What Everybody Ought To Know Before Buying A Short-Sale
Short-sales 101 - The Basics
First, Let’s Define A Short-Sale
Although short-sales have been around for a while, they recently become more mainstream because of the current economic downturn. After all, every media outlet needs something to hype and short-sales and foreclosures are great media fodder. So, what is a short-sale?
Simply put, a short-sale occurs when a homeowner sells their home short of what they owe on their loan. Homeowners must meet specific qualifications before their home will be considered for a short-sale:
1. The homeowner must currently be in default and behind on their payments for several months (although, there are more and more cases where this is not being required by the bank)
2. The homeowner must owe more on the home than what it is currently worth
3. The homeowner must have a legitimate hardship case, as defined by the bank
Sadly, this is painful time for the homeowner. They desperately need to get out from under the house payments, save their credit record from reflecting a foreclosure, and maintain a little dignity in the process.
A Few Short-Sales Rules
Rule #1 - Forget the infomercial, real estate seminar, forum-blogging hype. Very few people are buying homes for “pennies on the dollar” through short sales. If that’s what you are being told, someone is trying to sell you their version of a “get rich quick” scheme. The fact is, short-sales are difficult and there are often HUGE hurdles to overcome along the way. For many starry-eyed buyers, short-sales are really not worth the headache. If you start the process thinking this is going to be fun, think again. Seriously, think again.
Rule: Short-sales can be a very difficult transaction that often leaves buyers frustrated and disappointed.
Rule #2 - All the planets have to be aligned to make a short-sale work. Ok, maybe the cosmos are not involved but it can feel like it. The rules are changing every day, literally. Worst case, Washington bureaucracy can change the game in the middle of your deal. More common, the banks are over-worked and lack the systems to deal with short-sales in such high volume. Rule: our understanding of the process is subject to change at any given moment.
Rule #3 - Purchasing a short-sale requires a lot of time and patience. Understand, however, time is not on your side. If a homeowner is behind on their payments there is a limited number of days before the home is foreclosed on. Sometimes the banks will work with you, sometimes they wont. In many cases the foreclosure department doesn’t communicate with the loss mitigation department (and vice-versa) and they foreclose on the property right in the middle of the whole deal. Rule: Be prepared to lose a few deals because of the bank.
What Are You Really Up Against?
Ideally, the listing broker should obtain short-sale approval from the bank before the home is listed for sale. Since the homeowner is behind on payments, homes are often listed as “short-sales” without bank approval because of Rule #3. This is proverbial cart before the horse stuff. Even though an offer gets accepted by the homeowner, it frequently gets rejected by the bank. Once a bank approves the home for short-sale, the homeowner and listing agent have NO SAY in accepting a lower offer.
Perhaps the most difficult part of the process is working with the bank. Their office hours are Monday through Friday in their local time zone. Since they are currently inundated with short-sale and foreclosure proceedings, it is not uncommon for a short-sale deal to go on for 6-12 months! During that time, several things can occur:
1. The home has probably attracted numerous offers creating a competing offer scenario and the bank is free to choose whichever offer suits them best.
2. Every deal requires 2 -3 levels of management approval and signatures. Bureaucracy and red-tape at its finest.
3. The contact we had at the bank quit their low-paying, high-stress, thankless job and we will have to start the entire process over from square one.
Another common roadblock working with banks involves the existence of a second mortgage. Frankly, this can be a nightmare.
Scenario: A home was purchased for $250,000 with a 100% financing split between a first and second mortgage. Current market value for the home is only $225,000. A qualified buyer offers to purchase the home for $200,000. The home is secured by a $200,000 first mortgage and a $50,000 second (an 80/20 loan).
This is a VERY COMMON scenario. Many people don’t understand that approval is needed by BOTH leinholders. The first bank is perfectly happy with a $200,000 settlement because it completely satisfies their loan. However, the second bank can easily reject the entire deal because they are the only ones losing out. (By the way, most second mortgages are owned by investors who did NOT get a bailout. How happy do you think they are to cancel this note?) It really gets complicated when the second mortgage is part of a foreign real estate investment trust located in China!
It’s not just the banks either. There are often additional encumbrances attached to the property that must be satisfied: judgments/liens, clouds on the Title that must be cleared, and disconnected utilities that must be reconnected at the purchasers expense to name a few (without working utilities home inspectors can’t inspect the property).
Are Short-Sales Really A Gold Mine?
Maybe, maybe not. As mentioned above, many short-sales these days are attracting multiple offers. Everybody and their dog is looking for a bargain. Competing offers can drive the price up to market value rather quickly. When the market grows, it is possible to have some appreciated equity. It all depends on your specific goals.
Don’t forget about repair costs. HGTV and other real estate shows paint a romantic picture. “Johnny and Janie bought this piece of crap for only $200,000. After a 20 minute makeover, they are living happily-ever-after in their warm and fuzzy, uber-hip bungalow”. What they didn’t tell you is that it cost Johnny and Janie $60,000 in repair costs. Where did they get that extra $60k? Not many people have it laying around, so presumably they had to take out some kind of home equity loan or rack up their credit cards. Now, they’re into the house for $260,000. Maybe it was a good deal, maybe not. They probably could have saved themselves a lot of time and trouble if they would have started out looking for a $260,000 home.
Short-sales may be best suited for extremely patient buyers who are not in any hurry and, perhaps, “buy and hold” investors. (They make less sense for investors looking to fix and flip a property for quick profit, especially with the new 90 day HUD rules). Rarely will you find a short-sale discounted more than 20% below its appraised value (an appraisal or BPO, another HUGE problem, is ordered on every short-sale property and that value is used to determine a bottom line sales price for the banks). In reality many banks will only discount the homes between 5% - 10% off the appraisal. Again, if you have to update or fix up the home you’re probably better off buying a non-distressed property.
Conclusion
Purchasing a short-sale home requires SERIOUS patience and serious knowledge of the process. Be prepared to lose out on many deals and be prepared to do some work on the home after move-in. Short-sales can be a good purchase for a select group of buyers who are not pressured by time, who are happy with a 5%-20% discount, and who don’t have to put a lot of money into fix-up and repairs.
So, are you still interested in buying a short-sale property? If so, then start your search below and let’s go look at short-sale homes! I know what to expect, as long as you do too then it’s time to get started searching for that home. It could be a long road ahead of us.
Regards,
