This article discusses how to buy a short sale house from the homeowner, how short sale transactions work, and essential steps for success.
House flippers are always interested in getting a great deal on a home. Purchasing short sales can be very profitable if done right. However, this is only true if the buyer understands the short sale process entirely.
What Are Short Sales?
When a person selling a house is “short” the money needed to fully repay the mortgage lender, a short sale occurs. In a short sale the homeowner sells his or her property for less than the amount owed on their mortgage
A short sale transaction can only be made when the seller’s lender agrees to accept a reduced mortgage payoff amount and release the seller from his existing mortgage.
Who Are Short Sellers?
Short sellers are generally people who a) are in financial distress of some sort, and b) cannot sell their home for a sum greater than the mortgage on the house.
Short sellers can be young couples caught in a house flip gone bad, a single parent who loses their primary job, an elderly person with a HELOC and high medical bills, etc.
Short sellers are essentially anybody who owes more on their mortgage than the home is worth on the open market. They’re stuck with a home they cannot afford, and are desperate to get out without declaring bankruptcy or losing their home in a foreclosure.
When Lenders Accept Short Sales
Even though mortgage lenders lose money on a short sale, they may consider short sales in these scenarios:
SCENARIO #1: The borrower can’t make his or her monthly payments, is underwater (the market value of the house is much less than the mortgage) and does not have enough money to pay back the balance of the loan. Foreclosure is imminent or in process.
SCENARIO #2: The borrower is in financial distress and needs to move out of the property for health or other critical reasons. The lender believes it is only a matter of time before the borrower is incapable of paying for the home. The lender agrees to a short sale to avoid foreclosure, which is usually more expensive.
SCENARIO #3: The mortgage loan was made at the top of the market, the borrower has bad credit or has missed payments, other homes in the neighborhood are being sold short, and a buyer with a stronger credit rating wants to purchase the house.
How the Short Sale Transaction Works with a Homeowner
A short sale is similar to making a normal house purchase, except the seller is not in control of the sale price.
Short Sale Application
The homeowner will need to contact their bank and complete an application asking to be eligible to sell the home in a short sale. This is typically done after the homeowner receives an offer and accepts it “subject to bank approval”. But it can also be done before the house is listed for sale.
If the market value is substantially below the mortgage balance, and the seller is not in foreclosure already, the seller may be eligible to make a short sale.
Making the Offer to the Homeowner
The prospective buyer makes a formal offer in writing to the homeowner. The seller must first accept the offer before it goes to the lender for approval.
The buyer will also have to provide other documents, an earnest money deposit (1-3% of sale price), and proof of funds. Lenders will expect to see the buyer’s loan pre-approval letter or proof of cash available to make the purchase.
Bank Review and Approval
Upon review of the homeowner’s short sale application and the buyer’s written offer, the bank will conduct an appraisal to get an estimate of the market value of the home. The loan officer will also review the borrower’s payment history and financial condition to understand the probability of receiving the full mortgage amount.
The bank will then estimate the cost of accepting the short sale offer versus foreclosing and selling the house at auction. If the homeowner is not in a loan modification program, then the bank may attempt that remedy first before agreeing to a short sale.
If the homeowner has already received a loan modification and is still behind on the modified mortgage payments, then a short sale is preferred by banks over foreclosure. Foreclosures are very expensive and lengthy, and the bank is likely to recover more in a short sale than at auction. In this case the short sale application is likely to be accepted by the bank.
If accepted, the bank will send an official letter to the homeowner agreeing to a short sale. This does not mean the bank has accepted your offer — only that the bank will consider allowing a short sale.
Homeowner is Approved to Short Sell
The homeowner MUST have this short sale acceptance letter in hand for the deal to proceed. This is essential.
Remember, short sellers are in financial distress and will often do anything to get cash and avoid making mortgage payments. If the owner lists his property for sale below the amount of the outstanding mortgage, this generally violates the mortgage agreement and can constitute fraud.
A short sale is not valid unless it is done with the express prior written approval of the mortgage lender. Beware of a seller willing to quitclaim deed the house to you — in most cases this will not deliver clean title, and you may become responsible for the remaining mortgage balance(s).
Always demand the bank’s short sale acceptance letter. If the seller presents one, then he or she is a valid short seller.
Offer and Negotiation
The buyer now makes a formal written offer on the home. This is conveyed to the homeowner and the bank’s agent in writing.
The purchase offer will be reviewed by the loan officer, bank treasurer(s) and other parties responsible for protecting the bank’s capital. The offer may need to go through a periodic committee review along with other short sale offers before a written response is received. This can take anywhere from several days to weeks.
The bank will generally not accept the first short sale offer price. Banks will generally approve short sale offers that are between 5% to 10% percent under estimated market value. Anything below that and the bank will reject the offer.
Expect the bank to come back with a counter-offer. This may go back and forth for a few rounds as the lender tries to recoup as much of the homeowner’s mortgage balance as possible.
Sale and Release
Once the offer is accepted and payment is made, the title documents are prepared and the sale is completed.
At this point, the original homeowner is fully or partially released from his or her mortgage obligation to the bank. The bank accepts the new value of the home and takes a write-off of the remaining unpaid mortgage amount. The new owner takes title under different mortgage financing and the deal is done.
Things to Consider Before Making an Offer to a Short Sale Homeowner
Short sales can be more complex and take longer than other real estate purchases. Very few short sales are closed in 30 days or less. Flipping short sale houses rewards patience and perseverance.
There are Two “Sellers” in a Short Sale
In a short sale situation, you are essentially negotiating with two parties: the homeowner and the bank. If the homeowner accepts your offer amount, this does not guarantee that the bank will accept the offer. Expect significant delays between making an offer and getting a response, since banks are not enthusiastic about selling for less than the outstanding mortgage.
Research the Property Carefully
Because short sellers are generally in financial distress, they will often do anything possible to get more cash and stay in their home. This includes taking out second and third mortgages, HELOCs, ignoring foreclosure notices, hiring third-party services to negotiate their loans down, etc.
This stack of financial obligations can create a mess with multiple liens and judgements against the property. This is not something you want to buy into!
Make sure you conduct thorough research before making any short sale offers. You must identify:
- Who is on the title (title search)
- If a foreclosure notice has already been filed (title and/or judicial record search)
- How much is owed to all possible lenders (first, second, third mortgages and HELOCs)
Short Sale Homes Come “As Is”
Homes bought as short sale purchases are bought “as is.” This means that the lender will not allow the seller to pay for things like home protection plans for the buyer; termite, pest, or roof inspections, or other repairs.
Therefore, short sale buyers must conduct their own inspections, buy their own warrantees, and expect to fix problems (often big ones) with the house.
An Experienced Agent Can Really Help
Buyers should also hire agents who have experience with multiple short sales. Agents can help expedite transactions, act as a competent middleman between the bank and buyer, organize title searches and insurance, and protect the buyer’s interests.
Where There’s Smoke There’s Fire
Where there is one short sale there are likely to be many others.
Short sale buying opportunities increase substantially after a real estate bubble. Entire neighborhoods and towns can be “underwater” on their mortgages. At the same time a downturn in the economy can lead to many homeowner’s losing their jobs.
If you see a number of short sales in an area, then it’s a good idea to walk the neighborhood asking owners if they know of people looking to sell. You can also hand-drop or mail letters to homeowners in those ZIP codes and turn up some good investment opportunities.
Advantages of Buying from Short Sale Homeowners
Although buying a short sale from the homeowner can be time-consuming, it can offer great advantages, as well. For house flipping investors, short sales allow you to buy homes below market value. There is much less competition for these homes due to the complexities and time it takes to buy a short sale from the homeowner.