The short sale process was a common occurrence in the 2006 real estate crash but can happen at any time in any real estate market, not just during an economic crisis. Superficially, it may sound like a reasonable exit if you're underwater on a property and need to sell. It's slightly better than a foreclosure and much better than bankruptcy, but there is more to it than what meets the eye. And while many investors have gotten great deals on investment property by buying a short-sale house, it is not a given by any means. A short sale can be bad for both buyers and sellers depending on the situation and should be approached with a full understanding of the potential issues that can arise.
What is a short sale?
Millionacres has plenty of in-depth articles on what a short sale is, but in summary: It is when a piece of real estate is worth less than what is owed to the lender and thus sold at an agreed- upon discounted portion of the remaining loan balance. In the event of a short sale, the homeowner finds a willing buyer who negotiates with the mortgage lender to take a lesser amount than what is owed for the loan. This allows the homeowner to sell the house and the lien holder to at least recuperate some of the money without having to go through a lengthy foreclosure process, which is a completely separate process and different from a short sale.
Why is a short sale bad for the buyer?
A short sale is bad for the buyer because the short sale property is sold as-is, with little if any room for negotiation. If the home is severely underwater, the discounted price the lender may be willing to accept may still be above the current market value. Unlike a traditional sale, where there may be room for negotiating certain repairs, with a short sale any improvements will need to be made by the buyer.
Purchasing a short-sale home can also take significantly longer than buying a traditional piece of real estate. If this is an investment property, it may not seem like a big deal, but being tied up in the process for months on end just to hear back from the seller’s lender that the short sale offer was refused can not only be frustrating but a waste of valuable time spent looking for other properties.
Why is a short sale bad for the seller?
The waiting period for a short-sale approval isn't just bad for the seller, it can also be a negative for the property owner. A short sale is based on the premise that the mortgage holder is current on their mortgage but is experiencing financial hardship making it difficult to maintain the mortgage payment. If the seller is unable to maintain payments during the process or is unable to come to an agreed-upon arrangement with the mortgage company, then it could transition into a foreclosure proceeding after all the work was put into the short sale process.
As a seller, you'll likely have to hire a real estate agent just like a normal retail sale. This can further increase the minimum list price of the home because the realtor fees and other closing costs are tacked on top of what the mortgage lender is accepting. There are a lot of moving parts of a short sale that the seller must work and live through, including getting lender approval after hiring the real estate agent, going through the listing and showing process, finding a willing buyer, and staying current on monthly payments during that time, which can be frustrating and tiring.
Oftentimes one the biggest issues with a short-sale transaction for a seller is the impact on their credit score. When a seller is in this position, there may not be much they can do aside from requesting a loan modification. But it is important to realize that a short sale will still impact them in a negative way even though they're coming to a mutual agreement with the mortgage lender. This will have a lasting impact, potentially preventing the purchase of another home and mortgage for a significant amount of time. The seller will also be a less desirable tenant to landlords because of the lower credit score, unless a personal story pulls weight with them.
A short sale is not always bad; however, there are certainly major sticking points. Buyers and sellers alike should consider these issues prior to starting the process of buying or selling a home as a short sale. The seller will have to complete a short-sale package to prove financial hardship. If the lender does approve it, then iIdeally the seller may be able to get them to agree to a set payoff of the mortgage balance prior to listing. This can help with avoiding many of the headaches mentioned above. Regardless, it is best to have a real estate agent for both the buyer and the seller because they'll have the negotiation experience and insight to make this process go as smoothly as possible.