"Breaking Down a Short Sale"
What Is a Short Sale?
A short sale is a home that is available at a purchase price that is less than the amount owed by its current owner.
The transaction benefits the bank by allowing it to avoid repossessing the home in foreclosure, which is expensive and time-consuming. The seller avoids the credit hit that comes with foreclosure and the bankruptcy that sometimes accompanies it.
How a Short Sale Works
A short sale is a financial option that is sometimes available to homeowners who are distressed borrowers. They are behind on their mortgage payments and have a home that is underwater. That is, the home is worth less than the outstanding balance on the mortgage.
Barring an unexpected cash windfall, the owner is forced to part with the home. There are really only two options: A short sale or foreclosure.
Short sales are usually initiated by the homeowner when the value of a home drops by 20% or more. Before the process can begin, the lender who holds the mortgage must sign off on the decision. Additionally, the lender, typically a bank, needs documentation that explains why a short sale makes sense. After all, the lending institution could lose money in the process.
If approved for short sale, the buyer negotiates with the homeowner first and then seeks approval on the purchase from the bank second. It is important to note that no short sale may occur without lender approval.
Short sales tend to be lengthy and paperwork-intensive transactions, taking up to a full year to process. However, they are not as detrimental to a homeowner's credit rating as a foreclosure is. A short sale looks better to future lenders and creditors. It shows that the person took action before the bank moved to repossess the home. A homeowner who has gone through a short sale may even be eligible to purchase another home immediately.
How a Foreclosure Differs
In a foreclosure, the lender seizes the home after the borrower fails to make a certain number of payments. Unlike most short sales, foreclosures may take place after the homeowner has abandoned the home. If the occupants have not yet left, they are evicted by the lender in the foreclosure process.
Foreclosures do not normally take as long to complete as a short sale because the lender is concerned with liquidating the asset quickly. Foreclosed homes may also be auctioned off at a "trustee sale," where buyers bid on homes in a public process.
Homeowners who undergo foreclosure experience an immediate drop and precipitous drop in their credit ratings. In most circumstances, they must wait a minimum of five years to purchase another home or three years with an FHA loan. The foreclosure appears on a credit report for seven years.
Steps to a Short Sale
The short sale process varies from state to state, but the steps generally include:
Short sale package - A financial package is submitted to the lender by the seller. It includes financial statements, a letter describing the seller's hardship, and copies of financial records.
Short sale offer - If the seller accepts an offer from an interested buyer, the listing agent sends the lender the listing agreement, an executed purchase offer, the buyer's pre-approval letter, and a copy of the earnest money check.
Bank processing - The bank reviews the offer and either approves or denies the short sale. This can take several weeks to months.
The Short Sale Contract
In some ways, buying a short-sale property is just like any home purchase. However, in this case, the contract will specify that the terms are subject to the mortgage lender's approval.
The contract should also state that the property is being purchased "as-is." While the buyer may include language that allows the deal to be canceled if an inspection reveals considerable problems, it is unlikely a lower price can be negotiated. The bank is also unlikely to make any repairs, and the seller, being strapped for cash, is even less likely to help out.
Unlike a foreclosure, the lending institution does not own the property in a short sale. However, because it must approve the sale and will receive the proceeds, the buyer will be dealing mostly with the bank rather than the homeowner.
For underwater homeowners, a short sale can be a way to avoid repossession, eviction, and black marks on their credit ratings.
For a potential buyer, completing a short sale requires flexibility and a great deal of patience.
A buyer must make sure the deal is worth the effort.