Thanks to the housing crisis of the last decade, most consumers are familiar with real estate terms like “foreclosure” and “sub-prime,” even if they don’t fully understand them. But one term that might not be as familiar is “short sale.” Yet short sales provide a good opportunity for novice real estate investors to buy real estate below current market value.
Short Sale Math
A short sale, by definition, means that a lender has agreed to accept less than what’s owed on the mortgage as a debt paid in full. Short sales have been around for decades, but their existence was relatively unknown to the general public until lenders and agents alike began promoting the option. Here’s a typical short sale situation:
A homeowner buys a home five years ago for $500,000 and puts 10 percent down, borrowing $450,000. Over the next few years, not only does the home value fall, it falls to $300,000 based upon the relative selling price of nearby homes. But when property owners sell, they have to satisfy all existing liens on the property. In this example, the loan balance using a 30-year fixed-rate loan at 5 percent would pay down the mortgage to just over $413,000 after five years.
If the homeowner wanted to sell, the mortgage lender would say, “Fine, but you still owe us $413,000.” If the property value is $300,000, the seller needs to bring in $113,000 more just to cover the existing mortgage.
This scenario played out across the country during the housing crisis and still does to this day. Thousands of homeowners everywhere are “upside down” on their mortgages. That’s where a short sale comes into play and why real estate investors should be aware of them.
With a short sale, you’re negotiating more with the lender and less so with the owner. Why? Because the lender has the final say in whether they will accept less than what’s owed.
When a lender considers a short sale request, there are two possible outcomes: The home goes into foreclosure and the bank has another house in its inventory, or it accepts less than what is owed at a price closer to the current market value.
Advantages of Buying a Short Sale
So, what are the advantages to buying a short sale?
A better price. The primary advantage is a better price. Short sales are often priced below market, so a buyer can get a property for less than it would be worth if it were a traditional sale. The lender may be more anxious to negotiate a lower sales price in lieu of moving forward with a costly foreclosure.
A chance to inspect the property. With a short sale, you also have the opportunity to inspect the property before finalizing the sale. In contrast, you may have some degree of difficulty inspecting a home that’s already been repossessed — a full inspection may not even be an option. But when the home isn’t yet foreclosed upon, the owner may be more accommodating and allow you to hire an inspector to get a solid understanding of the property’s current condition. With that in mind, the property owner is required to provide you with a list of any known issues with the property, such as recent flooding or appliances that need repair.
Less competition. Considering a short sale purchase can also mean less competition. Investors who only concentrate on foreclosures — rather than pre-foreclosures — miss the short sale opportunity.
Financing is often available. Foreclosure or bank-owned sales typically require that you pay cash. With bank-owned sales, this is especially true if the property is in bad condition. In contrast, lenders are more likely to finance a short sale. Because the property owner still has a financial interest in the property — and is probably still living in it — short sales are by nature less “distressed.” A majority of the short sales offered are financeable.
The Short Sale Timeline
Short sales do have some challenges. One major consideration is the time it takes for a bank to approve a short sale request package. Some short sale approvals can take up to 60 days or more, although banks today seem to be reducing that time frame as more and more short sales are approved. Remember, you’re negotiating with the lender, and the real estate agent listing the home may not have very much experience with the short sale process, much less the owner.
Patience is important here. If the lender rejects your offer, you may receive a counteroffer that you can accept, counter and resubmit — and so on.
Finding a Short Sale
There are several ways to find a short sale. First, you can pay attention to “For Sale” signs that have a “Short Sale” rider attached with the contact information for the listing broker. The sign means the bank is open to a short sale request.
Another way is enlist the services of an experienced real estate agent like me. I know the market and will give you advice on whether a property is overpriced or underpriced. Do some of your own research on real estate websites, but keep in mind that their valuations of a property may not be entirely accurate.
You can also visit the local county recorder’s office and investigate “pre-foreclosure” notices or a Notice of Default. These are the first legal steps that lenders will take before filing for foreclosure. These notices show the property owner, contact information and the lender, along with other characteristics of the home. At this stage, the lender may be open to a short sale request but the owner must make the request, not you.
Understandably, these options can entail a lot of legwork on your part.
If you have your financing options ready to go and can find a short sale in this manner, not only will it streamline the process, but you’ll also have the opportunity to get a great deal at the same time.