Purchasing an investment property with the help of a short sale is a great way for investors to get into the real property investing business. This type of purchase differs from the ordinary real estate transaction due to some peculiar features that we will describe further in this article. Also, we will define the term ‘short sale’ more precisely. We will list the advantages and disadvantages of short-sell properties over the other types of real estate, describe how it works and compare the short sale with the foreclosure.
What Is Short Sale?
A short sale is a term in real property investing when the owner of the property sells it for a lesser price than the amount owed by the mortgage. In this case, the lender does not receive the whole sum of the loan. If the mortgage company agrees to get the amount of the debt partially, then the transaction can be completed.
The short sale is profitable for the bank in terms of avoiding foreclosure. Thus, it helps to save time and money. As for the seller, a short sale allows avoiding the expenses, connected with the foreclosure. Moreover, a short sale can help the homeowner prevent bankruptcy which sometimes follows the foreclosure.
How It Works
A short sale is an option that is suitable for the borrowers who missed their payments on the loan and now are in a critical situation. A short sale is applicable when the value of the house is lower than the remaining mortgage payment. In this situation, the homeowner has to choose from two solutions to the problem – foreclosure or short sale. The owner of the real estate usually applies the second option when the value of the house drops by 20% or more.
The short sale may happen only if all the required conditions are fulfilled. The main condition is the approval from the bank. These are the documents signed by the loan company, usually the bank, which describes why the short sale is needed.
When the bank provides the approval, the investor, or the person who is going to buy the commercial or residential property, negotiate the conditions of the agreement with the owner of the property. Then the buyer receives the approval from the lender or the bank. Sometimes the deal may occur without approval from the loan company.
The drawback of a short sale is a great amount of time and paperwork required to close the contract. It usually takes about a year. On the other hand, if to compare with foreclosure, a short sale is a better option due to the fact that it does not affect a credit history to a large extent. Future lenders and mortgage companies see that the person had taken steps to solve the situation before it became critical and the bank repossessed the house or the apartment. After the short sale, the owner of the house may even purchase a property quite soon.
Foreclosure vs Short Sale
Foreclosure differs from the short sale in some respects. When the borrower fails to pay off the loan, the mortgage company repossesses the property. Foreclosure may take place when the owner of the house leaves the property. If the tenants do not abandon the property, then the lender evicts them during the foreclosure.
Foreclosures usually take a shorter period of time than a short sale because the mortgage company needs to liquidate the property quickly. The houses that passed into the possession of a mortgage company can be auctioned and bought by the investors.
Foreclosure always has a negative impact on the credit rating. After the foreclosure, the homeowner can not acquire the other property for a period of five years. The foreclosure will be on a credit report for a seven-year period.
Short Sale Deal
The seller should submit the short sale package to the lender. This package typically consists of financial reports, the letter that describes the financial difficulties experienced by the seller of the property and the copies of the documents.
Short Sale Offer
When the purchase is confirmed by both sides – the previous homeowner and the buyer – the real estate agent collects the following documents: the purchase offer, the listing agreement, preapproval letter by the buyer and the money check. Then the agent sends the listed papers to the lender.
Bank Confirmation Statement
After completion of all stages, the last step is to wait for the approval from the mortgage company. The bank analyses the short sale offer and provides either the approval or the denial of the deal that takes from a few weeks to several months.
Some Features of Short Sale Agreement
The procedure of acquiring the short-sell piece of real estate is similar to acquiring any other type of real estate, like property for rent. The only thing that differs is the amendment that requires the approval of the contract by the mortgage company.
Another thing that matters is the clarification that the property is being purchased in its original state. The buyer can include the point that in case of significant problems, the deal may be canceled, but this does not imply the price reduction. Also, the bank and the seller will not make the needed repairs. The mortgage company does not have the property in its possession in a short sale, as opposed to the foreclosure. On the other hand, the buyer will deal mostly with the bank than with the owner of the property due to the reason that the bank is required to approve the sale.
Advantages and Disadvantages of Short Sale
If you are going to purchase the property through the short sale procedure and then rent it out or resell it in order to gain the income, then you need to consider that such transactions usually take a larger amount of time than common deals in the real property investing business.
You should take into consideration that you will not receive the returns of this piece of real estate quickly, because mortgage companies usually handle the short offers for several months. However, you can try to set the deadline for the bank if you want to accelerate the process.
Pitfalls in Short Sale
The approval from the Bank
The investor should check if the short sale is approved by the mortgage company. If the seller of the property has not worked everything out with the bank, then the buyer needs a large amount of time to wait for the approval. In some cases, the mortgage company is not interested in the purchase if the foreclosure is more beneficial.
To avoid this pitfall, the investor who is going to buy the property through the short sale should make certain that the homeowner received the approval to purchase the apartment or house through the short sale. Also, the potential buyer of the property may involve a skilled realtor or real estate agent who specializes in short sales.
The Final Offer
The price for the property is usually defined by the buyer of the property. The seller is not authorized to put up the price of the house because it is regulated by the mortgage company. Sometimes the bank may reject the offer from the buyer, especially when it is lower than the price established by the mortgage company.
The response of the bank concerning the price for the property may take quite a long time, that is why it is better to look for the other variants while waiting for the answer from the mortgage company. A realtor can prepare the short sale agreement that implies the ability to reject the offer at any moment.
Good or Bad Deal
It is a moot point, whether the short sale transaction is beneficial for the real estate investor. On the one hand, this is a great opportunity for the novice investors to purchase the property which price is below the market value, and a perfect chance to get into the real property investing business buying the affordable property. On the other hand, mortgage companies are usually not interested to reduce the prices significantly. In most cases, banks make a thorough analysis of the market rates before setting the price for the piece of real estate.
One of the advantages of acquiring the property via short sale is the lesser risk that the property will be ransacked or trashed. The property may suffer from a lack of maintenance due to the financial circumstances faced by the owner. However, there is a great possibility that the piece of real estate will remain in a satisfactory condition because the owner of the property still lives in the property. If we take the foreclosure, the homeowners often do not maintain the property in a good state.
The Bottom Line
A short sale is a special type of deals in real estate investing. Every real estate investor must decide to himself or herself whether the short sale is suitable for him or her, or it is better to choose the other type of investing. Besides some significant drawbacks like the indispensable condition to receive the agreement from the bank, and quite long waiting time, the short-sell property may be the first step for the beginner investor to start this business due to the affordable price of the investment property.
A short sale has some above-listed pitfalls, that is why we recommend hiring a reliable real estate agent or realtor who will help you to avoid some difficulties and common mistakes. Also, he or she will consult you on how to make the contract with flexible conditions that allow you to reject the offer if the bank puts a very high price or if you face some other unforeseen circumstances.