What is a short sale?
It can be pretty tough out there for prospective homebuyers, especially in red-hot housing markets. With low inventory and high demand quickly becoming the norm for the nation’s real estate markets, you’re more likely to get dragged into a bidding war with other house hunters.
Under these conditions, how can you possibly buy a house without overpaying? Sure, you can always refinance your mortgage later on to lower your housing costs, but that could be way down the road. Many homebuyers have turned to other types of home sales, such as foreclosures, with the hope of unearthing some housing hidden gems. Short sales, in particular, may seem appealing, but there’s a fair amount of risk to consider with these types of real estate transactions.
Is it the right move for you? Read up on short sales first before you decide to buy property through these agreements.
What does short sale mean?
Just about anyone who buys a house does so with the expectation that they’ll be able to sell it for a profit when they’re ready to move on to a new home. While there’s always some inherent risk in treating homes as investment vehicles, real estate is generally viewed as a sound way to protect your assets from inflation while improving your long-term financial outlook.
Things don’t always work out that way, though. Due to a variety of circumstances, homeowners may find themselves in a position where they absolutely need to sell their house for less than their original loan amount. In these scenarios, sellers are willing to take a loss on their home as long as they can recoup some liquidity from the transaction or simply unload the financial burden of homeownership.
That scenario describes a short sale. The proceeds from the transaction are not enough to cover the cost of the home loan — the original borrower is “short” on their mortgage. It’s a difficult situation for homeowners to be in, and the decision to execute a short sale certainly isn’t made lightly. For house hunters, however, short sales present opportunities to buy real estate at a discounted rate.
Why do homeowners conduct short sales?
You might be thinking that the seller is getting a bit of a raw deal with a short sale, and you would be right. By selling property for less than what it’s worth, homeowners stand to lose a lot of money — potentially hundreds of thousands of dollars. So, why go through with it?
The No. 1 reason homeowners might consider a short sale is because they’re financially distressed, and the situation has deteriorated to the point that their mortgage payments have become a burden they can no longer manage. Here are a few common scenarios leading to a short sale:
- The homeowner recently lost his or her job.
- Pay cuts or reduced working hours have significantly lowered the household’s total income.
- Various lenders have denied applications to refinance the mortgage and lower the monthly payments.
- Housing prices have bottomed out and the home is worth significantly less than the loan amount.
- The homeowners are facing foreclosure and would rather take a loss on the sale than deal with the repercussions to their credit score and ability to qualify for a future loan.
A short sale is a bitter pill for any homeowner to swallow, but in some situations, it’s the best option available.
Short sales vs. foreclosures: What’s the difference?
As we just mentioned, a lot of homeowners facing possible foreclosure would rather take their chances on a short sale than risk cratering their credit and digging themselves into an even bigger financial hole. From a buyer perspective, though, what’s the difference between a short sale and a foreclosure? After all, both present the enticing prospect of buying a house at a dramatically reduced price. Plus they both typically come with the caveat that the buyer accepts the home in an “as-is” condition. So, where do the two part ways?
The biggest difference between the two comes down to property ownership. When you purchase as part of a short sale, you’re buying a house from both the current homeowner and their lender. If a house is in foreclosure, that means the bank or lender has taken possession of the property from the original borrower. Often, foreclosures occur because borrowers have stopped making mortgage payments due to financial hardship.
Another important distinction to keep in mind is the amount of time it takes to complete a short sale vs. buying a house in foreclosure. Although the seller’s goal may be to unload their home as quickly as possible, the short sale process can take months — if not longer — to finalize. Expect the same back-and-forth negotiation you would with any typical home purchase. In comparison, completing a sale on a foreclosed house tends to go a bit more quickly. That’s assuming, of course, that the bank has already completed the foreclosure process and retains full ownership of the property.
Even though both short sales and foreclosed properties are usually sold as is, potential buyers need to consider the ramifications of that stipulation for each scenario. In a short sale, the seller likely lacks the funds to make any requested repairs while also wanting to get rid of the property as quickly as possible. While they’re probably not going to do anything to actively damage the home, they’re not going to go out of their way to improve it, either.
Foreclosed sales — such as going through Fannie Mae’s HomePath program, for instance — can be a bit trickier.* They’re highly charged and emotional events for the original homeowners, who may lash out at the property before it changes hands to their bank. As such, you may come across foreclosed homes in pretty rough conditions. Be prepared to take on some handiwork or repairs if you’re thinking about buying a foreclosure.
Pros and cons of shorts sales
It’s not hard to see the appeal of buying a house on a short sale. Who wouldn’t want to get a great deal on a house that’s worth more than the asking price? But there are advantages and drawbacks to consider with this type of transaction, so know what you’re getting yourself into beforehand.
Pros
- Asking prices are often lower than comparable homes in the area.
- Other buyers may steer clear of short sales, resulting in less competition.
- Buying a house at a discounted rate can free up funds to make renovations or simply increase your financial flexibility.
Cons
- Home is sold in “as-is” condition.
- Transactions can take a long time to complete.
- Required repairs could offset cost savings.
A buyer’s guide to short sales in 5 steps
Although there’s a fair amount of overlap between short sales and conventional real estate transactions, buyers will want to be prepared for every curveball the process may throw your way. Keep this buyer’s guide handy as you venture into the wide world of short sales:
- Get a preapproval letter
- Find a real estate agent
- Scrutinize the property
- Put in an offer
- Conduct inspections, appraisals and title research
1. Get a preapproval letter
Like any home purchase, you’ll want to get all of your financial ducks in a row before pursuing a short sale. That includes figuring out how much house you can afford, your budget and polishing your loan application credentials. Once that’s done, turn your attention to your lending options, deciding on a home loan type and lender that can provide a competitive interest rate. With a preapproval letter in hand, you can show sellers that you mean business and that the transaction is unlikely to fall through due to financing hiccups.
2. Find a real estate agent
Short sales can be tricky to manage, so it’s always good to have a seasoned expert in your corner who can answer questions, point out red flags and tell you when to pull the trigger on a house or walk away entirely. Hire a qualified real estate agent with experience buying property on short sales to cover all of your bases.
3. Scrutinize the property
The first thing you’ll probably notice about a short sale is the price — more specifically, how low it is compared to other listings in the area. Before you fall completely in love with a short sale listing, do your due diligence and see how the property stacks up to similar homes in your real estate market. Are there several other short sale listings in the neighborhood? That could point to a localized economic downturn, which might lead to long-term concerns about the area’s property values.
Casting a scrutinizing eye on the home itself is a no-brainer, as well. During your own walkthrough, look for potential structural issues or other problems that might require a lot of time and money to address. If those problems are severe enough, a short sale may not end up being the incredible deal it initially appears to be.
4. Put in an offer
If everything looks good — or good enough, anyway — it’s time to make an offer on the house. This is where things can get complicated. Even though you’re sending your offer to the mortgage lender, you may need to get written authorization from the seller first. You may even need to get that authorization letter notarized.
Just because the seller is willing to take a loss on the property doesn’t mean the bank or lender will feel the same way. Be prepared to negotiate on the purchase price and don’t be surprised if the final amount is more than the seller’s initial asking price.
5. Conduct inspections, appraisals and title search
Assuming both the seller and lender accept your offer, you still have a few final items to attend to before you can close on the house. Inspections, appraisals and title searches are standard operating procedures for any home sale, but they’re especially important with a short sale. You’re buying the house in as-is condition, so there’s no going back once the ink’s dry on your sale contract.
Home inspections will bring to light any issues that might give you pause. Some may be relatively minor fixes — replacing a water heater, for instance — while others could be much more problematic. Finding out this late in the game that the home needs a new roof isn’t ideal, but at least there’s still time to walk away. Home appraisals are important for securing your mortgage, as your lender will want to be sure the property is worth at least the amount of the loan itself.
Finally, a title search will confirm that there is a clear line of ownership running through the property’s entire history. Any liens or ownership claims will also come to light, so you and your lender can work out any disputes before finalizing the paperwork.
Once any outstanding issues have been cleared up and everyone has agreed to the terms of the sale, the house is yours!
When short sales go wrong
From unforeseen structural concerns to financing snafus, short sales can blow up in your face if you’re not diligent from Day One of the homebuying process. These are the most common complications to watch out for when chasing a short sale:
- Your loan qualifications aren’t up to the lender’s standards.
- The seller doesn’t qualify for a short sale.
- The lender has already sold the loan to another party.
- The house has fallen into disrepair and would require a significant investment to restore it to an acceptable condition.
- The lender believes the seller has set an asking price that is too low.
- The seller’s lender is missing important documentation needed to complete a short sale.
Hopefully, you won’t run into any of these problems. But it’s always good to prepare yourself for the worst-case scenario to avoid disappointment — or worse, commit to buying a house that’s more trouble than it’s worth.
In conclusion
Short sales offer homebuyers the chance to purchase real estate at a major discount. However, those cost savings often come with tradeoffs — namely, as-is purchase conditions and an often long sale process.
Still, under the right circumstances, a short sale could put you in the house of your dreams without breaking the bank. These types of real estate transactions can be tricky to navigate, so you’ll want all the help you can get to make sure everything goes smoothly. Work with both a real estate agent and a real estate attorney who understand the ins and outs of short sales to prevent any unpleasant surprises.
*Rate is not affiliated with Fannie Mae or any government agency.