Short Sales at a Glance
A short sale is a situation where a homeowner is unable to continue making their mortgage payment and must sell their property when the balance of the mortgage exceeds the current value of the property. It is called a short sale because the sale proceeds will be short of the outstanding mortgage balance. This type of sale is most common when property values are declining.
Real Estate Short Sale Process
The short sale process has multiple steps, and it’s common for a short sale to take 4-6 months to complete from the time the offer is accepted, and in rare cases, even longer. Below are the steps commonly found within the short sale process.
Step 1: Professional Consultations
It is recommended that a homeowner considering a short sale first consult with various professionals. In a short sale, any remaining debt will be canceled by the lender.
For example, if the sales proceeds are $110,000 short of the outstanding loan balance, the borrower will likely receive a 1099-C, which is treated as taxable income.
Each homeowner’s tax situation is different, and therefore, it is highly recommended that they consult with a tax professional for advice on possible ways to avoid paying taxes on the forgiven debt.
Another professional that a homeowner considering a short sale should consult with is a real estate agent. An agent with experience in short sales will make this complicated process a lot smoother by helping the homeowner navigate the lender approval and sales process.
Thinking about starting a real estate career? Download the Launching Your Real Estate Career eBook
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Step 2: Set the Right Asking Price
Setting the right asking price is key in the short sale process. The asking price must entice buyers while at the same time encouraging the lender to approve the sale.
The asking price is set by the homeowner and their agent but keep in mind that the lender has the last word. If the lender feels the agreed-upon sales price is too low, they will simply not approve the sale. The asking price must reflect current market conditions and the sales price of recently sold comparable properties in the same neighborhood.
Step 3: Lender Agreement
For a short sale to take place, the lender must agree to the sale. Since the lender will be taking a loss, for example, the outstanding loan amount is $350,000, but the proceeds from the sale will be $260,000, which would result in a loss of $90,000, the lender will need to agree to the sale of the property.
Before agreeing to the sale, the lender requires the borrower to provide financial documentation proving that they are unable to continue making the monthly mortgage payment.
Required documentation for lender includes:
- copies of paystubs or other income documentation
- copies of bank statements or other liquid assets
- a financial statement showing current assets and liabilities of the borrower
Step 4: Submit the Required Documents
Even though different lenders have different specific documentation requirements, the standard is the documents must prove that the borrower is unable to make the monthly mortgage payments at their current income and is unable to contribute to the canceled mortgage debt balance with their current assets.
The most common reasons why a borrower is unable to make the monthly mortgage payment is when
- their income decreases, such as when they lose their job
- or the mortgage payment suddenly increases as with an adjustable payment loan
If the borrower is unable to make their payment, they must prove this to the lender with current income documentation.
If the borrower has current liquid assets, such as bank account balances or stocks, the lender will require a payment from the borrower to offset part of the mortgage balance that will be canceled in the short sale.
The borrower must provide the bank with current assets documentation proving that they do not possess any assets that can be used to offset the canceled debt.
Step 5: Hardship Letter
A hardship letter is a letter from the borrower to the bank pleading their case and stating the reason why it is necessary and a good business decision for the bank to approve the short sale.
It is recommended that the letter state the benefits from the bank's point of view. In other words, why it makes sense for the bank to approve the short sale and why it is impossible for the borrower to continue with their current mortgage.
The hardship letter must be convincing and clearly written making the decision an easy one for the lender. This is a crucial step in the short sale approval process. If the approval is not granted the borrower will have to endure a foreclosure on their property.
Step 6: Find a Buyer
Finding a buyer during a short sale is no different than with a regular sale. At the beginning of a declining market when property values are still declining there will be many short sales and foreclosures on the market and few buyers interested in purchasing real estate property.
As the market hits bottom and property values begin to climb back up, buyers will begin looking to purchase properties with rock-bottom prices, and short sales and foreclosures will begin to sell much quicker.
Buyers wanting to purchase a short sale must have a flexible time frame since the lender approval process can take longer than it would with a regular 30 day escrow on a regular sale. This all depends on the specific lender and how quick their processing time is in approving the short sale.
Step 7: Proposal for the Bank
Once the buyer and seller have come to an agreement the next step is submitting a proposal to the bank for approval of the short sale. The proposal will include the homeowner's financial information proving that they are not able to continue making the monthly mortgage payment and that they have no assets to contribute to the deficiency between the sale proceeds and the outstanding mortgage balance.
It will also include a list of comparable properties showing that the agreed-upon sales price is reflective of current market conditions. The lender will confirm the current market value of the property by requesting a Brokers Price Opinion (BPO) from a neutral broker not involved in the sale of the property.
A BPO is similar to an appraisal but less thorough and therefore less expensive. Instead of being completed by a licensed real estate appraiser, it is completed by a licensed real estate broker or agent and simply gives the broker’s opinion of value by considering recently sold comparable properties.
How to Choose a Real Estate Broker >>
Short Sale Strategies for Buyers and Investors
Below are some tips and suggestions for buyers and investors when finding and selling short sales.
How to Find Real Estate Short Sales
The key to finding short sales is understanding the foreclosure process. A short sale is basically a homeowner in default who wishes to avoid a foreclosure.
When a borrower stops making their monthly mortgage payment they are in default. The lender will reach out to the borrower to discuss their situation and try to reach an agreement. If the lender is unable to reach the borrower or come to an agreement to solve the default, the lender will file what is known as a Notice of Default.
What is a Notice of Default?
A Notice of Default is a public notice filed with a court and the first step in the foreclosure process. Notices of Default can be found by searching county records, which are freely accessible to the public.
If you choose to outsource the search of the public records you could reach out to a title company to see if they provide lists of properties with recorded NODs or subscribe to a service that provides such lists for a fee.
Research Tips
Real estate records are maintained at the county level, so if you choose to search the public records yourself, first find your local county clerk’s office or the county in which you wish to find a possible short sale property.
Some counties also offer online requests for real estate records and/or a toll-free number as well as an email address for the request of such records. Also available are online search engines and services that provide you with lists of properties with recorded Notices of Default.
The two most common paid services are PropertyRadar and Rebo Gateway. For free information on recorded documents on a specific property, a simple call to your local title office, such as First American Title, will do.
The fees charged for these services vary greatly, so shop around to make sure you are not paying more than necessary.
Negotiating Tips
When negotiating a short sale keep in mind that the lender will have the last word in the sale terms. The homeowner in a short sale is simply wanting to walk away from their current mortgage and avoid foreclosure. They will receive no proceeds from the sale and, therefore, are not too interested in negotiating any financial terms of the transaction.
The lender, on the other hand, is the one that will be taking a loss in the sale and will be very interested in minimizing that loss. When negotiating, it’s always a good idea to keep the other party’s position in mind.
For example, in a declining market, the buyer will have more leverage because if the offer is not accepted, the next offer will likely be lower as the value of the property declines over time.
On the other hand, if property values are increasing, the leverage will be on the side of the seller, or lender in the case of a short sale, knowing that the property will be increasing in value over time.
In either case, the lender in a short sale will not be very willing to make many concessions since they will be taking a loss, oftentimes in the hundreds of thousands of dollars range.
How to Pass the Real Estate Exam >>
Pros and Cons of a Short Sales
The major benefit of a short sale to a buyer or investor is that the property will be purchased at a discounted price. In essence, at a price lower than the seller originally paid for the property.
As long as the buyer’s or investor’s timeframe is long-term, they will likely reap the benefits of value appreciation over time.
Among the cons of purchasing a short sale is the fact that the property will not be in optimal condition. Property owners considering a short sale will most likely reduce the maintenance of the property to a minimum to avoid further expenses.
Also, the seller will not be walking away with any cash from the sale; they will simply be able to walk away from a mortgage with a higher balance than the current value of the property.
This translates to the homeowner deriving no benefit from the cost associated with the property maintenance and upgrade of the property.
Another con is the timeframe to complete a short sale. A short sale will not be like a standard sale 30-day escrow. The lender approval process takes time according to their processing capabilities.
Short Sale vs. Foreclosure
The beginnings of a short sale and foreclosure look the same. The differences between a short sale and foreclosure come down to who sells the property.
In a short sale, the borrower sells the property they can no longer make payments on.
In a foreclosure, the bank or lender sells the property.
How a Short Sale Works
After the borrower is unable to continue making payments on their mortgage, the borrower will notify the bank that they will be attempting to sell the property themselves, a short sale.
The borrower enlists the services of a real estate agent for marketing and representation purposes.
In some cases, the same real estate agent will assist the homeowner with the lender approval process. In other cases, the services of a specialist with expertise and experience in obtaining lender approval of a short sale will be hired.
Once an offer from an interested buyer is accepted by the seller, that offer is submitted to the lender for approval. This is the step that takes time. Processing time for lenders varies, with an average of 1-3 months for approval and completion of the sale.
What Does a Real Estate Agent Do? >>
How a Foreclosure Works
Foreclosure is a lengthy legal process with many steps. In a foreclosure, the borrower decides not to proceed with a short sale and remains in the property until the foreclosure is finalized.
Some borrowers decide for the foreclosure to remain in the property for a longer period of time without having to make any mortgage payments,basically living in the property without any housing expense.
At the end of the foreclosure process, the borrower has no legal right to possession of the property and must vacate. The lender becomes the owner of the property and must continue with the sale of the property.
Lenders attempt to avoid foreclosure at all costs. It is a more expensive process for them, and in the end, they will be left with a property that is likely much lower in value and in worse condition without the proper maintenance from the borrower.
Also, the lender must now go through the process of selling the property they now own. In the vast majority of cases, this will happen in a slow market of declining values, and therefore, will need to assume the maintenance costs of owning the property until the right buyer comes along.
Short Sale Alternatives
Two of the most common alternatives to a short sale are a loan modification and a deed in lieu of foreclosure.
It is interesting to note that a lender is on your side if you are a borrower looking to avoid a short sale or foreclosure. The lender wishes to avoid taking a loss as much, if not more, than the homeowner wishing to avoid losing their property.
Unfortunately, in a market of declining values, homeowners either cannot or do not wish to continue making their mortgage payments.
Why pay on a mortgage with a balance of $600,000 when the property has a current value of $400,000?
Borrowers who are unable to continue making the mortgage payment but wish to avoid a short sale can ask the lender for a loan modification.
In a loan modification, the original terms of the loan are modified to make them more reasonable and affordable for the borrower. As an example, the term of the loan can be extended from 30 years to 40 years, thus lowering the monthly payment. Another option is to reduce the interest rate on the note, which also lowers the monthly mortgage payment.
The outstanding loan balance can also be reduced to more closely reflect the current market value of the property, serving as collateral for the loan.
In a deed in lieu of foreclosure, the borrower voluntarily transfers title to the lender in exchange of cancellation of the outstanding mortgage.
A benefit to the borrower is that this is a much simpler process than finding a buyer themselves and going through a short sale. However, many lenders will require that the borrower have attempted a short sale before and been unsuccessful in finding a buyer for the property.
A short sale and a deed in lieu of foreclosure are similar because in both cases the borrower will lose the title to the property and will be released from their current mortgage.
Real Estate Agent vs. Broker >>
How to Determine Profitability in a Short Sale Property
Profitability can be obtained from a short sale in one of three ways.
Through the Long-Term Increase in Value of the Property
Properties purchased at the height of the foreclosure crisis in 2008-2009, when property values hit rock bottom, 15 years later increased in value by 500-600% in some cases.
Using the Property as a Rental
Having been purchased at a discounted price, the property will likely produce positive cash flow covering the mortgage payment and other property expenses while still allowing the investor to pocket a portion of the monthly rent.
As rents increase and the mortgage payment remains the same, assuming a fixed-rate mortgage was obtained, the amount of positive cash flow will increase.
Buying at a Discount With Plans for Remodeling
Finally, for those investors willing to take a greater risk in exchange for a greater return on their investment, short sales with deferred maintenance can be purchased at a greater discount and remodeled to sell at a nice profit.
This is your typical “flip” investor. Those investors that purchase properties in need of some repairs and remodeling then sell the property for a much higher price after the repairs and remodeling are completed.
Reasons Real Estate Short Sales Fail
Below are some common reasons why short sales fail and what buyers and sellers should look out for when pursuing this route.
Home Value
The value of the home is the single most important number that will determine how much the lender will receive in exchange for the forgiveness of the outstanding loan amount.
For example, if the outstanding loan amount is $650,000 and the current home value is $475,000, and the selling expenses amount to $30,000, the lender will receive $445,000 as the net proceeds of the sale and will incur a loss of $650,000 - $445,000 = $205,000.
This is something that occurred millions of times across the United States during the foreclosure crisis and eventually led to the failure of many banks, mortgage companies, and investment bankers.
If the value of the property drops to $425,000, the lender will now lose $255,000 and so on and so forth. Since lenders want to minimize their losses, the home value is of great importance if the short sale will happen or if it will fail.
Liens
As property values increase some homeowners obtain home equity loans to cash out on the appreciation in value of the property. This amounts to having additional liens on the property.
The original purchase money mortgage would be in first position and any additional mortgages obtained would be considered junior liens such a second mortgage and perhaps a third mortgage.
If property values begin to decline, the homeowner might find themselves “underwater” in their liens. In other words owing more than the current value of the property.
For a short sale to proceed, all liens must agree to the short sale. If there are 3 mortgage liens on the property, all 3 lenders must agree to the short sale, this means additional negotiating to obtain approval of the short sale.
Let’s assume in this situation, there are 3 mortgage liens on the property.
A first lien for $550,000, a second lien for $80,000, and a third for $25,000.
If the property will sell for $475,000 you can see that there is not enough to pay off the first lien, and there is nothing left to pay the second or third liens.
In this case, the second and third liens will likely want to be paid some money from the proceeds of the sale. Maybe $5,000 or $10,000. These will all be separate negotiations.
The bottom line is that the more liens the property has, the more likely the short sale will fail.
Foreclosures, Short Sales, and REO Courses For Real Estate Professionals
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Frequently Asked Questions About Short Sale Properties
Below are commonly asked questions about the short sales in the real estate industry.
Is It a Good Idea to Buy a Short Sale Property?
It is always a good idea to buy real estate and buying a short sale property is no different. Warren Buffet was quoted as saying during the foreclosure crisis, “if it was practical to do so, I would buy a couple hundred thousand single family homes.”
The vast majority of wealth in the United States and likely the world is concentrated in real estate. There is a tremendous gap in wealth between those that own a home and those who rent.
The greatest benefit of owning real property is the leverage allowed by a home mortgage. It allows the purchase of a great asset with a small down payment.
Wealth builds up as the value of the property increases over time. The benefits inherent in purchasing real property far outweigh the minor drawbacks of purchasing a short sale property, such as the lengthy process and the deferred maintenance.
Who Covers the Financial Loss in a Short Sale?
Banks and lenders assume the risk of lending money in exchange for the payment of interest on the money borrowed.
In the loan approval process, they minimize risk by lending only to borrowers who meet certain strict criteria and who have solid collateral.
One factor that is beyond their control is market conditions. In the case of real estate, if market conditions deteriorate and property values begin to decline, the lender’s risk exposure will increase dramatically.
Do you remember the names Washington Mutual, Downey Savings and Loan, First National Bank of Nevada, IndyMac Bank, among many others? These banks failed in one year alone, in 2008, during the foreclosure crisis.
How Long Does it Take to Purchase a Short Sale Property?
An ongoing joke among real estate agents is that it shouldn’t be called a short sale, it should be called a long sale.
A standard sale process is a 30-day escrow. A short sale can take anywhere between 3 to 6 months.
At the beginning of the foreclosure crisis, short sales were taking 6 months or longer. The reason was banks were caught off guard since they did not have to deal with many short sales in the past, and now, all of a sudden they were receiving one file after another requesting approval of a short sale.
Banks were simply understaffed in this area. Eventually, the banks caught up and had fully functioning short sale departments, and it was not uncommon to complete a short sale in 3 months or even less time.
Mastering the Basics of Short Sales
Having a solid grasp of the short sale process and the differences between a short sale and a foreclosure is an important topic to understand when preparing for a real estate licensing exam.
Our online real estate license classes are crafted to guide you seamlessly from the moment you choose a career in real estate to obtaining your license, meeting continuing education requirements, achieving license upgrades, and engaging in ongoing professional development.
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In real estate, the term "short sale" often comes up as a strategic and complex transaction. This article outlines the intricacies of short sales, offers strategies for buyers and sellers, and explains how they function and why they happen within the real estate industry.
TABLE OF CONTENTS
- Short Sales at a Glance
- In-Depth Process of a Short Sale
- Strategies For Investors and Buyers
- Short Sales vs. Foreclosures
- Alternatives to Short Sales
- How to Determine Profitability
- Common Reasons Short Sales Fail
- Frequently Asked Questions
Short Sales at a Glance
A short sale is a situation where a homeowner is unable to continue making their mortgage payment and must sell their property when the balance of the mortgage exceeds the current value of the property. It is called a short sale because the sale proceeds will be short of the outstanding mortgage balance. This type of sale is most common when property values are declining.
Real Estate Short Sale Process
The short sale process has multiple steps, and it’s common for a short sale to take 4-6 months to complete from the time the offer is accepted, and in rare cases, even longer. Below are the steps commonly found within the short sale process.
Step 1: Professional Consultations
It is recommended that a homeowner considering a short sale first consult with various professionals. In a short sale, any remaining debt will be canceled by the lender.
For example, if the sales proceeds are $110,000 short of the outstanding loan balance, the borrower will likely receive a 1099-C, which is treated as taxable income.
Each homeowner’s tax situation is different, and therefore, it is highly recommended that they consult with a tax professional for advice on possible ways to avoid paying taxes on the forgiven debt.
Another professional that a homeowner considering a short sale should consult with is a real estate agent. An agent with experience in short sales will make this complicated process a lot smoother by helping the homeowner navigate the lender approval and sales process.
Thinking about starting a real estate career? Download the Launching Your Real Estate Career eBook
Download
Step 2: Set the Right Asking Price
Setting the right asking price is key in the short sale process. The asking price must entice buyers while at the same time encouraging the lender to approve the sale.
The asking price is set by the homeowner and their agent but keep in mind that the lender has the last word. If the lender feels the agreed-upon sales price is too low, they will simply not approve the sale. The asking price must reflect current market conditions and the sales price of recently sold comparable properties in the same neighborhood.
Step 3: Lender Agreement
For a short sale to take place, the lender must agree to the sale. Since the lender will be taking a loss, for example, the outstanding loan amount is $350,000, but the proceeds from the sale will be $260,000, which would result in a loss of $90,000, the lender will need to agree to the sale of the property.
Before agreeing to the sale, the lender requires the borrower to provide financial documentation proving that they are unable to continue making the monthly mortgage payment.
Required documentation for lender includes:
- copies of paystubs or other income documentation
- copies of bank statements or other liquid assets
- a financial statement showing current assets and liabilities of the borrower
Step 4: Submit the Required Documents
Even though different lenders have different specific documentation requirements, the standard is the documents must prove that the borrower is unable to make the monthly mortgage payments at their current income and is unable to contribute to the canceled mortgage debt balance with their current assets.
The most common reasons why a borrower is unable to make the monthly mortgage payment is when
- their income decreases, such as when they lose their job
- or the mortgage payment suddenly increases as with an adjustable payment loan
If the borrower is unable to make their payment, they must prove this to the lender with current income documentation.
If the borrower has current liquid assets, such as bank account balances or stocks, the lender will require a payment from the borrower to offset part of the mortgage balance that will be canceled in the short sale.
The borrower must provide the bank with current assets documentation proving that they do not possess any assets that can be used to offset the canceled debt.
Step 5: Hardship Letter
A hardship letter is a letter from the borrower to the bank pleading their case and stating the reason why it is necessary and a good business decision for the bank to approve the short sale.
It is recommended that the letter state the benefits from the bank's point of view. In other words, why it makes sense for the bank to approve the short sale and why it is impossible for the borrower to continue with their current mortgage.
The hardship letter must be convincing and clearly written making the decision an easy one for the lender. This is a crucial step in the short sale approval process. If the approval is not granted the borrower will have to endure a foreclosure on their property.
Step 6: Find a Buyer
Finding a buyer during a short sale is no different than with a regular sale. At the beginning of a declining market when property values are still declining there will be many short sales and foreclosures on the market and few buyers interested in purchasing real estate property.
As the market hits bottom and property values begin to climb back up, buyers will begin looking to purchase properties with rock-bottom prices, and short sales and foreclosures will begin to sell much quicker.
Buyers wanting to purchase a short sale must have a flexible time frame since the lender approval process can take longer than it would with a regular 30 day escrow on a regular sale. This all depends on the specific lender and how quick their processing time is in approving the short sale.
Step 7: Proposal for the Bank
Once the buyer and seller have come to an agreement the next step is submitting a proposal to the bank for approval of the short sale. The proposal will include the homeowner's financial information proving that they are not able to continue making the monthly mortgage payment and that they have no assets to contribute to the deficiency between the sale proceeds and the outstanding mortgage balance.
It will also include a list of comparable properties showing that the agreed-upon sales price is reflective of current market conditions. The lender will confirm the current market value of the property by requesting a Brokers Price Opinion (BPO) from a neutral broker not involved in the sale of the property.
A BPO is similar to an appraisal but less thorough and therefore less expensive. Instead of being completed by a licensed real estate appraiser, it is completed by a licensed real estate broker or agent and simply gives the broker’s opinion of value by considering recently sold comparable properties.
How to Choose a Real Estate Broker >>
Short Sale Strategies for Buyers and Investors
Below are some tips and suggestions for buyers and investors when finding and selling short sales.
How to Find Real Estate Short Sales
The key to finding short sales is understanding the foreclosure process. A short sale is basically a homeowner in default who wishes to avoid a foreclosure.
When a borrower stops making their monthly mortgage payment they are in default. The lender will reach out to the borrower to discuss their situation and try to reach an agreement. If the lender is unable to reach the borrower or come to an agreement to solve the default, the lender will file what is known as a Notice of Default.
What is a Notice of Default?
A Notice of Default is a public notice filed with a court and the first step in the foreclosure process. Notices of Default can be found by searching county records, which are freely accessible to the public.
If you choose to outsource the search of the public records you could reach out to a title company to see if they provide lists of properties with recorded NODs or subscribe to a service that provides such lists for a fee.
Research Tips
Real estate records are maintained at the county level, so if you choose to search the public records yourself, first find your local county clerk’s office or the county in which you wish to find a possible short sale property.
Some counties also offer online requests for real estate records and/or a toll-free number as well as an email address for the request of such records. Also available are online search engines and services that provide you with lists of properties with recorded Notices of Default.
The two most common paid services are PropertyRadar and Rebo Gateway. For free information on recorded documents on a specific property, a simple call to your local title office, such as First American Title, will do.
The fees charged for these services vary greatly, so shop around to make sure you are not paying more than necessary.
Negotiating Tips
When negotiating a short sale keep in mind that the lender will have the last word in the sale terms. The homeowner in a short sale is simply wanting to walk away from their current mortgage and avoid foreclosure. They will receive no proceeds from the sale and, therefore, are not too interested in negotiating any financial terms of the transaction.
The lender, on the other hand, is the one that will be taking a loss in the sale and will be very interested in minimizing that loss. When negotiating, it’s always a good idea to keep the other party’s position in mind.
For example, in a declining market, the buyer will have more leverage because if the offer is not accepted, the next offer will likely be lower as the value of the property declines over time.
On the other hand, if property values are increasing, the leverage will be on the side of the seller, or lender in the case of a short sale, knowing that the property will be increasing in value over time.
In either case, the lender in a short sale will not be very willing to make many concessions since they will be taking a loss, oftentimes in the hundreds of thousands of dollars range.
How to Pass the Real Estate Exam >>
Pros and Cons of a Short Sales
The major benefit of a short sale to a buyer or investor is that the property will be purchased at a discounted price. In essence, at a price lower than the seller originally paid for the property.
As long as the buyer’s or investor’s timeframe is long-term, they will likely reap the benefits of value appreciation over time.
Among the cons of purchasing a short sale is the fact that the property will not be in optimal condition. Property owners considering a short sale will most likely reduce the maintenance of the property to a minimum to avoid further expenses.
Also, the seller will not be walking away with any cash from the sale; they will simply be able to walk away from a mortgage with a higher balance than the current value of the property.
This translates to the homeowner deriving no benefit from the cost associated with the property maintenance and upgrade of the property.
Another con is the timeframe to complete a short sale. A short sale will not be like a standard sale 30-day escrow. The lender approval process takes time according to their processing capabilities.
Short Sale vs. Foreclosure
The beginnings of a short sale and foreclosure look the same. The differences between a short sale and foreclosure come down to who sells the property.
In a short sale, the borrower sells the property they can no longer make payments on.
In a foreclosure, the bank or lender sells the property.
How a Short Sale Works
After the borrower is unable to continue making payments on their mortgage, the borrower will notify the bank that they will be attempting to sell the property themselves, a short sale.
The borrower enlists the services of a real estate agent for marketing and representation purposes.
In some cases, the same real estate agent will assist the homeowner with the lender approval process. In other cases, the services of a specialist with expertise and experience in obtaining lender approval of a short sale will be hired.
Once an offer from an interested buyer is accepted by the seller, that offer is submitted to the lender for approval. This is the step that takes time. Processing time for lenders varies, with an average of 1-3 months for approval and completion of the sale.
What Does a Real Estate Agent Do? >>
How a Foreclosure Works
Foreclosure is a lengthy legal process with many steps. In a foreclosure, the borrower decides not to proceed with a short sale and remains in the property until the foreclosure is finalized.
Some borrowers decide for the foreclosure to remain in the property for a longer period of time without having to make any mortgage payments,basically living in the property without any housing expense.
At the end of the foreclosure process, the borrower has no legal right to possession of the property and must vacate. The lender becomes the owner of the property and must continue with the sale of the property.
Lenders attempt to avoid foreclosure at all costs. It is a more expensive process for them, and in the end, they will be left with a property that is likely much lower in value and in worse condition without the proper maintenance from the borrower.
Also, the lender must now go through the process of selling the property they now own. In the vast majority of cases, this will happen in a slow market of declining values, and therefore, will need to assume the maintenance costs of owning the property until the right buyer comes along.
Short Sale Alternatives
Two of the most common alternatives to a short sale are a loan modification and a deed in lieu of foreclosure.
It is interesting to note that a lender is on your side if you are a borrower looking to avoid a short sale or foreclosure. The lender wishes to avoid taking a loss as much, if not more, than the homeowner wishing to avoid losing their property.
Unfortunately, in a market of declining values, homeowners either cannot or do not wish to continue making their mortgage payments.
Why pay on a mortgage with a balance of $600,000 when the property has a current value of $400,000?
Borrowers who are unable to continue making the mortgage payment but wish to avoid a short sale can ask the lender for a loan modification.
In a loan modification, the original terms of the loan are modified to make them more reasonable and affordable for the borrower. As an example, the term of the loan can be extended from 30 years to 40 years, thus lowering the monthly payment. Another option is to reduce the interest rate on the note, which also lowers the monthly mortgage payment.
The outstanding loan balance can also be reduced to more closely reflect the current market value of the property, serving as collateral for the loan.
In a deed in lieu of foreclosure, the borrower voluntarily transfers title to the lender in exchange of cancellation of the outstanding mortgage.
A benefit to the borrower is that this is a much simpler process than finding a buyer themselves and going through a short sale. However, many lenders will require that the borrower have attempted a short sale before and been unsuccessful in finding a buyer for the property.
A short sale and a deed in lieu of foreclosure are similar because in both cases the borrower will lose the title to the property and will be released from their current mortgage.
Real Estate Agent vs. Broker >>
How to Determine Profitability in a Short Sale Property
Profitability can be obtained from a short sale in one of three ways.
Through the Long-Term Increase in Value of the Property
Properties purchased at the height of the foreclosure crisis in 2008-2009, when property values hit rock bottom, 15 years later increased in value by 500-600% in some cases.
Using the Property as a Rental
Having been purchased at a discounted price, the property will likely produce positive cash flow covering the mortgage payment and other property expenses while still allowing the investor to pocket a portion of the monthly rent.
As rents increase and the mortgage payment remains the same, assuming a fixed-rate mortgage was obtained, the amount of positive cash flow will increase.
Buying at a Discount With Plans for Remodeling
Finally, for those investors willing to take a greater risk in exchange for a greater return on their investment, short sales with deferred maintenance can be purchased at a greater discount and remodeled to sell at a nice profit.
This is your typical “flip” investor. Those investors that purchase properties in need of some repairs and remodeling then sell the property for a much higher price after the repairs and remodeling are completed.
Reasons Real Estate Short Sales Fail
Below are some common reasons why short sales fail and what buyers and sellers should look out for when pursuing this route.
Home Value
The value of the home is the single most important number that will determine how much the lender will receive in exchange for the forgiveness of the outstanding loan amount.
For example, if the outstanding loan amount is $650,000 and the current home value is $475,000, and the selling expenses amount to $30,000, the lender will receive $445,000 as the net proceeds of the sale and will incur a loss of $650,000 - $445,000 = $205,000.
This is something that occurred millions of times across the United States during the foreclosure crisis and eventually led to the failure of many banks, mortgage companies, and investment bankers.
If the value of the property drops to $425,000, the lender will now lose $255,000 and so on and so forth. Since lenders want to minimize their losses, the home value is of great importance if the short sale will happen or if it will fail.
Liens
As property values increase some homeowners obtain home equity loans to cash out on the appreciation in value of the property. This amounts to having additional liens on the property.
The original purchase money mortgage would be in first position and any additional mortgages obtained would be considered junior liens such a second mortgage and perhaps a third mortgage.
If property values begin to decline, the homeowner might find themselves “underwater” in their liens. In other words owing more than the current value of the property.
For a short sale to proceed, all liens must agree to the short sale. If there are 3 mortgage liens on the property, all 3 lenders must agree to the short sale, this means additional negotiating to obtain approval of the short sale.
Let’s assume in this situation, there are 3 mortgage liens on the property.
A first lien for $550,000, a second lien for $80,000, and a third for $25,000.
If the property will sell for $475,000 you can see that there is not enough to pay off the first lien, and there is nothing left to pay the second or third liens.
In this case, the second and third liens will likely want to be paid some money from the proceeds of the sale. Maybe $5,000 or $10,000. These will all be separate negotiations.
The bottom line is that the more liens the property has, the more likely the short sale will fail.
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Frequently Asked Questions About Short Sale Properties
Below are commonly asked questions about the short sales in the real estate industry.
Is It a Good Idea to Buy a Short Sale Property?
It is always a good idea to buy real estate and buying a short sale property is no different. Warren Buffet was quoted as saying during the foreclosure crisis, “if it was practical to do so, I would buy a couple hundred thousand single family homes.”
The vast majority of wealth in the United States and likely the world is concentrated in real estate. There is a tremendous gap in wealth between those that own a home and those who rent.
The greatest benefit of owning real property is the leverage allowed by a home mortgage. It allows the purchase of a great asset with a small down payment.
Wealth builds up as the value of the property increases over time. The benefits inherent in purchasing real property far outweigh the minor drawbacks of purchasing a short sale property, such as the lengthy process and the deferred maintenance.
Who Covers the Financial Loss in a Short Sale?
Banks and lenders assume the risk of lending money in exchange for the payment of interest on the money borrowed.
In the loan approval process, they minimize risk by lending only to borrowers who meet certain strict criteria and who have solid collateral.
One factor that is beyond their control is market conditions. In the case of real estate, if market conditions deteriorate and property values begin to decline, the lender’s risk exposure will increase dramatically.
Do you remember the names Washington Mutual, Downey Savings and Loan, First National Bank of Nevada, IndyMac Bank, among many others? These banks failed in one year alone, in 2008, during the foreclosure crisis.
How Long Does it Take to Purchase a Short Sale Property?
An ongoing joke among real estate agents is that it shouldn’t be called a short sale, it should be called a long sale.
A standard sale process is a 30-day escrow. A short sale can take anywhere between 3 to 6 months.
At the beginning of the foreclosure crisis, short sales were taking 6 months or longer. The reason was banks were caught off guard since they did not have to deal with many short sales in the past, and now, all of a sudden they were receiving one file after another requesting approval of a short sale.
Banks were simply understaffed in this area. Eventually, the banks caught up and had fully functioning short sale departments, and it was not uncommon to complete a short sale in 3 months or even less time.
Mastering the Basics of Short Sales
Having a solid grasp of the short sale process and the differences between a short sale and a foreclosure is an important topic to understand when preparing for a real estate licensing exam.
Our online real estate license classes are crafted to guide you seamlessly from the moment you choose a career in real estate to obtaining your license, meeting continuing education requirements, achieving license upgrades, and engaging in ongoing professional development.
