bank will accept the net funds (the $150,000 value, less sales costs) as payment to fully settle and extinguish the existing mortgage. Because the funds from sale were short of paying off the entire mortgage, it’s called a short sale.
But why would an owner want to do this? The answer is relatively simple — an owner with a property underwater may choose to pursue a short sale option to sell the house, which would relieve him or her of the debt and mortgage payments. Many times, people pursuing these are in financial trouble and really need to do the transaction to reset and restart their financial lives. However, while it can help their finances significantly, it will also damage their credit report for a few years and probably prohibit them from purchasing another home during that time. However, most people are much more concerned about getting rid of the house and the associated debt than worrying about any hit to their credit report.
But not any owner can do a short sale because it must first be approved by the lender, which may not happen. If the owner makes a lot of money and can easily pay the existing mortgage payments, the bank might reject the owner’s request for a short sale. Then, the owner would have to figure out their best course of action — either continuing to pay the mortgage, or letting it go into foreclosure.
But why would a bank want to let an owner off the hook by doing a short sale? If a property owner is in distress or has already stopped paying on their mortgage, there is a high probability they are eventually going to lose the property to either a foreclosure auction or short sale. The reason a bank would prefer a short sale is because it is much less costly to the bank. The bank is going to lose money regardless of whether they foreclose on the house or sell it in a short sale, but a short sale is a much more orderly process with the owner on board, so the house probably will be kept in better condition. In a foreclosure, not only is the owner unhappy with the bank, so they may do some damage, but they certainly won’t care about the property. There are also significant legal fees involved in a foreclosure. In addition, the bank may have to spend money to evict the owner after foreclosure, then the house will be vacant for months, which increases the chances of vandalism. On top of all of that, the bank must pay insurance, property taxes, HOA fees etc. during their ownership, which probably averages nine months. Foreclosures almost always cost the bank a fortune, so an orderly short sale is much better for the lender.
That brings us to the concept of buying a home that was sold in a short sale. Short sales are listed on the local realtor multiple listing service (MLS), just like all the other properties. Sometimes, short sales can be at a lower price than similar units being sold via traditional sales, but not always, so either way, you need to review comparable market sales to better ensure that the price you are offering is a fair deal for yourself.
The biggest issue with short sales is that owners often list them for sale on the MLS right when they start the process of applying for short sale approval. The downside of doing this is that the process of getting a bank to approve the sale could take up to six months, especially if there is more than one loan on the property, if it is in bankruptcy, or if there are outstanding HOA fees. This means that even if the seller accepts your offer, you'll still need the bank to approve it. Since that can take months, you shouldn’t get your hopes up that you will be able to purchase that particular property because for a variety of reasons, the bank may not approve the deal. This is why real estate sales professionals do not like short sales. There is too much uncertainty, and the bank may not consent to the sale, so you don’t get the house and the agent doesn’t get a commission.
This begs the question of why anyone should even consider buying a short sale. Well, if it is a great property that is the right property for you for all the right reasons, you should chase the property and try to get it under contract. Hopefully, you will and it won’t take too long to get the sale moving with the bank’s approval. But here’s the most important thing: since they take so long, don’t stop shopping for another property that will suit you needs. If you find a comparable or better one, (and you can!) purchase the new property and cancel the short sale after you close escrow on the new property. It shouldn’t cost you any money to do this, but make sure to discuss this with your realtor and read your contract carefully.
As you can see, there is good reason to pursue short sales when you are trying to buy a property. Hopefully, when you do, you’ll find a great house for yourself at a fair price. Good luck!