Whether buying a new house or struggling to keep up with your mortgage payments, you might have encountered the term “short sale.” In the case of the latter, perhaps you’ve heard that a short sale can help you out of a tight spot. Meanwhile, crafty house hunters can bag a bargain with a short sale.
But what is a short sale on a house, how does it work, and what are the pros and cons? This guide includes everything you need to know about short sales.
What Is a Short Sale Home?
Short-sale homes refer to properties sold for less than the amount owed on their mortgage. For example, if you have a remaining mortgage balance of $300,000 and list your home for $250,000, it would appear as a short sale.
When a short-sale home sells, the total earnings will be less than the remaining mortgage balance. As a result, the seller, and more specifically, the lender, will lose money from the transaction. This requires the lender to accept the loss and forgive the remaining debt owed, which, of course, isn’t profitable.
However, it’s not impossible and can be a viable solution for people struggling to repay their mortgage.
How Do Short Sales Happen?
Short sales can occur for several reasons. Often, a person must sell their property due to either a change in their financial situation which means they can no longer afford their mortgage repayments, or they’re required to relocate suddenly.
Moreover, a downturn in the local market is often the reason for the price of their home falling to less than they paid for it. Or a home in need of major repairs can also drastically drop in price.
Short Sale vs. Foreclosure
While similar, there’s a big difference between a short sale and foreclosure. For the most part, sellers and lenders prefer to avoid foreclosure, making a short sale the lesser of two evils. Here’s how they differ:
1. Initiation
The seller is the one who initiates a short sale, while the lender is responsible for forcing a foreclosure in a final attempt to recoup some of their losses when a homeowner defaults on their loan.
2. Type of Sale
For the most part, a short sale works in much the same way as a regular sale, with the buyer dealing with the seller, either directly or via an agent. Again, as in a regular sale, negotiations and viewings are possible.
When a home is foreclosed, the previous owner has usually been evicted, and the property abandoned for some time. Foreclosed homes tend to be sold at auctions, as-is, with no option for the buyer to negotiate or view the property in advance.
3. Impact on Seller’s Credit
The seller’s credit isn’t as severely damaged during a short sale compared to a foreclosure. As a result, they can typically apply for new loans within a year or two. However, after a foreclosure, their credit score will plummet. As such, it can take seven years before they can take out another substantial loan.
4. Better for Lenders
Lenders will always opt for a short sale over a foreclosure as it gives them a better chance of recouping more of the loan. Additionally, they can avoid the cost of lengthy legal proceedings and potential real estate agent costs if the property fails to sell at auction.
Despite this, lenders will only agree to a short sale in the right circumstances. So, for example, if you can still afford your repayments, it’s highly unlikely that they’ll agree to a short sale.
How Do Short Sales Work?
In general, most short sales follow the steps below:
1. Seller and Lender Discuss Options
The seller begins proceedings by discussing the viability of making a short sale with their lender. They’re normally required to submit a short sale package, typically containing the following:
A hardship letter describing how they got into their current situation and what they’ve done in terms of finding a solution.
Proof of assets and income, such as bank statements, pay slips, medical bills, divorce decree, or a termination notice from their former job, that provide evidence that they cannot keep up with payments and have no assets to aid them.
Optional comparative market analysis to justify their chosen sale price, provided by a real estate agent. If your home needs significant repairs, it’s also a good idea to provide estimates from at least three contractors to complete the work.
2. House Listed for Sale
If the lender agrees, the seller will then list the house for sale as normal. Ideally, they’d work with a real estate agent with short sales experience. The agent will draw up a sales contract for potential buyers, but the lender must approve the contract, giving them the final say. So, even if the seller and buyer agree, the lender can decline the offer.
3. Lender Considers Offers
The lender goes through the offers and examines the sales contracts. They can then reject or even ignore an offer, reject but provide terms they would accept, or accept the offer outright.
4. Buyer Considers Counter-Offer
The offer returns to the buyer, who can accept or reject the lender’s terms.
5. Sale Proceeds
If the buyer accepts, the sales procedure goes ahead, with all the earnings going directly to the lender. Once the transaction is complete, the buyer moves in, and while the seller has recorded a loss, they have avoided foreclosure and bad credit, enabling them to move forward.
Should You Buy a Short Sale?
Advantages
Short sales certainly aren’t risk-free, but if you’re looking for a new home, they do offer several benefits:
Bag a bargain: Short sales often have pretty low price tags, especially if the property requires repairs. As such, many short sales are fixer-uppers, enabling buyers to purchase more house for their buck, potentially in a neighborhood they might not otherwise be able to afford. This is an excellent choice for enthusiastic DIYers.
Desirable financing terms: The lender typically wants to sell the home rather than force foreclosure. As such, they may offer buyers more attractive terms to sell it quickly and avoid the extra costs and hassle of foreclosing.
Able to view the home: Foreclosures are also bargains, but you can’t often view them in advance, so you never really know what you’ve signed up for. With a short sale, however, you can view the home as usual and have an inspection, ensuring there will be no nasty surprises when you move in.
Disadvantages
It’s essential to know the risks involved in buying a short sale before you make an offer:
They take a long time to complete: Short sales often take several months to complete, far longer than a typical sale.
Lenders can change their minds: During the entire process, other buyers can put offers in, potentially driving up the price or seeing your offer suddenly get refused, even if it seemed like a sure thing.
The seller cannot complete repairs: While you can view a short sale, as a buyer, you’ll typically be expected to absorb the cost of any repairs that might be necessary. However, you can still make your offer contingent on the result of a home inspection.
