What is a short sale?
A short sale, also called a pre-foreclosure, happens when a homeowner sells their house for less than what they owe on their mortgage.
If you’re in the market to buy a house, it’s a good idea to explore all your options. One option is a short sale. Because a short sale is a relatively uncommon type of real estate transaction, you might have heard the term but wonder what it means.
It's possible to get a great deal on a short sale house, but the short sale process is typically complex. It works for some people, but it isn’t for everyone. Here’s some information to help you decide if buying a short sale home is the right move for you.
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- What is a short sale?
- What are the benefits of a short sale?
- What are the drawbacks of a short sale?
- What to consider before buying a short sale property
- How to buy a short sale property
- Helpful tips for buying a short sale property
What is a short sale?
A short sale in real estate, also known as a pre-foreclosure, occurs when a homeowner sells their house for less than their mortgage balance. Sellers of short sales aren’t selling at a lower price to give you a break — they’re doing so because they’re in financial distress and can no longer make their mortgage payments. Selling the house short is usually a better option for the homeowner than allowing the home to go into foreclosure.
Short sales were more common during the years directly after the housing crash of 2008 because home values plummeted, leaving many people with a mortgage greater than the home’s value — a situation called "being underwater" on the home. Those owners couldn’t sell their homes for what they owed and didn’t want to continue paying a mortgage greater than the home’s value.
You won’t see too many homes being sold as short sales anymore since right now houses tend to hold their value or even appreciate. That means you can often simply sell your home for market price and pay off the lender. Short sales, therefore, can be somewhat difficult to find, but they’re still out there.
The lender needs to approve the sale
The mortgage lender needs to approve the short sale for the process to happen. First, the homeowner sends the lender a hardship letter, explaining the situation. If the lender approves the short sale, that lender has two options: forgive the remaining balance the homeowner owes, or go after the owner for the amount still owed, called the deficiency.
Say, for example, the lender allows the owner to sell the home for $400,000, but the owner owes $450,000 on the mortgage loan. The deficiency is $50,000. The lender can either forgive the deficiency or seek a deficiency judgment against the borrower. Lenders can use methods such as garnishing wages or withdrawing from the owner’s bank account to get the money back.
Short sale vs. foreclosure
Both a short sale and foreclosure are the result of a homeowner not being able to make their mortgage payments anymore. With a short sale, the homeowner takes action to minimize the damage to their credit score by selling the house, with approval from the lender, for less than what they owe.
With a foreclosure, where the bank takes back the home, the lender initiates the procedure. The foreclosure process usually starts after a homeowner stops making between three and six mortgage payments. Both a short sale and a foreclosure result in the homeowner losing the home.
What are the benefits of a short sale?
A short sale can benefit both buyers and sellers for a variety of reasons.
Benefits for buyers
- Lower home price — Sellers of short sales are usually extremely motivated to sell, which means they’re often willing to accept a lower offer, or they list the home for less than comparable homes for sale.
- Less competition — Many potential buyers aren’t interested in dealing with the complexities of buying a short sale, meaning you might face less competition when buying one of these homes.
- Better home condition — If you’re looking at both foreclosures and short sales to get a good deal, short sales may be in better condition than foreclosures. With a short sale, the owner is typically still living in the home and keeping up basic maintenance, whereas with a foreclosure, the home is often vacant and neglected.
Benefits for sellers
- Eliminates mortgage debt — If a seller can’t afford to pay their mortgage or they owe more than the house is worth, they can get out of the deal without having a foreclosure on their record.
- Better than foreclosure for credit score — A short sale typically hurts the seller’s credit score, but usually not as much as a foreclosure would, particularly if no deficiency balance is on their credit report and they sold the home before they missed any mortgage payments.
- Can typically buy another home sooner — Having a short sale on a borrower’s credit report means they don’t need to wait long to buy another home. They might only need to wait two to four years. With a foreclosure, buyers typically need to wait seven years before being able to purchase another home.
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What are the drawbacks of a short sale?
A short sale isn’t a perfect solution. There are drawbacks both buyers and sellers should consider.
Drawbacks for buyers
- Long process — You must take many steps when buying a short sale, and the homebuying process takes longer than a normal sale would. A home not in short sale status usually closes in less than 45 days, whereas a short sale can take six months or more to close.
- Lender approval required — Even if the seller accepts your offer, the lender might not approve the sale price. For the deal to happen, you might need to pay more for the home than what the seller is asking.
- The house is sold as is — Short sales are often on the market because the owner is in financial hardship, meaning they might not have been maintaining the home, letting it fall into disrepair instead.
Drawbacks for sellers
- Hurts credit — Although a short sale doesn’t hurt a credit score as much as a foreclosure, it still lowers credit scores, making it difficult to get loans or even rent another house or apartment until scores rise again.
- Might owe additional money — Since the sales price doesn’t cover the balance due on the mortgage, the seller may still owe money even after losing the home. If the deficiency is forgiven, they might need to pay taxes on it.
- Loss of a home — Not only will the seller lose a home they might not want to sell, they’ll lose the down payment and any possible equity they might have built.
What to consider before buying a short sale property
If you want to buy a short sale to save money, you’ll need to work harder to make the deal happen than you would with a traditional real estate transaction.
It may be somewhat difficult to find a short sale property, and once you do, there’s no guarantee you’ll get the home — even if the seller accepts your offer — since the lender has the final say. You’ll also need to be prepared to do some repair and maintenance work since the house is being sold as-is and the seller won’t be making any repairs.
Once the buying process begins, you’ll need to be prepared to wait for months for the deal to close, and at any point, the transaction could fall through. For example, the lender might accept another offer. Or, if there are other lienholders on the property — if the seller has a second mortgage or a HELOC, for example — those lenders also need to approve the transaction.
If the deal falls through, you’ll have to start from scratch to find another home to buy, after putting in much time and effort. You may end up with nothing to show for all your hard work, except perhaps the learning experience.
How to buy a short sale property
If you’re interested in buying a short sale property, you’ll generally need to take these steps:
- Find a house. You can start by browsing online real estate listings. The listing will often tell you whether the home is being sold as a short sale — sometimes the listing will say "pre-foreclosure."
- Enlist the help of a real estate agent. Because short sale transactions are more complex than traditional real estate deals, it may be beneficial to hire a Realtor® who specializes in this area and has Short Sales and Foreclosure Resource (SFR®) certification from the National Association of REALTORS®, which you should see on their email signature and on their card.
- Get an approval letter from your lender. Unless you’re paying cash for the home, you’ll need to get pre-approved from your own lender to buy the house. The seller’s lender generally requires this.
- Make an offer. Your real estate agent can guide you on whether to offer more, less or the listing price based on information they’ve gathered on the home. Your agent can also draw up the necessary contracts.
- Get a home inspection. It’s important to have a professional home inspector look over any home before you buy it. Because a short sale is an as-is transaction, if the inspection shows major defects, the seller won’t be able to address them. But you’ll want to know in advance if you’ll be facing any major repairs.
- Run the numbers. Just because you’re considering a short sale property, it doesn’t automatically mean you’ll save money. If the lender asks for an increased price or if the house needs extensive repairs, what you thought was a good deal might cost you the same or more than a traditional home sale.
- Do everything asked of you. The sooner you do everything asked of you by the seller (or the listing agent) and their lender, the better. This both speeds up the process and reassures all parties that you’re still on board.
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Helpful tips for buying a short sale property
Here are a few tips to keep in mind when buying a short sale property:
- Make a realistic offer. If you try to lowball the price too much, the lender might turn you down.
- Offer to pay the seller’s closing costs. It might help the deal go through if you pay the seller’s closing costs, which are a percentage of the sales price.
- Be patient. Be prepared for a long process filled with paperwork and negotiations with the seller’s lender. Know this before you start, so you’ll be prepared for the ride.