If you are involved in real estate investing, you may have wondered “how does a short sale work?” The truth is, the short sale process is no big mystery. Like with many distressed properties, buying a short sale is a bit more complicated than a standard sale. A bank, or more than one bank, is involved. The prior owners are involved. There are likely some back taxes and back HOA or condo fees to be settled. However, there is a process. Here, we will answer the question, “how does a short sale work” for the investor.
Related: 5 Things to Know Before Buying a Short Sale Home
How Does a Short Sale Situation Start?
The answer to how does a short sale work for the buyer begins with examining how short sale properties come to exist. Short sale homes are properties in which the seller has made a financial arrangement with the bank to sell the property for less than the outstanding loans on that property. Imagine a scenario where a homeowner placed a minimum down payment on a home. Following that, the real estate market rose a bit, and the owner then took out a loan against the property. For example, a home equity loan or cash-out refinancing. Then, the market either corrected or it declined a bit.
Here is where the short sale process for the seller starts. At this point, the owner of the future short sale property is residing in a home in which he or she has negative equity. In other words, the owner owes more to financers (banks) than the value of the property. One term often used for this situation is the homeowner is “underwater.”
Next, imagine that same homeowner has the unfortunate experience of having other financial trouble. An income stream goes away due to a lost job. Or the owner has unexpected bills they cannot pay and still pay their mortgage or mortgages. Suddenly, the homeowner is faced with having to sell a home worth less than they owe.
How Does a Short Sale Work – Seller and Banks
If the owner imagined above is not so far into debt that they must abandon the property in bankruptcy, they may be fortunate enough to work out an arrangement with the bank or banks who hold the mortgages on the now distressed property. The short sale seller and the banks agree that the owner will list the property for sale and that the proceeds will go towards paying off the balance of the loans. How does a short sale work for the seller? One way is that they are able to eliminate the outstanding debt on a property they have zero equity in. Another is they may avoid bankruptcy.
It may seem logical to ask, how does a short sale work for the banks? This question is easy to answer. The banks look at the housing market and understand that unless they can sell the properties in the near term, they may not recoup their outstanding loans. The owner will declare bankruptcy, the real estate market will continue to decline, and the banks’ balance sheet will only look worse over time. Since the banks now become the owners of an empty property, they also assume tax and fee debt that only grows as the property goes unpaid for. In an attempt to cut their growing losses, the banks agree to a short sale program.
How Long Does a Short Sale Take?
Simply put, the short sale home buying process is not quick. Buying a short sale home takes patience. Unlike a conventional sale with two parties plus two agents involved, a real estate short sale may have up to six or seven parties involved. The buyer first negotiates with the owner of the property and makes an offer. If the seller agrees, the sale then has to be approved by all of the lenders involved. This can take multiple weeks to months. A short sale in real estate is not a fast transaction.
Related: 7 Tips for Making an Offer on a Short Sale
Financing a short sale is also trickier than with a conventional investment property. Although the financing process is similar to buying any property, a short sale in real estate raises red flags with lenders. They will want to scrutinize the appraisal and the home inspection. Short sales have gained a reputation (perhaps unfairly) for being run down money pits. The departing owners have little to lose by deferring maintenance and needed repairs. The final challenge is closing before a loan approval expires.
Related: How to Find Short Sales: 4 Best Ways
Short Sale Details
How does a short sale work transaction wise? One word can answer this- details. The short sale process for buyers is much more detail-oriented than a traditional sale. It is almost a certainty that the sellers have stopped paying other bills if they cannot manage to pay a mortgage, the single most important bill to one’s credit rating. Expect the property taxes, water bill, condo, and HOA fees, and all other types of utilities to have outstanding balances. In addition, there may be contractor liens on the property. Mashvisor strongly recommends using a closing attorney to ensure that all of these details are sorted prior to the closing date. Be involved. Ask to see the receipts. Call the town’s tax collector yourself and verify that there are no tax liens or contractor liens filed.
One Plus and One Minus to Buying a Short Sale
One plus to a short sale real estate transaction is that the seller never has any contingencies. Due to the nature of the sale, they must move out upon the closing date set by the process. In many cases, they have moved on already. This is also the biggest minus. Because the sellers feel as if they have no stake in the sale, and indeed they do not, they may leave the property in rough shape. Be prepared for major renovations.
A Short Sale Has Other Benefits Too
Although we have focused on the question of how does a short sale work for the buyer, there is another aspect to consider. That is, “how does a short sale work for the community?” A short sale benefits the community in multiple ways. The seller moves on to repair their credit and rebuild their financial health. If the investment property is in a condo community, the unpaid fees are returned to the community accounts at closing. The property taxes are paid to the town. Perhaps most importantly, a property that is very likely run down and abandoned is returned to proper standards. This lifts the community up and restores the value of abutters’ property.
Mashvisor has many tools that a short sale buyer can take advantage of. To get started, check out the Mashvisor Property Marketplace where you can find and analyze short sale homes.