A “short sale” is real estate lingo for a house that’s being put up for sale for less than the homeowner owes on the mortgage, Usually, the homeowner is in financial distress and is trying to avoid foreclosure; sometimes, the seller has already defaulted on the loan.
Who initiates a short sale can vary. When the mortgage crisis of 2007 to 2009 occurred, lenders were unprepared for the volume of defaults, and it was largely left to the sellers to propose short sales to them as an alternative to foreclosure. (This was a frustrating process, as lenders took their time about answering, and sometimes continued pursuing foreclosure regardless.)
As the many foreclosures worked there way through the system, however, it became more common for lenders to reach out to sellers who get behind on their home payments. The lenders would offer them relocation money and a path toward preapproval for a short sale. The lender will also, as part of this process, order a BPO (best-price offer) analysis, showing what amount the house could sell for.
The seller’s lender will still need to approve the actual short sale after an offer has been submitted, which adds a potential hurdle—not to mention time delay—to the process. Unless a buyer offers the preapproved BPO amount, the lender may still need to run some numbers, trying to balance the amount that would be lost on the loan against the probable loss (of time and money) if the property continued on into foreclosure.
A short sale may have an incredibly attractive low price, but that doesn’t necessarily make it a good deal for the buyer. The seller may have overpaid to begin with, or the market may have fallen significantly. And as explained below, the buyer you may end up responsible for significant additional costs that weren’t accounted for in the selling price.
If you’re interested in purchasing a short sale property, choose a real estate agent who’s dealt with them before, and who is able to collect as much information as possible from the seller or the seller’s agent before you make an offer. Here’s what you want to find out.
How much the homeowner owes on the property. If it’s a lot more than you’re willing to pay, the lender is unlikely to approve the sale. Lenders reportedly favor offers of at least 85% of the property’s appraised market value, but in very badly distressed real estate markets, have been known to accept as little as 50% of this amount.
Whether the homeowner took out more than one loan on the property. If so, you’ll need the approval of all affected lenders in order to close the sale. The more lenders are involved, the harder that will be to get, because they must each agree to taking a smaller portion of the house sale proceeds.
What kind of legwork has already been done. Banks will approve a short sale only if the seller is in financial distress or has actually defaulted on the loan. Make sure the seller has at least contacted the bank and gotten confirmation that the bank will consider a short sale. Unless you’re not in any particularly hurry to buy a place, you don’t want to waste your time waiting for a bank to respond to an offer if you’re fairly certain it will just be rejected anyway.
If you still want to buy a short sale after doing some basic homework, expect several differences from regular sales.
Short sale sellers will often approach the lender with the first offer received, even if it’s on the extremely low side. Why? Because once they’ve started the long process of gaining bank approval, they don’t want to derail it by bringing in an alternate offer.
The lender, who is ultimately approving payment of the real estate agent commissions, may negotiate them down with the seller’s agent, and the buyer's agent will get paid less as a result. If you, the homebuyer, have already agreed to pay your agent more in a buyer’s brokerage agreement, you’ll have to do so out of your own pocket.
Short-sale properties are typically offered in their present condition, with no reductions for repair needs. And repair needs are likely, given that the owner probably couldn't afford much maintenance. To make sure you know what state the property is in, be certain to include an inspection contingency in the contract, allowing you to have the property professionally inspected and to back out of the deal if you’re not satisfied with the results. See Contingencies to Include in Your House Purchase Contract and Getting a Home Inspection for details.
In a normal sale, closing costs are usually split between the seller and the buyer, but the bank will likely refuse to pay any of them in a short sale.
You may spend months waiting for your offer to be approved or rejected by the bank. Make sure your offer terminates at some realistic point in the future.
When the lender finally approves your offer and sends the seller the paperwork to finalize the deal, it’s not uncommon for the seller to discover that the lender has inserted language saying that even after releasing the mortgage, the lender can come after the seller for the difference in what is owed—which, for the seller, defeats the purpose of the short sale, and may make the deal fall through.
In addition to working with a real estate agent with expertise in short sales, it’s a good idea to seek advice from a real estate attorney who’s experienced in handling legal issues involved with short sales. See Real Estate Attorneys and Home Purchases.
Short sales definitely involve extra work and hassle. Unless you’re going to get a property at a deep discount—even after adding up the costs of your real estate agent’s commission, repairs, and closing costs—and you have enough time to wait around for the bank to respond to your offer, you’re probably better off buying a house that isn’t conditioned on an unusual form of bank approval.
And to learn about other creative alternatives for buying an affordable home, such as looking for foreclosure properties and FSBOs, see Nolo’s Essential Guide to Buying Your First Home, by Ilona Bray, Alayna Schroeder, and Marcia Stewart.