Short Sale - Explained
What is a Short Sale?
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Table of ContentsShort Sale (Real Estate) DefinitionA Little More on What is a Short Sale (Real Estate)Short SettlementDeficiency JudgmentShort sale Margin requirementHome Short Sale ProcessBenefits of a short sale to a home sellerLimitations of short sale to a home sellerBenefits of short sale to the home buyerLimitations of short sale for home buyers Differences Between a Short Sale and a ForeclosureThings to Know About a Short SaleAlternatives to a Short SaleShort Sale Strategies for Buyers and InvestorsPrepare to Hurry Up and WaitFinding Short-Sale PropertiesKnow the NumbersDetermine ProfitabilityAcademic Research
What is a Short Sale (Real Estate)?
In real estate, a short sale refers to the sale of a property at a value less than the amount owed on it. When a financial distressed owner sells his property at an amount less than what is needed to settle a mortgage debt, it is a short sale. When a lender secures a lies on a property due to the inability of a borrower to make payments, if the homeowner sells the property at a value less than the amount to be repaid, it is a short sale. Proceeds realized from a short sale are given to the lender. In some states, lenders are required to forgive the difference in a short sale while some states allow the lender get a deficiency judgement. A short sale can also occur in the investment market. It refers to a situation in which an investor sells borrowed securities with the aim to repurchase the securities when there is a price decline so that the borrowed securities can be returned in the future. Oftentimes, short sales occur in the real estate in which a person sells a home for less than the amount of debt owed on the property.
How Does a Short Sale Work?
Generally, begin a financially distressed borrower carries out a short sale, the lender must be aware and consent to the sale. A pre-foreclosure sale is another name is short sale is called. A detailed paperwork containing all necessary documentation must also be made available during a short sale process. A short sale in real estate has two important contents:
- A lender (Mortgage Company) must agree to a sale proceeds less than the amount owed as a debt.
- The sale should be below or at the appraised value of the property.
The selling price is basically described to be at or less than the value appraised for the process to be possible. Any experienced buyer will not pay more than the appraised value. The lending company on the other hand will not accept to provide a mortgage greater than the appraised value of the property. This will limit the short sale earnings to a maximum yield of the property's appraised value. A short sale in a mortgage scenario mostly occurs when the lender realized that the mortgage may never be paid or when the mortgage owner encounters financial distress.
Sometimes the bank is not bound to accept the appraised value and can demand for more. In such case, the demand for a greater selling price, but less than the amount owed, is called Short Settlement. The short sale can only be attainable when the lien holder (lender) is willing to accept less than the debt owned and also agrees a selling price at or below the appraised value of the property.
After the short sale of a real estate is done, there is usually an unpaid balance owed to the creditor, this is called a deficiency. Some short sale agreements do not automatically relieve the borrower from their duties to pay the deficiency unless there is an agreement between the parties or if provided by the law.
Short sale Margin requirement
As defined above, in short sale, the investor borrows shares which he sells with the hope that the price of shares will fall and he will buy them back at a cheaper price. The earnings got from the sale are investors margin account. Since short sale involves a transaction of shares that the investor does not own, there are important margin requirements. This margin is what is used as collateral of the shares borrowed. Margin requirement is the sum of money needed to be held in the account at the time of short selling. The maintenance margin is the amount needed to be in the account at any time after the first According to the Federal Reserve Board, it is important for all short sale accounts to hold 150% of the value of short sale proceeds at the time sale is commenced. This 150%is the full value of the short sale earnings, which is 100%, plus an extra margin obligation of 50% of the short sale value.
Home Short Sale Process
- The home seller contacts the lender and submits an application to be allowed into the short sale program.
- The lender verifies relocation assistance to the borrower.
- The lender provides the terms of the short sale. This includes forgiveness in case of any deficiency or any other incentive in case of successful closing.
- Selecting of real estate agent who is qualified to handle short sale.
- It is helpful to get a Broker Price Opinion letter to establish an approximate market value of the property. This is not the same as appraised value.
- Submit the short sale offer to the lender and getting approval of the sale.
- Negotiate with the lender on how to go about the deficiency burden.
Benefits of a short sale to a home seller
- Credit score benefit - Short sale is greatly preferred to foreclosure in terms of credit score. Firms that deal with credit scoring award a credit score lower for foreclosure than when a home seller uses short sale option. This not only protects the homeowners score but also allows him to buy another home in the future without the problem of low credit score.
- Emotional advantage - The homeowner who may not be able to pay for the mortgage either due to low income or medical issue could be in distress. The option of short selling his home would be more satisfying than foreclosure. The homeowner can proudly say I sold my home and moved on.
- Saves on home sale fees - With the normal traditional home sale, the seller bears the fees, charges and real estate agent commission.in short sale, those additional charges are paid in by the bank and not the home seller.
Limitations of short sale to a home seller
- No profit made - In short sale, there is no profit made from the sale of the home. This is because the mortgage lender gets all the proceeds from the sale.
- Dependence on the mortgage lender - The home seller requires approval from their mortgage lender. They cant make the short sale decision on their own.
- Financial constraints for another home purchase Due to the fact that the home seller gets no profit from the sale of the home, they could face a financial problem to purchase a new home. In this case, once the home seller short sells his home, he will have to start from scratch.
- Finding a buyer short sale requires the home seller to find a buyer for his property. Finding a buyer who will offer an acceptable price might be a challenging task.
Benefits of short sale to the home buyer
- Reduced price - The biggest benefit is the chances of owning a home at a reduced price. When a house is in a short sale, it means that both the homeowner and the lender want to sell the home and get out of the loan. This comes with a lower price than in the traditional way of home sale.
- Less competition Many first time buyers may not want to get involved in the complexity of short sale. This leaves a space for only patient buyers hence less competition.
Limitations of short sale for home buyers
- Longer home purchase process there is a lot of paperwork involved in short sale. This takes a longer period to sell a home (120 days) compared to traditional home sale which usually takes 45 days.
- Lender involvement - lender gets direct involvement in the price negotiation. This may mean higher price than when the home is sold by the homeowner. This is because the bank may require to recover all the fees and charges involved in short sale.
- The property may be in a bad state - A short seller may not have the finances required to keep up with the home maintenance and repairs. It is therefore advisable for a short seller to work with the real estate agent who is well experienced and also work with a professional home inspector to examine the property.
Differences Between a Short Sale and a Foreclosure
Homeowners who are unable to continue with mortgage payment or mortgage loans taken from lenders due to financial constraint are often forced to part with their property to settle the debt. A short sale is different from a foreclosure, although, homeowners who are financially distressed can choose between these two options. Lenders initiate foreclosures on borrowers who are delinquent, this process leads to the forfeiture of the property used as collateral in the debt contract. A foreclosure is a last resort for a lender, it is a legal right that allows a lender to seize the property of a borrower who has failed to make repayments. Unlike short sales which the homeowner does himself, a lender executes a foreclosure against the homeowner. Homeowners who do not leave the home that has been forfeited in a foreclosure can be evicted by the lender. A short sale requires a longer process than a foreclosure and foreclosed properties are sold through a bidding process such as a public auction or trustee sale. Another distinction between these two concepts is that a homeowner involved in a short sale can purchase another property, although with strict regulation but a homeowner with a foreclosed home has a minimum of five years as a waiting period before purchasing another home.
Things to Know About a Short Sale
Both short sales and foreclosures affect the creditworthiness of individuals, but in varying degrees. Although a short sale is not good for the credit rating of a homeowner, it does not have grave consequences like a foreclosure. In some short sales, the difference between the sales value and the original value of the mortgage is forgiven by lenders while some lenders proceed to get a delinquent judgement in order to get the balance. However, a short sale does not always mean the remaining debt will be forgiven or negated owing to the part of the mortgage where the borrower promises to repay a lender. This part of the mortgage can be enforced even after the proceeds of a short sale have been paid to the lender.
Alternatives to a Short Sale
There are other possibilities to settling a debt if the borrower is financially distressed. Before opting for a short sale, there are other options that borrowers should weigh before settling for short sales. A loan modification or revised payment plan can be granted by a lender which allows a homeowner stay in their homes while they recover and stand strong financially. Purchasing PMI (private mortgage insurance) with a mortgage is another way to hedge short sales. PMI companies generally give their clients the chance to recover from financial hardships and generate income to settle the debt.
Short Sale Strategies for Buyers and Investors
Investors in the real estate industry also use the short sale strategy, it is a way used by buyers to secure homes at lower prices. Aside from being used in real estate, short sales are also used by buyers and investors in the securities market. The short sale strategy involves the sale of borrowed securities with the expectation the the price would reduce.
Prepare to Hurry Up and Wait
Before you opt for a short sale, there are some important things to know;
- Short sale transaction is time-consuming: you need to prepare to wait a long while if you want to engage in a short sale. The processing is rigorous, participants need to wait for lenders approval and banks approval which might take a long time.
- Short sale package: a short sale package include; financial statement and records, health records, tax papers, divorce papers and proof of loss of job (if applicable) This package is presented to the lender after evidence and documents revealing the hardship of the borrower has been filed.
- Bank Review: Getting a banks approval for a short sale requires time, because the bank will need to review the price before agreeing to it.
- A short sale offer: This is the offer a homeowner, who is the seller accepts from a buyer. All the agreements reached on re sale of the property are contained in the offer which is then submitted to the bank.
Finding Short-Sale Properties
If you often experience difficulty in finding short sale properties, you need not worry about looking for those properties around. Simply check all available short sale properties listed on real estate websites, the lists are compiled by real estate agents. However, it is important to note that not all short sales listed have been approved by the bank, this means you will have to search for pointers to separate those awaiting bank approval from those that have been approved. Going through real estate agents is another way to find short sale properties. These individuals have expertise in the field and can recommend the best short sale property.
Know the Numbers
Before making an investment in real estate, it is crucial to know the numbers as this determines having a successful deal. Knowing the numbers entails knowing the worth of properties and determining whether it is set at a good price for sale or otherwise. Purchases that are on the high end do not profit investors, this is why they weigh many options carefully before deciding on what property to purchase. Here are some tips that will help in buying a property that is in good condition for a good price;
- The purchase price must be good in a way that an investor can easily make a turn around and resell the property and make a profit.
- Cost of repairs and renovations of the property must not be on a high end.
- When the value of the property is estimated after pair has been made, the investor should not be at a loss. This is putting After Repair Value (ARV) into consideration.
- The carrying cost of the property which includes mortgage and interest payment, property taxes, insurance, and utilities bills must be put into consideration.
When investing in a short sale property, determining its profitability is important. For the purchase to the profitable, the costs on the property must be less than the After Repair Value (ARV). If the values are the same or the costs close to ARV, making gain would be impossible. The formula for determining profit in a short sale investment is; Profit = ARV Purchase Price R&R Costs Carrying Costs There is a percentage of profit that real estate investors anticipate to make when they make an investment. Purchase of short sale properties is one major ways investors buy a property for a lower price and in turn make profits. Generally investors make profit in short sale properties by selling them at a higher price to make profit or retain their ownership so that they can earn a profit on them through rent.
- What is a mortgage?
- Homeowners Protection Act
- Deed in Lieu of Foreclosure
- Tax Deed
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