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A short sale occurs when a homeowner sells their home for less than they owe on the mortgage.
The lender of the original mortgage gets all of the sale proceeds and forgives the difference or gets a deficiency judgment, which requires the original borrower to pay what’s left over.
Short sales occur when an owner is in a dire financial condition and can no longer keep up with their mortgage payments. Instead of waiting for the bank to foreclose, the homeowner initiates the short sale by applying to the mortgage lender.
Part of this includes demonstrating financial hardship and proving the seller doesn’t have the income or assets to pay back the balance of their existing loan. The short sale must be approved in advance by the mortgage lender.
Short sales don’t always cancel all the remaining mortgage debt, but they are less harmful to the owner and the lender than foreclosures. In a short sale, lenders waive the lien against the property used to secure the loan.
However, the second part of the mortgage is a promise to repay, and lenders can still enforce this part of a loan through a new note or the collection of the deficiency.
Short Sales vs. Foreclosures
Short sales and foreclosures may occur when a homeowner struggles to keep up with mortgage payments or if an owner is underwater on their loan and owes more than a property is worth.
There are differences, and it’s important to understand them before considering either option. For example, a seller can enter a short sale voluntarily, but foreclosures don’t give a homeowner a choice.
They are forced on a homeowner who has repeatedly demonstrated an inability to pay and is several months behind on mortgage obligations.
After a lender approves a short sale, a seller is in charge of selling the property only to a certain degree. Because the lender is trying to recoup as much of their loan as possible, they are responsible for negotiations and determining whether or not to accept or reject buyers’ offers.
By contrast, foreclosure is a legal action that seizes an owner’s property.
Both negatively impact a seller’s credit, but a foreclosure is much more damaging to a seller’s credit and how long they must wait to get a mortgage again. Foreclosures are also expensive and can sometimes force an owner to file for bankruptcy.
With a foreclosure, the mortgage holder repossesses the home and will resell it to make good on its initial investment. Foreclosures take less time because the lender wants to liquidate the asset quickly to recoup their outlay.
If a house is in foreclosure and a sheriff’s sale has taken place, there is a six-month redemption period for an inhabited property between the sale and when the property gets turned over to the winning bidder.
During that redemption period, the homeowner can try to sell it. An owner can also try to pay what they owe, get the house out of redemption, and keep the home.
However, when the redemption period expires, the home is fully foreclosed. It doesn’t matter if a buyer has a purchase agreement because the seller has no right to it anymore.
The Implications of a Short Sale
A short sale transaction involves a home buyer seeking a bargain on a value-priced piece of real estate. Short sales do come with more of a time commitment and more risk than a traditional home-buying process.
Short sales do benefit the new home buyer and can limit financial negatives for the lender and seller vs. the downsides of a foreclosure. All parties are motivated to get the deal done when faced with the alternative.
Lenders are motivated to cut their losses, sellers want to get out of a bad financial situation, and buyers have the advantage of less competition. This offsets the complicated financial wrangling that often accompanies a short sale deal.
In addition to avoiding foreclosure, sellers may have the majority of their debt retired when a short sale goes through, and many times, the lender may fully accept all proceeds from the short sale and write off the remaining debt as a loss. Sellers lose all negotiating power, and since they owe more money than what the sale produces, they won’t see any money from the home sale.
A short sale allows the seller to obtain a mortgage immediately with an FHA loan as long as there are no late mortgage or installment payments in the last year before the short sale and no late mortgage or installment payments in the year before applying for the new mortgage. Outside of an FHA loan, the waiting period for another mortgage may be as long as 7 years.
Buyers purchase the property “as is” and may need to put in a lot of added work and money to make repairs and improvements.
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Steps in the Short Sale Process
The lender controls short sale transactions, which can be more complicated and time-consuming than routine transactions. These are typical steps in the process.
Get Approved For Financing
While it’s always beneficial for buyers to obtain initial approval before making an offer, it’s even more critical in a short sale, as the lender will want to ensure that the new buyer can purchase the short-sale property after a bad experience with an original mortgage holder.
Working with a Real Estate Agent
Finding a short sale home requires more work. Instead of culling through listings in your area, you’ll focus on preforeclosure property listings online.
You can also search through public records by contacting the local county court. An agent will have experience finding troubled properties and can explain various hurdles you may face with this type of transaction.
Do Your Research
This is critical for a short sale. Get all the information you can about a property that might be a good candidate, including reviewing comparable sales in the area to find out the home’s value.
Real estate agents have access to the multiple listing service (MLS), which provides information on the prices of homes currently on the market and recently sold.
You’ll also need to determine how much the seller owes the lender. Before you purchase a short sale, make sure you know every lienholder who has a claim to the property and check to ensure there are no other liens on the home.
Your best bet is to ask a title company to do a title search on the property.
Make an Offer
Use whatever you can to determine whether a lender will accept your offer to buy a home in a short sale. Understand that while you’re looking to score a deal, the lender is trying to recoup as much of the remaining mortgage balance as possible.
Also, be aware that a larger downpayment than normal is often required for short sale deals.
Get the Home Inspected
Short sale properties are sold “as is,” so you can’t negotiate a lower price if you find problems. Sellers are required to disclose defects, but often, an owner faces chaotic financial issues and may be looking for any way out of a deal. Trust by verify on your own.
You may still get a deal if you discover the home needs a new roof or has major plumbing issues but finding those out in advance helps you better determine if a short sale still makes long-term financial sense.
Closing the Sale
After the lender has accepted the short sale, you must ensure that the lender and other lienholders will release the collateral. The more lienholders there are, the longer this process can take, at least four months and possibly longer in many cases.
Finally, it is the nature of short sales that sometimes, no matter how talented and experienced an agent is, a deal can fall through. An agent’s hands are tied because the bank, an investor, or whoever makes a decision just says “no.”