A short sale results when a seller doesn't receive enough cash from a buyer to pay off their mortgages. The seller could have paid or borrowed too much for the property. The housing market may have dropped, so its fair market value is less than the current mortgage balance. This might sound like a good deal for the buyer, but these homes usually sell "as is" and can take longer than normal to close.
A short sale can only happen if the lender agrees to accept less than is owed on the existing mortgage. Here are are some of the pitfalls for buyers looking into short sale homes.
Short Sales Don't Mean a Discount
Banks are eager to lend money in a rising market. They might give out a loan that is too much for the buyers to handle. When the market finally drops, the owner is left with little equity and a mortgage that a sale will not pay off. Buyers end up owing more on the home than it is worth.
You're not automatically picking up $100,000 in equity if you purchase a short sale home for $400,000 that sold for $500,000 a few years ago. The seller paid too much during a housing market uptick.
Although it's against the law, some appraisers are pressured by banks to appraise a home at the amount a buyer wants to borrow.
Agents Might Be Pushing the Sale
New or unethical real estate agents might push a seller into a short sale when the seller doesn't qualify for one. Sellers must submit evidence of financial hardship to their lender before a short sale can be approved.
Some agents will list homes as short sales without ever talking to the lenders or pre-qualifying the sellers. That causes you and your agent to waste time, and possibly money, when looking into a home.
Homes Sell As Is, 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 get more money back by taking the home into foreclosure instead.
Lenders typically only accept short sales when the home is worth the short sale price, which means market value.
The mortgage company will most likely pay the transaction's closing costs when it agrees to a short sale. Lenders expect you to purchase the home in its present state. Most of the time, they'll refuse to improve it or pay for any issues found in a home inspection, such as:
- 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 a few weeks to a few months for a lender to respond to a short sale purchase offer. It depends on when the seller filed the notice of default, the lender's backlog of foreclosures, and how much paperwork the seller has already sent in.
Sometimes sellers have more than one mortgage on their home. In such cases, it can take even longer to satisfy both lenders.
Some lenders reserve the right to change 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 are passed, or if new data crosses their desk.
Lenders generally have lawyers on staff or contracted. Ordinary buyers do not, which can make it tough to deal with their demands.
Lender Commissions and Higher Closing Costs
Lenders who have sold loans to Fannie Mae or Freddie Mac tend to pay commissions to the agents, but others might demand a discount. Real estate agents can end up doing two to three times the work on a short sale, something they don't enjoy doing.
If you've agreed to pay your agent a certain percentage under a buyer's broker agreement, and your agent refuses to waive it, you could be liable for the difference between what the lender will pay and the amount your contract states.
Lenders will rarely pay for "extras" in short sales like a seller would be willing to do. You'll have to pay for them yourself if you want any extra services or provisions at closing. Lenders will often refuse to pay for standard seller closing costs, such as transfer taxes. You'll likely have to pay for them out-of-pocket.
There's No Control, and Sellers Aren't Motivated
Don't count on closing escrow by a specific date. A short-sale closing process can take a long time. The seller's lender calls the shots, not you or your lender. If you're trying to close escrow at the same time you sell your current home, it might not work out. Make sure you have a backup plan.
There's little incentive for a seller to cooperate with a short sale once they discover the negative effect it has on their credit. Although a seller might be able to buy another home within two years after a short sale, some have no intention of buying another home ever again.
The Bottom Line
A slim margin of short sales might be profitable for buyers, but it's usually better to purchase a home that's not in default. 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 were to go through foreclosure instead.