In real estate, the term “short sale” refers to a transaction in which a financially challenged homeowner sells their home for less than the amount owed on their mortgage. The property is purchased by a third party (not the bank), and all proceeds go to the lender. The lender has two options: forgive the outstanding sum or pursue the homeowner with a deficiency judgment, which forces them to pay the lender the difference in full or in part. In some places, a short sale must legally forgive this disparity.
- In real estate, a short sale occurs when a house is sold for less than the amount remaining outstanding on the mortgage.
- A short sale must be approved by the mortgage lender.
- The lender may forgive the difference between the sale price and the mortgage amount, although this is not always the case.
- For the seller, the financial ramifications of a short sale are less severe than those of a foreclosure.
- The buyer must assess costs and ensure that there is room for profit when the residence is resold.
Understanding a Short Sale (Real Estate)
A short sale is when a home is sold for less than the mortgage sum. For example, a homeowner may sell their home for $150,000 with a $175,000 mortgage. The shortfall in this case is $25,000 (minus any closing and other selling charges). The mortgage lender must approve the short sale, also known as a pre-foreclosure sale, before it can proceed. The lender, usually a bank, also needs proof that a short sale makes sense. After all, the lender may lose a lot of money. No short sale without lender consent.
Short sales can take up to a year to complete due to the amount of paperwork involved. However, short sales do not harm a homeowner’s credit as much as foreclosures. Contrast this with a short sale in investment. An investor who sells borrowed securities in anticipation of a price decrease must return the same number of shares at a later date. It’s a crime to discriminate in short sales. Affirmative action is available if you believe you’ve been subjected to discrimination based on race, religion or national origin. Reporting to the Consumer Financial Protection Bureau (CFPB) and/or the Department of Housing and Urban Development (HUD) (HUD).
Does a Short Sale Hurt Your Credit?
A short sale harms a person’s credit less than a foreclosure, but it is still a bad record. Any property transaction that is not paid as agreed is a negative on a credit score. So, short sales, foreclosures, and deeds-in-lieu of foreclosure all hurt credit. Short sales don’t usually eliminate mortgage debt after a sale. All mortgages have two sections. An example of this would be a mortgage lien. The lien protects the lender if a borrower defaults. It allows the lender to sell the property to recoup their losses. In a short sale, this is waived.
It also includes a pledge to repay. Lenders can still collect the deficiency or issue a fresh note to enforce this portion. Lenders must authorize the short sale, thus borrowers are sometimes at their mercy. To get a lender to agree to a short sale, the buyer’s financial problems must be new and not previously hidden.
Short Sale vs. Foreclosure
These are two financial solutions open to homeowners who are late on their mortgage payments, or both. The owner is forced to sell in both circumstances, but the timetable and repercussions differ. When a borrower defaults on payments, the lender seizes the property. Foreclosure is the lender’s last resort. Unlike a short sale, lenders start foreclosures. The lender seeks to recoup its initial mortgage investment by forcing the sale of the overdue borrower’s home. Foreclosures are also common if a homeowner abandons their home. If the residents remain, the lender evicts them.
Once the lender has access to the property, they request an appraisal and try to sell it. Because the lender wants to liquidate the asset quickly, foreclosures usually take less time than short sales. Trustees sales are public auctions where customers bid on foreclosed homes. Unrestricted buying of a new house is possible for homeowners who have completed a short sale. Foreclosed homeowners should expect to wait two to seven years to buy another home. Foreclosures are reported for seven years. While a foreclosure allows you to walk away from your house, it comes with serious financial ramifications, such as needing to file for bankruptcy and ruining your credit. The extra labor involved in a short sale may be worth it in the end.
Loan modification and private mortgage insurance are less disruptive alternatives to short sales.
Short Sale Alternatives
Before you accept a short sale, speak with your lender about the potential of a new payment plan or a loan modification. One of these choices may allow you to remain in your house while regaining your footing.
If you have private mortgage insurance, you have another option for staying in your house (PMI). Many homeowners who put less than 20% down on a property were obliged to purchase PMI. If the PMI firm believes you have a good possibility of getting out of your current financial condition, it may advance funds to your lender to catch up on your payments. You’ll have to pay back the loan eventually.
Details of Avoiding a Short Sale
Convincing the Lender
Before starting the process, the struggling homeowner should understand the lender’s position on working with them on a short sale. Since the lender is not compelled to perform a short sale, it is up to them.
Not something that was not revealed when the homebuyer applied for the loan. Scammers won’t get any sympathy from lenders. In the case of predatory lending, you may be able to persuade the lender to allow you to sell your property even if you haven’t experienced any substantial financial setbacks since buying it. Stop buying unnecessary items to increase your chances of completing a short sale. You don’t want to appear irresponsible to the lender.
Other factors may prohibit a short sale from being approved. If you haven’t defaulted on your mortgage yet, the lender is unlikely to deal with you. A lender may refuse a short sale if it believes that foreclosure will yield more money than allowing one. If a cosigner signed the mortgage, the lender may not allow a short sale.
If you think your situation calls for a short sale, talk to a bank decision-maker about it. Don’t just call a customer service rep. Ask to talk with the lender’s loss mitigation department right away. If you don’t like what the initial decision-maker says, try talking to another one the next day. If the lender agrees to a short sale, you can start working on the proposal and locating a buyer.
You should consult an attorney, a tax specialist, and a real estate agent at this stage. While these are expensive professional services, if you make a mistake by attempting to handle a sophisticated short-sale transaction on your own, you could end up in even more financial difficulties. You might be eligible to deduct these service fees from the proceeds of your house sale. Professionals that are familiar with short-sale transactions will be able to advise you on how to settle them.
Setting a Price
Make sure to incorporate the cost of selling the property into the total amount of money you need to get out of the situation when determining an asking price. Of course, you want to sell the house for as near to the amount owed on the mortgage as feasible, but there will inevitably be a shortfall in a down market. Even after a short sale, the bank in some states will want you to pay back all or part of the gap.
Gather Your Documents and Find a Buyer
Gather all of the documentation you’ll need to show the lender your financial difficulty. Bank statements, medical bills, pay stubs, a termination notice from your previous work, or a divorce judgment are some examples. It is up to you to make a suggestion. Because the lender is the recipient of the money, the lender must eventually authorize a short sale after getting all the data. It is your responsibility to find a buyer for your house.
Submit Your Proposal to the Bank
You are ready to submit the buyer’s offer and your proposal to the bank once you get them. Your proposal should contain a hardship letter describing the conditions preventing you from paying your mortgage payments. You want to preserve your interests while simultaneously appealing to the bank. If a lender denies a short sale, it may use your financial information to pursue you in foreclosure. Any remaining cash assets may be used to maintain mortgage payments or to cover any deficits between the sale price and the mortgage amount. An attorney familiar with short sales can guide you through the process.
Because lender approval takes longer than conventional home purchases, short sales frequently fail. The buyer may find another house while you are unavailable. Be ready for this. If the short sale goes through, check with the IRS to see if you owe taxes on the difference. Also, be aware that a short sale can still impact your credit score by showing months of missed mortgage payments as late payments on your credit record. The bank decides what to report, therefore you should try to persuade them not to record your missed payments.
Your bank may be more understanding if you inform them of your situation before you fall substantially behind. While this isn’t ideal for your credit, it’s better than a foreclosure.
Short Sale Strategies for Buyers and Investors
Short sales can also provide excellent opportunities for buyers to get into houses at a reduced price. Here are a couple of tips to help you make smart decisions when considering the purchase of a short-sale property.
Learn How to Find Short Sales
Real estate brokers and websites list the majority of short-sale properties. Some postings may not be labeled as short sales, so check for indicators within the offering, such as being subject to bank permission or allowing time for the bank to reply. 1
When it comes to identifying and closing short-sale properties, a skilled real estate agent may make all the difference. Short sale and foreclosure resource (SFR) certification is a qualification granted by the National Association of Realtors for agents who specialize in short sales (NAR).
Short sale and foreclosure specialists have acquired specific training in qualifying sellers for short sales, dealing with lenders, and protecting buyers. It’s crucial to remember that certification doesn’t guarantee that an agent will have the experience you’re searching for, and that lack of certification doesn’t rule out the possibility. In either case, you’ll want to make sure any possible real estate agents have experience with short sales.
Short Sales Take a While
Recognize that short sales are difficult and time-consuming processes. A lender’s approval of a short sale can take weeks or months, and many purchasers who submit an offer end up canceling it because the short-sale process takes too long.
The processes for short-sale transactions vary by state, but they usually include:
- Short sale package: By providing a financial package to their lender, the borrower must demonstrate financial hardship. Financial statements, a letter detailing the seller’s hardship(s), and financial records, such as tax returns, W-2s, paycheck stubs, and bank statements, are all included in the package.
- Short sale offer: Each time a seller accepts an offer from a buyer, the listing agent notifies the lender and delivers a short-sale package with the listing agreement and executed purchase offer. The process will be delayed if a document is missing or if the bank makes a filing error.
- Bank processing: The bank’s examination of the offer can take anywhere from a few weeks to many months. It will either approve or deny it in the end. It’s crucial to remember that just because a seller accepts an offer doesn’t indicate the bank will. The bank will reject the offer if it believes it can make more money through foreclosure proceedings.
It’s All in the Numbers
It is said in real estate investing that the money is made in the purchase. As a result, a good buying price is frequently the key to a successful transaction. If you can obtain a decent deal on a property, you’ll have a better chance of making a profit when it’s time to sell. On the other hand, if the buying price is too high, your profit margin will most likely diminish.
You should be able to purchase the property, restore it to its former glory, and resell it for a profit. Investors need to be able to turn around and sell the property quickly—usually at a loss—and a favorable buying price allows them to do so.
However, the buying price is only one of the most essential figures. You’ll also need to do some other computations, such as:
Repairs and Renovations Costs
These prices will vary based on the condition of the property and your ambitions for it. It’s worthwhile to devote the time and effort necessary to create a realistic budget, as this is one of the figures you’ll need to decide whether or not the investment will pay off.
Material, labor, permits, inspection fees, waste removal, storage charges, and dumpster rentals are all factors to consider. A thorough inspection (before closing) can reveal any major costs, such as a fractured foundation, bad wiring, or substantial termite damage.
After Repair Value (ARV)
After any repairs and upgrades, the ARV is an estimate of the property’s fair market value (FMV). This number is used by investors to analyze whether a property has profit potential. Comparables are the greatest approach to determine a property’s ARV (comps). These are properties that have recently sold in the vicinity (usually within a mile of the subject property) that have similar square footage, such as the number of bedrooms and bathrooms, as the subject property.
Carrying costs are the expenses you incur in order to keep the property. The longer you own a home, the higher your carrying expenses will be, which include:
- Payment on a mortgage (including interest)
- Insurance on real estate taxes
- Fees for condos and associations
- Utility services (electric, gas, water, sewer, trash)
The whole of your costs (buy price, repair and renovation expenditures, and carrying costs) must be less than the ARV for an investment to be profitable. It will be difficult or impossible to generate a profit if your costs are close to or higher than the ARV. By removing the purchase price, repair and remodeling expenditures, and carrying costs from the ARV, you may calculate the prospective profit:
Profit = ARV – Purchase Price – R&R Costs – Carrying Costs
Real estate investors often expect a 20% profit on a property, and some utilize market-specific rules to appraise properties. Purchase price plus repair and maintenance expenditures should not exceed:
- 80% of ARV in a market where home values are rising
- 70% to 75% of ARV in a flat market
- 60% to 65% of ARV in a market in which home values are decreasing
If an ARV is $200,000, your total investment should be around $160,000 in a rising market, $140,000 in a flat market, and $120,000 in a declining market. They help reduce risk in shifting market situations. In a rising market, you can risk more because you will get your ARV or better when you sell. In a down market, you are less likely to get your ARV, therefore spend less.
What Is a Short Sale?
A short sale occurs in real estate when an owner sells their home for less than its mortgage value. This usually occurs when the owner is in financial distress and has fallen behind on his or her mortgage payments. The owner is required to sell their home to a third party, with the proceeds going to the lender. Before the short sale can take place, the lender must approve it. Due to the volume of paperwork involved, the process of a short sale can often take up to a year.
What Is the Difference Between a Short Sale and a Foreclosure?
In a short sale, the homeowner initiates the process. The owner will demonstrate the extent of their financial distress to the lender by providing documents such as a recent loss of employment, divorce decree, or bank statements. After the lender agrees to proceed, it is the homeowner’s responsibility to find a buyer. The lender initiates the foreclosure process, essentially seizing the home after the owner fails to make payments. Because the lender wants to liquidate the assets as quickly as possible, the foreclosure process is generally faster than a short sale.
Is It a Good Idea to Buy a Short Sale Property?
Purchasing a short-sale property can be advantageous in many cases for prospective buyers. However, it is critical to be aware of some of the disadvantages. Short sales can take a long time to complete, with lenders sometimes taking months to approve the deal. After the seller’s approval, the bank may take several weeks to approve the price. If the bank believes that a foreclosure proceeding will be more profitable, it may reject the short sale and proceed with the foreclosure.
The Bottom Line on Short Sales
A short sale property might be a great way to save money on a home purchase. While the purchase price may be more than a foreclosure, the costs of making the home marketable may be lower, and the seller’s disadvantages may be less severe. Due of the lengthy procedure, buyers and sellers must be patient. An expert real estate agent can assist you negotiate with the bank.
While many investors buy short-sale houses to resell for a profit, others choose to keep the property and rent it out. In either instance, a property’s profit potential must be assessed before purchasing. Because tax rules are complex and continually changing, you should always consult a certified public accountant (CPA) who is knowledgeable about real estate investing and related tax regulations. It can make or break an investment.