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Here's How to Buy & Finance a Short Sale Property

Short sales differ from most home purchases in almost every way. At every step, from shopping to negotiating to mortgage financing, short sale properties are just harder to deal with. Here's what you need to know.

A "short sale" indicates that the sales price of the property is less than the amount the former homeowner owed against it. With so many American homes underwater, it's a common sight in real estate listings these days. But a short sale does not mean a screaming deal for the homebuyer -- at least, not necessarily. Just because the mortgage lender is probably taking a loss doesn't mean that the property is priced way below market value.

"People want to get houses for half price, and that's not going to happen," says Tina Uchytil, a Nevada-based REALTOR.

In general, short sales do offer some discount from the market value of the property -- anywhere between 5 percent to just over 30 percent, according to RealtyTrac's first-quarter 2010 figures. If short sales didn't come with some discount, there would be no reason for buyers to deal with the myriad headaches that these transactions can present. Make no mistake, short sales come with headaches, so you need to know what to expect.

Why short sales are more difficult

Short sales are different from foreclosure sales because the lender has not taken the property back, so the owner conducts the sale. The mortgage lender does not set the price; however, it does have to approve the terms because it will not be repaid in full from the proceeds of the sale. Since the bank must agree to lose some of the money it lent, it will want final approval of the terms.

 Most banks will not agree to a short sale in writing until the seller undergoes a lengthy application process and there is at least one formal offer on the table . A property may be listed as a short sale even before the lender has actually agreed to accept a lower payoff.

Uchytil says that mortgage lenders can sit on buyer offers for weeks or months, probably hoping for a better offer before giving up on the process. "I have seen them foreclose on properties that had short sale offers on the table," she says.

Short sales try the patience of buyers

If you need to buy a house quickly, a short sale is not for you. A short sale can take months, and many prospective buyers never see it through.

Candace Zansler of Reno, Nevada relates her typical experience purchasing a short sale property: "It was certainly worth the wait, but the waiting -- yikes! The hangup was with the banks. The seller had to get something like three loans forgiven, and we were the third accepted offer. I believe the others gave up after six months."

Uchytil agrees, "Most [buyers] get fed up and walk."

Another barrier to a speedy transaction is that buyers may be asked to pay unexpected fees. In some cases, the mortgage lender who holds the loan adds a fee payable by the buyer to try to recover some costs. This fee goes by names like "short sale administration fee" or "short sale processing fee" and may be about 1 percent of the sales price.

These fees are in line with Federal Housing Administration (FHA), Veterans Affairs (VA), and Fannie Mae and Freddie Mac guidelines, which also allow for buyer payments for delinquent taxes or delinquent homeowners association fees.

All these hurdles help explain why the majority of short sales do not close. A 2009 report  by research firm Campbell Communications put the completion rate of short sales at less than 25 percent.

Tips for short sale buyers

Remember these tips to keep short-sale-purchase headaches to a minimum:

  • Find a pro who is familiar with short sales: Some multiple listing services (MLS) allow public access, and you can see if properties listed are short sale (also called pre-foreclosure) properties. You can browse these listings online on your own, but once you get serious, consult a reputable real estate agent with plenty of short sale experience. This professional can save you time and help you avoid costly rookie mistakes.
  • Adjust your expectations: Don't get your heart set on a specific property. Odds are you won't get it. You'll probably make several offers, and after that, it may take months to close once you have an accepted offer.
  • Focus on single-lien properties and single-family properties: Every extra loan servicer in the mix adds another layer of frustration, so favor properties with only one lien over those with second mortgages. Avoid condominiums, at least if the owners are delinquent in their association dues (unless you don't mind paying to get them current).
  • Find out what authority the loan servicer has on the property: A "fully delegated" file gives the servicer the authority to make a decision on investors' behalf without sending them all the paperwork for review. On the other end, a "non-delegated" file confers no authority -- in which case the servicer must forward all documents for an investor to make the ultimate decision about approving a transaction. A "non-delegated" file adds time but it is, unfortunately, the most common arrangement.

Financing short sales

Financing a short sale purchase is not much different from financing a traditional home purchase. Sometimes, the property's lien holder may require that you get preapproved or prequalified for a mortgage with it before approving your offer. This is because it wants to be sure that you can complete the purchase.

Even if this is the case, you are under no obligation to use the same mortgage lender which is releasing the property, so you should of course shop for the best mortgage rates as you complete your escrow. Note, however, that you won't be able to nail down current mortgage rates because the process takes so long that a rate lock would be useless.

Keith Gumbinger, vice president of HSH.com, says, "Yes, preapproval is a good idea, but given what is likely to be a plodding and trying negotiation period, it would seem that patience is not only a virtue, but rather a necessity. Expected timelines may need to be adjusted accordingly."

Short sales vs. foreclosures or REO

All this hassle begs the question: Why bother with short sales? After all, you can probably get bigger discounts buying foreclosed homes or REO properties already on the lenders' books.

Short sales do have one or two advantages over other types of financially-distressed properties. Since owners are motivated to sell in order to keep a foreclosure off their credit histories, the homes are generally kept in decent condition. No one is pouring cement down the toilets or kicking holes in the walls.

In addition, short sale properties are transferred free and clear of any liens. If you purchase a foreclosed property on the courthouse steps, you could inadvertently buy property with unknown liens and other title glitches. You won't have problems getting title companies to insure a short sale property, which is required to get a mortgage on the home. In the wake of the robo-signing scandal, this is no small matter. It's potentially harder to get title insurance and complete a purchase of a property once it has been foreclosed.