At first glance, the term “short sale” invokes thoughts of a quick turnaround time in a real estate transaction. For example, a house in Washington D.C. goes on the market one day, and buyers hastily write offers the next. While this seems like a logical interpretation, a short sale actually has nothing to do with the time it takes to sell a real estate property.
Instead, a short sale refers to being “short” on money, specifically on the amount needed to pay the seller’s mortgage in full. In mortgage lending, a borrower pledges his or her house as collateral. This is why mortgages are often referred to as asset-based loans (with an asset being a house) or secured loans (since they are secured by the property). If the borrower fails to pay the mortgage as agreed, the lender has the right to claim his or her house to recoup the losses.
However, in some cases, a property might be worth less than what the borrower actually owns on it. It puts both the borrower and the lender in a difficult financial situation. The borrower cannot just list and sell the property to a buyer with the highest offer since even that highest price is not enough to cover the mortgage balance. On the other hand, the lender is aware that going through the regular foreclosure process might not be the best route to take. Foreclosures are lengthy and costly for the lender and, when the property is worth less than its mortgage balance, might be more pain than gain. In such cases, the lender can decide to accept an offer that is below what is actually owned but nevertheless minimizes their losses. If this is the case, the lender approves, aka gives permission to, the short sale to proceed.
The short sale process in Maryland, Virginia, Delaware, and Washington, DC hinges on a bunch of factors aligning just right.
A home seller evaluates all options
First, the homeowner’s financial difficulties can’t be resolved in other ways. A lender is likely to examine other options to resolve the homeowner’s debt before consenting to a short sale. The homeowner must truly be facing financial hardship. To be considered for a short sale, the homeowner submits financial documents and a hardship letter explaining the situation.
Lenders agree to a short sale
Second, the primary lender – and any other lienholders – must agree to the sale. When transacting a short sale, the seller’s lender is the boss. A lender (not the homeowner) negotiates the sale. The lender has the authority to accept an offer, submit a counteroffer, and lay out the terms of the real estate transaction. In addition, the lender pays for an appraisal and is instrumental in setting a listing price. A real estate agent lists the property for sale. (Read about short sales from the perspective of a real estate agent in this National Association of REALTORS article: https://www.nar.realtor/short-sales-foreclosures). Short sales are listed in the MLS system and identified by a specific disclosure: The 3rd Pary Approval Required. The term “third party” refers to the lender, with a seller and a buyer being (traditionally) the first and the second parties.
Buyers submit offers to purchase
Lastly, a qualified buyer or buyers – with approved financing and earnest money – submit an offer to purchase the property. When selling real estate through a short sale, the buyer cannot be related to or affiliated with the seller. The buyer makes a reasonable offer which the lender accepts or counters. Negotiations continue until a deal is reached or the sale falls through. With multiple parties involved, the sale process often is lengthy and complicated, especially if there are multiple mortgages or liens on the property. It’s not uncommon for the process to take six months or longer. In addition, there is no guarantee that a short sale would go through as only half of them get approved by a lender.
A short sale avoids foreclosure
When all of these factors work together, a short sale is a done-deal. The homeowner avoids foreclosure and is freed from all or some of his mortgage obligations. The homeowner’s credit rating takes a hit but is likely to recover quicker than with a foreclosure. The lender saves the time and money associated with foreclosure and avoids the risk of losing even more money by selling the home in a foreclosure auction.
Home buyers can get a good deal
For real estate investors, short sales represent an opportunity to buy a property well below market value. Unlike with foreclosure auctions, there is plenty of time to conduct the title search, appraisal, and home inspection to minimize your risk. In addition, homes sold as short sales are typically less distressed physically than foreclosures and might require fewer and less-extensive renovations.
If you are a real estate investor interested in the short sale route, talk to your realtor first. An experienced real estate agent should be able to set your expectations regarding how many short sales are typically in your area at any given time, the typical approval rates and time frame, and what kind of discounts you can count on. You can also search for short sales on your own on sites such as Zillow.