What is a Short Sale Property?
A short sale property is a home that’s sold for less than the homeowner owes on a mortgage — The lender forgives the remaining debt.
If a homeowner can’t make mortgage payments, and the value of his home drops significantly, he is stuck — He can neither pay the mortgage nor sell the house to pay off the debt. To avoid foreclosure (the bank repossessing the house), the borrower can ask the lender’s permission to short sell the property. If the bank agrees to absorb the remaining debt, the homeowner can sell the house for a price that’s lower than the amount outstanding on the mortgage. For buyers, short sales can sometimes mean a good deal, but the process is often long, tedious, and full of uncertainty.
Imagine a homeowner owes $100,000 on a mortgage. However, the property’s market value drops to $80,000. At the same time, he loses his job. Foreclosure is inevitable, so the homeowner asks the bank’s permission to short sell the house. The bank agrees to let him sell the home for $80,000 and forgive the remaining $20,000.
A short sale is like buying a house on clearance…
The bank believes it can’t make back all the money it lent to the borrower, so it allows the owner to sell the home for less and accepts a loss. For a buyer, that can mean buying a home at a discount. But that perk can come with downsides, such as getting the house “as is.”
A short sale occurs when a borrower sells a property for less than he or she owes on a mortgage, and the lender takes the financial loss. It’s usually a last resort for homeowners who can’t pay their home loans and are facing foreclosure.
To get permission to short sell a house, a homeowner must prove to the lender that it’s the best option. The borrower needs to demonstrate that he or she can no longer make mortgage payments because of financial hardship and can’t sell the property at a high enough price to pay off the debt in full.
With the lender’s permission, the homeowner can sell the house at a lower price, and the lender will generally forgive the remaining debt. However, in some states, the seller may be responsible for paying back the difference between the property’s value and outstanding debt (known as a deficiency). In these scenarios, the seller should ask the lender to waive the deficiency before short selling the house. That way, the bank can’t sue the seller for not paying back the remaining debt. In some states, a seller must pay taxes on the forgiven amount.
Here are the typical steps a homeowner takes to complete a short sale:
Before the homeowner can attempt a short sale, he or she must get the lender’s approval. Sellers should research their lender’s process, but usually a seller has to include the following in a request:
Evidence of seller’s hardship: This could be utility shut-off notices, tax returns, pay stubs, bank statements, divorce papers, or evidence of job loss. The lender must believe the seller has no hidden assets and is truly in a desperate situation. If the seller has assets to draw on, the lender will likely not approve the short sale.
If the bank agrees to short sell the house, it’s time to find an agent who specializes in these transactions. The agent will review the situation, determine a good listing price, and list and market the house.
The agent attracts potential buyers and starts negotiations. Eventually, the seller finds an interested buyer who makes an acceptable offer.
After agreeing to an offer, the seller must present it to the lender for review. There may be further negotiations because the bank wants to get the best deal possible. The bank may take a long time to process the offer. If the lender agrees, the owner can sell the home.
Once all parties agree, they officially record the sale. The next step is closing, when homeownership transfers to the buyer.
Here’s how the process looks from a buyer’s point of view:
Buyers can hunt for short sales themselves or hire a real estate agent to do so. A key place to look is a multiple listing service, which is an online database of houses for sale. Some have phrases that indicate a potential short sale:
The agent investigates options and approaches the most promising short sale opportunities. Ideally, the seller already has approval from a lender to short sell the home. If not, the seller will have to get approval. The buyer’s agent will negotiate with the seller’s agent and hopefully agree to a price.
Once the buyer and seller agree to an offer, the seller asks the bank to review it. If the bank approves, the buyer can purchase the house. All parties sign paperwork to make it official, and the short sale takes place. The buyer usually buys the home “as is” and is responsible for any needed repairs.
Short sales and foreclosures are both possible outcomes when a homeowner falls behind on mortgage payments. With a foreclosure, the lender repossesses the home from the borrower. After the lender seizes the property, it usually auctions off the home.
With a short sale, the borrower still owns the home and sells it to a buyer, just at a price that’s lower than what he or she owes to the lender. Since the bank forgives the remaining debt in a short sale, it must approve the sale.
Both a short sale and foreclosure will hurt the borrower’s credit score, but the foreclosure will likely be worse. A short sale can lower a credit score anywhere from 85 to 200 points. With a foreclosure, a credit score can drop as much as 300 points or more.
Everyone involved in a short sale — the seller, buyer, and lender — can benefit from the transaction.
A short sale allows a seller who is struggling financially to avoid foreclosure and not have to pay back part of their mortgage debt. A short sale may damage someone’s credit score, but it’s usually less of a hit than a foreclosure.
For the buyer, a short sale can be an opportunity to buy a home at an unusually low price.
Short sales can be appealing for banks, too. Foreclosures are time-consuming and expensive. If a bank takes possession of a home, it must take care of the property, possibly make repairs, and sell the home. In a short sale, the homeowner maintains the house and takes responsibility for selling it. For the bank, short sales can help minimize losses and prove the lesser of two evils.
The lender suffers a financial loss by absorbing the debt. The seller walks away with a credit hit, no home, and no profit.
While buyers can benefit from short sales, there are potential downsides, too:
The sale can take a long time to close. The lender takes more time to review an offer than in typical real estate transactions. For short sales, the bank must analyze more information, such as reviewing whether foreclosure is a better option.
Complex negotiations. In a traditional real estate sale, only the buyer and seller negotiate. With short sales, there are more parties involved: The lender must approve the sale, and if there are additional mortgages, those lienholders must approve as well.
The home sells “as-is.” Buyers typically have to buy a short sale property in its current condition. That means the buyer is on the hook for required repairs or any unknown defects that emerge.
Closing costs for the buyer. In a normal real estate transaction, the seller usually agrees to pay for some or all of the buyer’s closing costs, such as inspections and repairs. In a short sale, the buyer is negotiating with the lender, who will likely refuse to pay any of these costs.
The seller may be uncooperative. This may seem counterintuitive since the seller is in a desperate situation, but it does happen. The seller may not cooperate because a short sale will negatively affect his or her finances. Even though the short sale may be better than a foreclosure, the seller may still be reluctant to give up his or her home.The success of a short sale depends partly on the homeowner’s cooperation in producing documents and writing a hardship letter, and the seller typically also has to pay some closing costs or agree to take on other debt for this purpose. If he or she refuses, the sale can fall through.
Short sales can be a good deal, but they come with potential pitfalls. Buying a home for less than the seller owes may mean the buyer is getting into the market when property values are low. If they bounce back, that can be a good investment. And if the buyer gets the house for less than what it’s appraised for today — perhaps because the seller is in a bind — then he or she immediately gets some equity.
But the seller may have bought the house when property values as a whole were higher. That means its current price tag may be similar to that of other homes on the market, and not necessarily a better deal. Plus, buyers may have to pay for extra costs compared to a traditional real estate transaction, such as repairs or higher closing costs. Not to mention short sales can be a long and troublesome process.
Buying short sale properties takes fortitude and patience. Buyers may want to research short sales thoroughly and keep an eye out for other properties at the same time.
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