How to Buy a Short Sale

By: , Contributor

Published on: Feb 11, 2020 | Updated on: Feb 12, 2020

Investors interested in buying a short-sale property should make sure to read these tips before committing.

Real estate investors on the hunt for a short-sale property are looking for one thing -- a great deal. A short sale is a real estate transaction where the owner's lender agrees to sell to a new buyer, short of what is owed by the original owner. This happens because a home's value has declined and the original homeowner owes more on their mortgage payments than their home is worth. A buyer looking to purchase a short sale generally gets the property at a reduced sale price.

What is a short sale?

Buying a property through a short sale is different from buying a home at a foreclosure auction or one that is fully owned by the bank. Here are a few key differences between short sales and foreclosure auctions:

Short sale vs. foreclosure auction

Short Sale Foreclosure Auction
The home is put up for sale by the homeowners. The bank takes ownership of the property and puts it up for sale after the homeowner fails to make their mortgage payments on time for a lengthy period.
The homeowner still lives in the home. The home is usually already abandoned.
You can (and should) request a disclosure statement. Does not come with a disclosure statement.

Because of these differences, properties in a short sale are generally in much better shape than properties going through a foreclosure.

However, keep in mind that homeowners in a short sale are already in some financial trouble, as the home is worth less than what the homeowners owe. Typically, these homeowners are so behind in their mortgage payments that they are not likely to catch up. If the short sale does not occur, a foreclosure is next.

But short sales can be beneficial in preventing foreclosure. If a homeowner is unable to make mortgage payments for a significant period of time, the homeowner can try to settle their loan debt with their lender through a short sale. Once a short sale transaction closes, the debt is settled and the seller is off the hook for the difference.

Therefore, in a short sale, the buyer is still dealing with the homeowners during the sale process while also dealing with the lender. A deal cannot be completed without the lender's approval.

Why buying short sales is hard

Having to deal with both the homeowner and the lender to successfully reach a deal makes short sales difficult for buyers. And because the sale cannot occur until you receive both homeowner and lender approval, the short-sale process can also take longer than normal.

Why buying short sales can be worth it

The primary draw of short sales is that buyers can take advantage of them to pick up properties below their market price. Just be sure to factor maintenance costs into your budget to work out whether the transaction still makes financial sense. If so, short sales can be great value-add purchases. A value-add is when the buyer makes an active effort to elevate the value of a property, typically through a significant capital improvement program such as a partial or property-wide renovation.

Another potential benefit to buyers is that in order to avoid going through the foreclosure process, which includes the cost of eviction as well as administrative and maintenance costs, banks may offer buyers of short-sale properties favorable financing terms to make the sale more attractive.

Some short-sale red flags

There are a few things to keep an eye out for while short-sale shopping:

  • Properties with multiple lenders involved.
  • Prices that are far too low.
  • Sellers that require a fee for the right to purchase.

Let's explore these in more detail.

Keep an eye out for how many lenders you will have to deal with. If the original homeowner owes multiple lenders for the property, that will only make the process more drawn out for the buyer. For this reason, try to find short-sale properties where you'll have only one lender to deal with. Remember that along with the homeowner, lenders must also be on board with the deal in order for the sale to go through.

Second, some agents will set a very low price point on a short-sale property to attract buyers’ attention. That is why you might even see some properties listed for $1. This does not mean the lender will accept the deal. Do some market research to find out what other properties' values are in the surrounding area, and use that analysis as a base value to make a legitimate offer.

Finally, it is illegal for a seller to require buyers to pay them for the right to purchase the seller's property. Do not follow through with sellers who suggest this practice.

How to buy a home on a short sale

Do the research

Go through the short-sale process with an experienced real estate agent. Agents will contact the property's listing agent to find items such as title, foreclosure notice filings and the number of lenders and how much is owed to each. Experienced real estate agents will also help with making an initial offer and with determining closing costs.

If the amount owed on the house in relation to its approximate value is high, this makes it a worthy candidate to consider. If, however, the homeowner already has a lot of equity in the house, the lender might not be too pressed to sign off on the deal.

Next, find out the track record of the short-sale property listing agent. That listing agent will deal with the lender directly, not with your agent, and lenders must agree to the terms for the deal to be completed. For this reason, if that property's listing agent has a poor track record, your deal can fall through the cracks. The short-sale listing agent is responsible for submitting the short-sale package to the lender and negotiating the deal.

Also, find out how many competitors you're going up against. Though you won't be able to find out the details of other offers, knowing how much competition you're up against will be useful. You want your offer to be above everyone else's, but of course still below market price, as ultimately that is the main benefit of a short sale.

Get a property inspection and disclosure statement

If a property is up for a short sale, the space may not be so well preserved. Though it will likely be in better shape than a property going through foreclosure, you will still want to ensure the property is free of any serious maintenance issues. Or, if you are an investor, make sure you budget the maintenance work you will need to do into the purchase price. Heavy maintenance work should not be a deal killer for investors, but make sure you know the numbers will pencil out in your favor. Most buyers might be put off by how much work will be needed on the property, but an investor should see this as a possible opportunity for a solid value-add investment.

Also, request a disclosure statement to indicate whether a house is in a flood plain or had any unpermitted renovation. Because short sales are sold by the homeowners and are not yet fully bank-owned, you can and should request a disclosure statement. Disclosure statements reveal anything that is wrong or can potentially go wrong with the property.

Be sure to get a home inspection from an experienced inspector and request a disclosure statement before you commit.

Make an offer

Unless you're buying with all cash, the first step is to get pre-approved for a mortgage. You will need the lender approval in your official offer, so hold on to that.

If you are thinking of buying a short sale to rent the property or flip it, you may not have the same lending options as a conventional buyer. Look into your options in order to secure the best financing. You are under no obligation to use the same mortgage lender that is releasing the property, but as noted above, using the same mortgage lender might give you a better deal, as this mortgage lender will want to find a buyer in order to avoid the foreclosure process.

You will want to do this step before the property you're interested in is even approved for a short sale. This is because though a lender has the freedom to take a long time to get back to you on whether to go through with the deal, buyers are expected to move quickly to close. In evaluating a buyer's offer, the seller's mortgage lender will consider the buyer's ability to purchase the property. For this reason, buyers should secure pre-approval for financing before an offer is submitted.

Once you're ready to make your offer, make sure the offer includes the following five items:

  1. Purchase contract of the buyer and seller.
  2. Earnest money deposit to prove you are a serious buyer. This will go toward your down payment.
  3. Pre-approval letter showing proof the buyer can match the offer. Send a current pre-approval letter, dated within the last 30 days.
  4. Data on recent home sales in the area to prove your offer is comparable to market prices.
  5. Proof of funds. This can include copies of bank and money market account statements, as well as equity lines of credit and certified financial statements.

Lowball offers don't work. Remember, the mortgage lender will be losing money on a short sale, and they will want to recoup as much of their losses as they can. Banks will only agree to sell the home as a short sale if they believe it more advantageous than going through the foreclosure process. Use your agent to find information on market prices, and then go from there.

Things to keep in mind

The short sale process is much more difficult than a standard sale. Most buyers end up ditching the purchase altogether because it can take too long for lenders to review an offer and get back to them. From there lenders can even then accept, counter, or not respond. Though some close more quickly than others, short sale deals can take up to a year to complete. Additionally, if the property has first and second mortgage lien holders, the process will become that much more arduous. This is why it's so important to look for a property with only one lender.

Buying a house on a short sale isn't easy, but if you do your homework and go into the process knowing what to expect, it can be a great way to find a value-add investment in the real estate marketplace. You can end up scoring a great deal on a property for below market price with favorable financing terms.

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