How Does Buying a Short Sale Work?
Last Updated on August 23, 2022 by Mark Ferguson
As an investor, I have purchased many short sales for long-term rentals and fix and flips. As a Realtor, I have helped sellers sell short sales and buyers purchase short sales as well. Short sales are very unique and much different from fair market sales and even REO sales (foreclosures). Owner-occupied buyers and investors can get incredible deals on short sales, but it is not always easy to get the deal closed. Buyers, sellers, real estate agents all must work hard and be very patient when dealing with a short sale. There is no guarantee a deal will get done until the closing documents are signed and the transaction is funded.
How do short sales work?
A short sale is much different from an REO sale, which I describe here. An REO sale is when the bank has foreclosed on a property and the bank takes back possession of the home. The bank can then sell the home and make all decisions on the sale. A short sale is when the owners of the home have not been foreclosed on, but owe more to their lender or lien holders than they can sell the home for.
In a short sale, the bank does not own the home and cannot accept offers or control the sale, but the bank has the final say on if they will accept a lower amount than what they are owed. The owner of the home still chooses a real estate agent, sets the listing price, and can accept or reject offers. When the seller accepts a buyer’s offer that does not mean the bank will accept less than they are owed unless it is a preapproved short sale which is rare.
After an accepted offer, the bank will go through a process to decide if they will take less than they are owed to get the loan off their books. There is no guarantee they will accept a short sale, but they should give some indication to the parties if they think there is a chance of acceptance.
Why do sellers want to do a short sale?
Usually, sellers are doing a short sale because they are facing foreclosure. A foreclosure can destroy someone’s credit as can a short sale, but many times a short sale will do less damage. Most people would rather say they sold their home then say they lost it to foreclosure. Some banks even pay sellers to complete a short sale! A short sale is usually cheaper for the bank as well since foreclosures can cost tens of thousands of dollars in legal fees and give the banks a bad name.
Even though it is up to the seller to complete a short sale in most cases, that does not mean they will always be easy to work with. Many times people in distress will not act quickly or logically. Not only do you have to deal with a bank that may take a long time to make a decision you may have to deal with sellers who are not happy with the situation either. This is all part of a short sale and buyers must be patient.
Why do banks want to complete a short sale and accept less than they are owed?
When the owners of a home fall behind on their mortgage, the banks can foreclose after a certain amount of time. The problem with a foreclosure is it is very expensive and time-consuming for the bank. The foreclosure process is different in each state, but in any state, it can cost 10’s of thousands of dollars for the bank to pay lawyers and legal fees.
Right now (2022) it is taking more than 900 days on average to complete a foreclosure in the United States! Before the last housing crash, it took less than 200 days on average. While that forclosure is in the process the homeowner still owns the home. They may not even have to make payments, so banks much prefer a short sale.
The other problem banks run into when they try to foreclose is they must attempt to work with the homeowners to avoid foreclosure. The government has implemented many regulations to try to decrease the number of foreclosures. Banks have to offer loan modifications and prove they made attempts to work with the homeowners.
By doing a short sale the bank saves time, and money and reduces the risk of not completing the foreclosure process correctly. In a previous mortgage settlement between the government and the largest banks in the country, banks had to pay 26 billion in fines and restitution for not completing foreclosures correctly.
How long does a short sale take?
I have completed short sales in less than two weeks, but it is extremely rare for this to happen. I would count on it taking at least six weeks for a short sale to be accepted and you should be willing to wait months in some cases. The bank wants a lot of information from the sellers and this can take time to get it all together and make sure it is all correct. Some banks will not offer short sales if they think the buyers can afford to keep making payments. They don’t want to take a loss if the owners can keep paying. Much like a buyer getting a loan has to provide a lot of financial information to the bank, so does the seller of a home during a short sale.
The banks also have to determine the value of a short sale, which can take some time. They want to make sure they are basing their short payoff on the actual value of the home. The banks do this by ordering broker price opinions from agents (the listing agent and independent agents) using desktop valuations and full-blown appraisals. Each bank has a different formula for how much they will accept and many times it varies with each situation.
What are the chances of a short sale offer being accepted?
Before you go through the time and hassle of a short sale you need to know if it is all worth it? There is no magic formula for the chances of each short sale being approved, but the closer the offer is to the actual value the better chance the short sale offer will be accepted. If you are trying to steal a property from the bank there is a good chance the bank will pass on the offer.
If the offer is not accepted you are usually out nothing except the time it took to make the offer and the time you waited. I have had many short sale offers accepted by the seller, but rejected by the bank. Do not expect every short sale offer accepted by the seller to close!
Another thing to watch is the foreclosure date if the house is in foreclosure. There is no law that says the bank has to give time for a short sale or extend the foreclosure sale if an offer has been accepted by the seller. If I am the buyer or representing a buyer I always watch the foreclosure date and make sure the listing agent is aware of the foreclosure date and I take action to get that date extended if needed.
Some of the items that will make or break a short sale are the real estate agents involved and how experienced they are, if there is a negotiator involved and how many liens are against a property.
Are short sales easier to complete now than in the past?
Most people have probably heard nightmares about the short sale process. The truth is it can be a nightmare in some cases, but in other cases, it can be a smooth and easy process. In most cases, a short sale will take notably longer than a traditional or REO sale. The reason for the delay is the bank and lien holders have to approve accepting a lesser amount than what they are owed and it takes a lot of sifting through paperwork and processing from a large corporation.
Short sales were a fairly new thing after the last housing crash. It was a learning process for everyone and many banks took months, some even years to approve sales! Over the years, the process has been improved and many banks have faster approvals but it can still take a very long time.
What if there are multiple loans or liens against a home?
In many cases, a short sale may not just be asking one lender to take a short payoff. There may be a second loan, judgment, or other liens on the home that also need to be negotiated. The more liens there are, the more difficult it is to get a short sale payoff accepted. If you are making an offer in a short sale be ready to wait, especially if there are multiple liens.
The difficulty with multiple liens on a property is many times the first loan will limit how much they will allow a second loan to be paid. The second loan may not like how much the first is allowing them to be paid and the deal won’t get done. I have dealt with some judgments that will not accept anything less than full payment and this makes it very difficult to complete a short sale.
How can buyers get a great deal on a short sale?
Banks like to do short sales over selling their homes as REOs because it costs them less money. This is one reason the banks will take less than market value on short sales. Even if the bank knew it could sell a home for $10,000 more as an REO listing, it may save the bank money to sell the home as a short sale.
Because the bank will take less than market value, it is an excellent opportunity for investors and owner-occupants to get a great deal on a home. Investors may have to wait to make an offer on an REO property, but they actually have an advantage with short sales. Many times properties need work and most likely the seller isn’t going to make any repairs. If the home won’t qualify for FHA or conventional loans it limits the buyer pool for the home. A seller may be more likely to take an investor offer that is lower than an owner-occupied offer since it is unlikely an owner-occupant loan will go through.
How to make an offer on a short sale
Most short sales are listed on the MLS and a buyer can make an offer on them with the help of a Realtor. The list price is usually determined by the seller with the help of their Realtor. Some short sales have list prices that are pre-approved by the bank. These pre-approved short sales are hard to find as most banks will not start the short sale process until they receive an offer. This is why the short sale process can take longer than a regular sale.
The seller makes the decisions on what offers to accept and how much to accept. Sometimes sellers will accept extremely low offers if they are running out of time before the foreclosure sale. I have purchased a few short sales that were well below the asking price because the sellers were running out of time.
Once an offer is received most banks will ask for a short sale package from the listing agent or negotiator. This package will include all the financial information, pay stubs, bank accounts, a hardship letter, and more from the seller.
I have bought a few short sales and one of the most important things to do when trying to buy a short sale is to act quickly. Many times the sellers will accept the first decent offer that comes in which may be lower than the asking price.
How do contracts on short sales work
The contract process for short sales is different for each state as each state has its own laws. In Colorado, it is typical that no earnest money can be deposited until after the short sale is accepted in writing by all lien holders (short sale acceptance). In Colorado, the buyer or seller can also cancel the contract at any time for any reason before short sale acceptance. Once the short sale is accepted, then the contract is enforceable like a regular contract. The appraisal, inspection, and loan process are usually not started until after the short sale acceptance as well.
Should you use a short-sale negotiator?
In some transactions, a short sale negotiator is used by the buyers and listing agent. The short sale negotiator works with the seller and the lien holders and he or she will do their best to get the lien holders to accept the offer. Sometimes the lien holders will pay the short sale negotiation fee and sometimes the buyers will actually pay it. The fees for a short sale negotiator can vary wildly from flat fees that are a few hundred dollars to thousands of dollars or a percentage of the sales price.
A short sale negotiator can speed up the process with the bank if the listing agent is not on the ball getting things done. if the listing agent knows what they are doing and has time to get everything to the bank, a short sale negotiator may not be needed. It also may be tougher to find a short sale negotiator now than in the past when there were more short sales. If we see more short sales pop up we may see more negotiators pop up again as well.
How to Avoid short sale fraud
Short sale fraud used to be the number one most investigated crime by the FBI. There are many rules the buyer and sellers must abide by because the lien holders are accepting less than they are owed. It is difficult to know exactly what makes up short sale fraud, but if you are lying or withholding information from the banks who are accepting the short payoff, it could be fraud.
The banks will also ask the buyer and seller to sign paperwork known as a short sale affidavit. This affidavit says the seller and buyer are not related, the seller is not going to rent the home back from the buyer, there are no outside contracts or agreements, etc. If any of these clauses are violated it could be considered short sale fraud.
If you think any party to the transaction, including the real estate agents, is doing something fishy be careful! People went to jail for short sale fraud.
Most banks will want a house listed with an agent on the MLS to give buyers the opportunity to make an offer on the property. If a property is not really listed for sale, or only put on the MLS to appear to be available but it is already under contract, that could be an issue. If you are an investor seeking out short sales and want to work directly with banks that could be an issue as well if other buyers are not given the opportunity to offer on the properties as well. the banks want to get the most money they can and if someone is trying to trick them into taking less by not marketing the property to buyers, trying to fake low values, or lying about the condition of the property it could land all parties in a lot of trouble.
It can take time, work, and sometimes disappointment before you are able to purchase a short sale. They are also few are far between thanks to the recent hot real estate market. Things could cool down and we could see more short sales come on the market but I am not expecting a massive increase any time soon. Even in very hot markets, there are short sales on properties that have been destroyed or for some reason have loans well above the current value.
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