Is buying a home in a short sale right for you?

When buying a home, you may run across properties that are listed as “short sales." Buying short sales can be a complicated process.  Before you consider making an offer on a short sale property, it is probably a good idea to have a basic understanding of how a short sale works as well as the advantages and disadvantages of buying short sales.

What is a Short Sale?

A short sale occurs when the lender allows the borrower to sell the property for less than what is actually owed on the loan and agrees to forgive any balance owed by the borrower.  Most buyers obtain financing to purchase a home through a lender in the form of a mortgage loan. Until the loan is paid in full, the lender retains a legal interest in the property which is used as security for the loan. Traditionally, when a borrower defaults on his/her loan payments; the lender would then foreclose on the loan, take possession of the property, and sell the property to recover his (i.e. lender's) financial investment. Under normal market conditions, this allows the lender to recoup its investment since the value of an average home appreciates at about three percent per year. However, it is not uncommon to find that real estate markets in many areas have “bottomed out,” meaning that home values have plummeted to reach its lowest point. This, in turn, means that many homes that were used as security for a mortgage are now worth less than the balance that is owed on the loan. In these situations, a lender may incur significant legal expenses and waste a considerable amount of time foreclosing on a property that cannot be sold for what is owed on the loan. This is where the concept of a “short sale” comes into the picture.

An example may help explain how buying short sales works. Imagine that borrower Sue purchased a home six years ago for $300,000 by obtaining a mortgage through lender XYZ. Sue’s current mortgage balance is $250,000. However, Sue defaults on her mortgage payments and is facing foreclosure. The real estate market where Sue lives has bottomed out over the last six years, and her home is now worth only $210,000. Lender XYZ knows that they will not recoup the $250,000 owed on the mortgage even if they foreclose. Moreover, they will incur legal fees of over $20,000 and spend close to a year in the foreclosure process. Lender XYZ, therefore, agrees to consider a short sale. This, in turn, allows Sue to sell the home for its true market value of around $210,000. In addition, once the short sale is complete Sue’s debt to lender XYZ will be considered paid in full.

Advantages and Disadvantages of buying a Short Sale

Buying a home through a short sale can potentially allow a buyer to purchase a home at a great price; however, buying short sales can be a lengthy and complicated process. Because you are not just dealing with the seller, but with the lender who is directly involved in the process as well, a short sale typically takes much longer than a traditional sale - often taking three to four months or longer to complete. Ultimately, the lender must agree to all the terms of the sale in order for the sale to go through. For a buyer who has the time and patience to see a short sale through to the end, the benefit is that he will probably get more house for his money than a traditional sale can offer.  Another benefit of buying a home that is in a short sale is that they tend to be in far better condition than other distressed properties that are in different stages of the foreclosure process such as REO/bank owned properties. This is because most homes in a short sale are still occupied by the owner during the process - unlike REOs, which are usually left vacant and unattended for months. What's more, previous owners of short sale properties tend to  have made an effort to sell the home before they even went into default knowing that they were at risk of foreclosure.

Properties listed as short sales can be located through your local real estate agent. The complexity of a short sale negotiation makes the assistance of an experienced real estate agent helpful.