During your house hunting journey, you may have encountered properties on the market labeled as “short sales” or, sometimes, pre-foreclosure sales. These houses are often priced below other similar properties, but your real estate may have warned you that dealing with a short sale comes with many headaches.
So, what is a short sale in real estate, and what can you expect when trying to purchase one of these properties? This guide will help you better understand a complex real estate transaction and weigh the pros and cons of buying one.
What is a short sale in real estate?
A short sale occurs when property owners find themselves incapable of paying their monthly payments and at risk of defaulting on their mortgage. To avoid foreclosure, the lender agrees to let the owner sell the property for less than the remaining balance due on their home loan. The proceeds of the sale go entirely to the lender. Depending on the situation, the mortgage issuer may decide to forgive the remaining debt or require that the mortgagee pays part or all the balance (also called a deficiency judgment.)
The lender could also lose a lot of money in the transaction, and short sales are always subject to their approval. The property owner must prove to the bank that a short sale is the only solution. For instance, if they lost part or all their income following the sickness or death of the primary breadwinner. The lender will also decide on approving the short sale or not depending on whether the property will likely reach an acceptable price on the market – if the house is worth less than what is owed due to deferred maintenance or a declining market, for example.
What is the difference between a short sale and a foreclosure?
Short sales and foreclosures are distressed sales that occur when the property owner cannot keep up with the mortgage payment obligations. However, they are two separate transactions. In a foreclosure, the mortgage lender seized the home after the mortgagee defaulted on their payments. It typically takes place sometime after the owner has abandoned the property. Property owners have more control over the short sale process. Although they are not part of the negotiation process, they are the ones to initiate the transaction and often occupy the property until closing.
Foreclosures come with lots of headaches for both lenders and homeowners and are often the last resort solution. It is a long, often costly, and legally involved process. The occupants may also voluntarily damage the property to diminish its value.
For property owners, a foreclosure is synonymous with a sharp drop in their credit score that prevents them from buying another house for up to seven years and could even make finding a rental difficult. Although short sales impact their financial history, the effect is lesser, and, depending on the circumstances, they could buy a property within two years. Therefore, it can be in everybody’s interest to avoid the process when possible.
What are the pros and cons of buying a short sale?
While buying a short sale has its advantages, it is a more complex transaction than typical real estate deals since the lender is involved. Some real estate agents are wary of being involved in these operations. Here is a list of pros and cons to help you decide whether buying a short sale is the right move for you.
Pros of buying a short sale
- Short sales are typically a good deal and priced lower than comparable properties since the seller is motivated. However, unlike foreclosures – when the lender is willing to liquidate a property sitting empty for some time – the mortgage issuer hopes to recoup as much of their investment as possible. Therefore, beware that your offer should be acceptable to the lender for the sale to go through.
- Short sales have a bad reputation, and some agents may discourage their buyers from getting involved in this type of transaction. Therefore, there may be less competition than for conventional properties or foreclosure. It reduces the chance of a bidding war, and you could end up with a great deal.
- Short-sale properties typically hide fewer nasty surprises than foreclosed homes. Since the foreclosure process is long, houses often sit empty for months (even years) before being listed for sale and may suffer from significant deferred maintenance and damages. Besides, it is not uncommon for property owners to trash the house before being evicted. However, homeowners typically occupy a short sale until closing, and it is in their interest for the house to reach top dollar. A property in good to average condition significantly raises your chances for your mortgage to be approved, especially if you are planning to use a government-backed mortgage such as FHA, USDA, or VA loans. Nevertheless, they are typically in financial distress and may not be in a position to keep the house up to date. Therefore, home inspections are a must.
Cons of buying a short sale
- There is a reason why short sales often raise red flags for real estate agents. Despite their names, short sales can take a long time to close since the lender must approve each step. It rarely takes less than 30 days for the deal to go through, and delays can be extended into months if the underwriters are backed up. Besides, there is always a chance that the bank stalls the process and may not approve the sale, in the end, wasting potential home buyers’ time. It is best not to get too attached until you hold the keys in your hand when it comes to short sales.
- Since the property owners are short on cash and the lender is trying to recoup as much of their investment as possible, short sales are typically sold “as is.” While there are often in fair to average condition, there may be deferred maintenance (peeling paint, mold, etc.) that could jeopardize your chances of getting approved for some types of mortgages.
- There is less room for negotiation than traditional transactions. The lender has the ultimate say in approving or not the offer. Although they are motivated to sell, they are already taking a loss in accepting a short sale. Before accepting the terms, most lenders will conduct a thorough market analysis, and it is unlikely that they will let the property go for a steep discount. Besides, there is rarely room for concessions and repairs.
- Finally, some real estate agents may refuse to deal with short sales based on the time involved and the likelihood of the sale falling through. If you want to purchase a short sale, it is best to choose a Realtor who is used to dealing with this type of transaction and can help you navigate the lender requirements.
After graduating with a Master’s degree in marketing from Sciences Po Paris and a career as a real estate appraiser, Alix Barnaud renewed her lifelong passion for writing. She is a content writer and copywriter specializing in real estate and finds endless fascination in the connection between real estate, economic trends, and social changes. In her free time, she enjoys hiking, yoga, and traveling.