When you’re browsing the listings, you might encounter the terms pre-foreclosure or short sale. What’s the scoop on these homes?
It all starts when homeowners with mortgages find themselves under water — property values drop, and a homeowner owes more on the loan than the house is worth. Further, the owner has fallen on difficult financial circumstances and is unable to find assets or sources of income to keep covering the regular monthly payments. Hoping to avoid foreclosure and keep some control over the transfer of the property, the homeowner asks the lender to approve a short sale of the home — meaning the lender will agree to receive less money than the outstanding mortgage balance from an unrelated person who buys the house.
Unless a foreclosure process is already well underway, the lender could agree to a short sale, simply to avoid the high costs of foreclosure. Often, a bank won’t foreclose until the homeowner attempts to make a short sale — hence the phrase pre-foreclosure.
As with most other listings, the homeowner in a short sale puts the home on the market and negotiates with buyers through real estate agents. But there is one major difference. Even if the lender does say yes, it’s OK to do a short sale, that lender isn’t bound to accept just any offer. After all, it’s the lender who is being paid through a short sale. So, the lender may go through with the sale — or foreclose instead.
After facing foreclosure, a homeowner must wait three to seven years before getting another mortgage. A short sale, which is a negotiated settlement undertaken voluntarily by the homeowner, can shorten that wait. A short sale may impact the seller’s credit less harshly than a foreclosure, too. Still, having a mortgage in default lowers a homeowner’s credit score. A negotiated settlement is negative history, and it will probably remain for seven years as a visible part of the short sale seller’s credit record.
Of course, foreclosure and short sales are not the only remedies for a mortgage that can’t be paid. For example, you might consider how both compare to the deed in lieu of foreclosure.
☛ Read more about various alternatives to foreclosures worth considering when a homeowner cannot keep up with monthly mortgage payments.
How the Short Sale Process Works
To start the ball rolling, a homeowner approaches the lender. The lender gives the homeowner a list of required documents, as it would in an initial mortgage application process. Usually the homeowner writes a statement that the home’s value does not cover the debt and there are no other assets or other means to repay it. If the lender is convinced that short sale makes the most sense, it will approve the request — but it doesn’t have to; and, depending on state law, the lender can even go after the homeowner for what it doesn’t recover through the sale through a deficiency judgment.
The real estate agent lists short sales, and creates the contracts between sellers and buyers, subject to mortgage lender approvals. If and when the lender accepts a final contract, the parties attend the closing. The mortgage lender receives the sale proceeds, and removes the original mortgage lien, clearing the title. Finally, the deed is conveyed to the buyer.
But if there are other lien holders — for example, banks that let the homeowner borrow home equity lines of credit — it won’t be so simple. These junior lien holders also have an interest in the property, so their approval is necessary as well. Expect them to require contributions before they’ll remove their liens. Sellers who cannot or will not come up with the extra funds may blow the whole deal unless the buyer agrees to step in and pay the extra costs.
Note: In some short sale agreements, the mortgage lender waives the right to go after the homeowner for the deficiency — the amount of debt not paid back through the short sale. Yet the homeowner could owe tax on the benefit of a deficiency waiver. Learn about Home Foreclosure and Debt Cancellation directly from the Internal Revenue Service on its website, and get assistance with tax questions.
If You’re Interested in Buying a Home Through a Short Sale
Are you thinking of buying a home? Then you could come across a short sale listing that sparks your interest. Is the listing you’re looking at subject to bank approval (review required), or is it pre-approved by the bank? If it’s pre-approved for the short sale, you know the lender is already prepared to let the home go at a certain price, which puts you one step ahead in the timeline.
Should you decide to pursue the short sale listing:
- Hire a real estate agent experienced with the short sale process, so you correctly work with the required documentation and the paperwork you submit appropriately protects your interests.
- Ask if your lender handles short sales when you apply for your own pre-approval for a mortgage.
- Have your pre-approval as soon as possible, so the seller’s bank can consider you a prospective buyer as it decides whether to approve the short sale.
- Check the county records to ascertain the debt burden on the property and anticipate what liens will need to be satisfied.
- Hire a licensed, local real estate inspector to carefully examine the house you plan to buy. (In short sales, buyers should anticipate having to cover inspection and repair costs.)
Your real estate agent will submit your offer and earnest money, and work with all necessary documents, including the HUD-1 settlement statement and your purchase contract and addendum, outlining conditions that must be met for the contract to go through. And that could take weeks, as the seller reviews and puts together all required information.
In a typical best-case scenario, you find a great short sale home. You find yourself competing with other hopeful buyers, and you offer the market value of the home so you can satisfy the seller’s lender and the junior lien holders. Your lender gives you your pre-approval letter. In about eight weeks, all the lien holders have given the sale a green light. Your agent sets up the inspection and appraisal. In just a few more weeks, you’re sitting at the closing table, and voilà! The deed to the home is yours.
Now, what about the typical worst-case scenario? Perhaps the seller and the bank approve your offer. You’re several weeks into the process when you get a call; the deal is off. Turns out your seller has private mortgage insurance that would mitigate the loss, so the lender calls off the sale and forecloses. A seller may back out of the short sale contract for other reasons, too. Maybe you are outbid, or maybe the seller files for bankruptcy.
So, Should You Bid on a Short Sale Home?
It all depends. With a short sale, you can expect to buy a property at a fair value, and the home is likely to be well maintained, because the seller is motivated to avert a foreclosure scenario and wants to show the lender at least one attractive bid on the property.
It is entirely possible to negotiate a deal — but don’t expect a steal. The mortgage lender has approved the short sale to recover unpaid debt. It has every reason to appraise the home, and to look at sales of comparable homes in the area. This means your offer has to be solid to receive serious consideration.
But if you love a home that happens to be listed as a short sale, it could indeed be worth your consideration.
Further References
Ben Luthi, What Is a Short Sale? Experian (Jul. 15, 2020).
Freddie Mac: Buying a Short Sale Property.
Photo credit: Gustavo Zambelli, via Unsplash.