Why Buyers Should Be Wary of Short Sales
A short sale results when sellers don't receive enough cash from buyers to pay off their mortgages. Maybe the seller paid too much or borrowed too much for the property to begin with, or the market has dropped so the property's fair market value is less than the existing mortgage balance. This might sound like a good deal for the buyer, but these homes usually sell "as is" and can take longer than usual to close.
A short sale can only happen if the lender agrees to accept less than what's owed on the existing mortgage, and there are plenty of inherent pitfalls involved for buyers.
Short Sales Don't Mean a Discount
A buyer isn't automatically picking up $100,000 in equity if a home was purchased for $500,000 a few years ago and now it's approved for a short sale at $400,000. This just means that the seller paid too much, most likely in a rising market, and now the market has fallen. The seller, therefore, has no equity and the mortgage is underwater.
Banks that were eager to lend money in appreciating markets sometimes allowed borrowers to over-mortgage their homes. The borrower's loan balance exceeded the value of the property. Appraisals are subjective, and not all appraisers place the same value on a home.
Although it's against the law, some appraisers are pressured by banks to appraise at the amount the homeowner wants to borrow.
Inexperienced or unethical real estate agents might push a seller into considering a short sale when the seller doesn't actually qualify for one. Sellers must prove a hardship and submit evidence of that hardship to the lender before a short sale can be approval, but some agents will list homes as short sales without ever talking to the lenders or pre-qualifying the sellers.
Buyers can face numerous other obstacles as well.
Homes Sell at Market Value
Lenders aren't naive or unaware of the value of a home. They'll insist on a comparative market analysis (CMA) or a broker price opinion (BPO) before agreeing to a short sale. A lender might hold out for a higher price if it believes it will recover more money by taking the property in foreclosure instead.
Lenders typically only accept short sales when the home is worth the short-sale price, which means market value.
Homes Sell "As Is"
The mortgage company is most likely paying the closing costs of the transaction when it agrees to a short sale. Lenders, therefore, expect buyers to purchase the home in its present condition, and they'll typically refuse to improve its condition by paying for suggested repairs that might be disclosed in a home inspection.
This can include important work like:
- Clearing a pest report
- Roof repairs
- Other deferred maintenance
- Home protection for the buyer.
It Can Take Longer to Close
It can take anywhere from two weeks to two months to get a response from a lender on a short sale purchase offer. It depends on when the Notice of Default was filed, the lender's backlog of foreclosures, and how much paperwork the seller has already submitted.
It can take even longer to satisfy the demands of the second lender if two lenders are involved because two loans are secured by the property.
Lenders Can Change Conditions
Some lenders reserve the right to renegotiate the terms of a short sale at the last minute. The lender might attempt to change the terms of the contract if the market changes, if new laws pass, or if new information crosses the lender's desk.
Lenders generally have lawyers at their disposal, and ordinary buyers do not.
Lenders Might Demand a Commission Discount
Lenders who have sold loans to Fannie Mae or Freddie Mac generally pay traditional real estate commissions to the agents, but others might demand a discount. Real Estate agents can end up doing two to three times the work of a conventional transaction and they don't appreciate being paid less to do more.
You could be liable for the difference between what the lender will pay and what your contract stipulates if you've agreed to pay your agent a certain percentage under a buyer's broker agreement and your agent refuses to waive the difference.
Higher Buyer Closing Costs
Lenders will rarely pay for "extras" in short-sale transactions like a seller would be willing to do. You'll have to pay for them yourself if you want any additional services or provisions at closing.
Sometimes lenders will even refuse to pay for standard seller closing costs, such as transfer taxes. And you'll probably have pay for them out-of-pocket if you want any specific inspections.
You'll Lose Control of the Transaction
Don't count on closing escrow by a specific date. A short-sale closing process takes an indefinite amount of time. The seller's lender calls the shots, not the buyer nor the buyer's lender. If you're trying to close escrow concurrently with the sale of your home, know that it might not happen and make sure you have a backup plan.
There's Little Seller Motivation
There's little incentive for a seller to cooperate with a short sale once they discover that the negative effect of a short sale on their credit is much the same as that of a foreclosure. Although sellers might qualify to buy another home in two years after a short sale versus seven years with restrictions on a foreclosure, some have no intention of ever buying another home again.
The Bottom Line
A slim margin of short sales might be profitable for a buyer, but it's usually better to purchase a home that's not in default, as most short sales are. And any real estate professional who's been burned by a short sale that fell apart in the past will probably steer their new buyers elsewhere.
Realize, too, that listing agents might push sellers to list as a short sale because they wouldn't get the listing if the sellers went through foreclosure instead.