First, Let's Define A Short-Sale

Although short-sales have been around for a while, they recently become more mainstream because of the economic downturn we've all experienced over the past several years. 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, every sale is based on an appraisal or "broker price opinion" (BPO) that determines the current market value of the home. Banks are well aware of what the home is worth and are going to fight to sell the home as close as possible to market value. If you get a short-sale for 20% below market, you got a STEAL. More realistic, you're looking at 2% to 5% below market value. For many bargain hunting home buyers, the trouble of going through the process to get 5% off is just not worth the headache.

What You Need To Know: It's highly unlikely that you'll buy a short-sale home for $0.50 on the dollar. That ship has sailed. Prices are based on the appraised value of the home and banks will refuse offers much lower than market value. Short-sales can be a very difficult transaction that may or may not be worth the modest discount you might get.


Rule #2 - All the planets have to be aligned to make a short-sale work. Ok, maybe the cosmos are not involved but trust me, it can feel like it. Short-sales are difficult, there are often HUGE hurdles to overcome, and more of them do NOT go through than do. If you start the process thinking this is going to be fun, think again. Seriously, think again. For example, many short-sales have both a first and a second mortgage. BOTH of those banks have to agree to the short-sale. What happens if that second mortgage was bundled into a mortgage back security, sold on Wall Street, and now is tied to a Teachers Union retirement fund in Illinois? You got it, it's a COMPLICATED MESS.

What You Need To Know: There are a LOT of moving parts to a short-sale that complicate the process significantly. The odds are against you. That's not to say it can't work out, many do... but most do not.


Rule #3 - Purchasing a short-sale requires a lot of time and patience. Short-sale transactions can easily take 3 - 12 months because of their complexity. Understand, however, time is not on your side. Sometimes the banks are willing work with everyone, sometimes they wont. I have seem more than one case where the foreclosure department didn't communicate with the loss mitigation department (and vice-versa) and they foreclosed on the property right in the middle of the whole deal - even though it was to their advantage to approve a short-sale! I have also seen several homeowners get an offer on their home but are denied a short-sale. They lost their house to foreclosure and then the bank puts the home on the market for LESS than what the original offer was. INSANE!!

What You Need To Know: Many buyers end up frustrated and disappointed after they have waited for so long only for the deal to NOT work out. Be prepared to lose a few deals because of the bank. If you don't have time or are not a patient person, SHORT-SALES ARE NOT FOR YOU!

What Are You Really Up Against?

Ideally, the listing broker should start the short-sale approval process with the bank before the home is listed for sale. However, that's not always possible. Homes are often listed as "short-sales" without bank approval because of Rule #3 and many banks require an offer on the home before they will even discuss it. It would be nice, though, to know if they will even consider a short-sale BEFORE everyone starts the process.

Keep in mind, the bank DOES NOT OWN the home. The homeowner does. This is a key distintion between short-sales and foreclosures. When an offer is submitted it must FIRST be approved by the homeowner and then sent to the Bank for approval. However, even if an offer gets accepted by the homeowner, it frequently gets rejected by the bank. At that point the bank will typically reveal what price they will accept. The homeowner generally has NO SAY in accepting anything less than what the bank approves.

I'm sure you know by now the most difficult part of the process is working with the bank. Their office hours are Monday through Friday in their local time zone. They are inundated with short-sale and foreclosure proceedings. Again, it is not uncommon for a short-sale deal to go on for 3 - 12 months! If there are 2 banks involved - buckle your seatbelt, it's going to be a bumpy ride.

A few more points to consider:

1. Many short-sale homes attract multiple offers. Sometimes the bank will "cherry pick" whichever offer suits them best. Others will take them one at a time. The first offer than comes in often serves only to "fish out" a counter-offer from the bank so we know what they will accept for the next offer.

2. Every deal requires an assignment of a professional negotiator, 2 -3 levels of management approval, and signatures from countless parties. Bureaucracy and red-tape at its finest.

3. Short-sale positions are often low-paying, high-stress, and thankless jobs. It's not uncommon for the initial contact person assigned to the file to be gone 30 days later. That means we will have to start the entire process over from square one.

As I mentioned above, another common roadblock working with short-sale homes involves second mortgages. Frankly, these 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 $175,000. The home is secured by a $200,000 first mortgage and a $50,000 second.

This is a VERY COMMON scenario. Many people don't understand that approval is needed by BOTH first and second leinholders. Even if the first bank is willing to accept $175,000, the second bank can easily reject and kill the entire deal. 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. Everybody and their dog is looking for a bargain and the banks know this. Ultimately, the bank wants to sell the home as close to marke value as possible. There are exceptions, though.

By the way, don’t forget about other issues like repair costs. HGTV and other real estate shows paint a very romantic picture of buying distressed properties. "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 rehab 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). 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 2% - 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 2%-10% 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 you're game, so am I. I've painted a pretty bleak picture because I want you to understand the reality of the process. It's laborious and frustrating. However, I'm willing to work hard and walk with you all the way through it. I know what to expect, as long as your eyes are wide open then it's time to get started searching for that home. It could be a long road ahead of us.