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Monday, August 2, 2010

WHAT IS A "SHORT SALE" in REAL ESTATE?


You might have heard the term “Short Sale” from time to time. But what exactly is a “short sale?”

Bear with me, I’m going to get real basic here for awhile: First let’s define the term: “Short” from the phrase “Short Sale.”

When the value of a home becomes significantly less than the amount owed on the home, it is said to be “short.” That’s slang for less of the actual value. The home “falls short” in value.

For instance, the owner has evidently let himself get into a financial bind. Obviously he can’t wait the years it will take for inflation to bring the value back up to what it was when it was purchased. And, he can’t afford to make the scheduled house payments.

This is a term people call being “upside down.”

What happens? The borrower either has to sell the property or face foreclosure. All of this means the proceeds from the sale of the home will “fall short” of what is owed the financial institution.

Possibly the solution is to make a deal with the bank to accept less than the amount owed. Yes, banks can do that. Especially in today’s slow housing market.

The bank has two choices: Accept the “short sale” and take a loss, or allow the home to go to foreclosure. As explained in my previous blog, no one really likes foreclosures.

In a foreclosure, the bank is stuck with real estate owned (REO). The problem: If the bank now owns the home, it must continue upkeep of the home, pay utilities, pay taxes, and keep it secure from vandals.

In a true foreclosure, the borrower would normally take a heavier “hit” on their credit score. In this topsy-turvy housing market with record numbers of foreclosures happening, the foreclosure typically no longer holds such a threat to the credit score.

Today a short sale and foreclosure hold similar “hits” to the credit score. Which sounds strange to me, but I understand that’s the case.

In a “short sale” the bank and borrower agree to sell the property for less than what is owed on it. The bank agrees to “take a loss.” The bank agrees to allow the borrower to sell the property as a loss. But this does not absolve the borrower from his debt to the bank.

The borrower may agree to sign a note for the balance of the loan not recovered in the sale of the property. Not all borrowers or banks do this. Why would a borrower even want to do this?

THE SHORT SALE:
Short sales are not good for the neighbors. The home is now on the market for substantial lower price than the competing properties. (This brings down property values)

Let’s say the home has a mortgage on it for $300,000. The seller (who is also the borrower) puts the home on the market for $240,000. This results in a $60,000 short fall from the borrowed amount.

Suppose someone wants to buy the home at the short sale price. The seller then signs a contract with a buyer to purchase the home for $240,000. That’s not the end of it. The bank must now approve the proposed buyer and the sale amount.

HINT: In all “short sale” advertising you’ll see the terminology like: “subject to third party approval.”

Normally, the bank has “underwriters” (those are the hierarchy of people who must approve the amount of sale, and buyer). This underwriting may go through several “levels” of approval by the bank officers before the loan and buyer are approved. This delay can last for six months or more! Banks do not hurry this procedure.

Short sales are usually the LEAST EXPENSIVE WAY to buy a home. But it is also the most time-consuming, and even heart breaking. For example:

The bank “approves” the sale between the borrower and the buyer. A closing date is set for 45 days from the date of approval.

But it’s not over… If on day 44, someone else decides they like the “short sale” house they may put an offer on the home. The new buyer may make an offer to the seller for $250,000. Even though there’s a contract on the table for $240,000, the seller will likely present the new offer and throw out the $240,000 offer, EVEN UP TO THE TIME OF CLOSING, and kick the original buyer out of the picture.

Unfair? Not to the bank, seller, or new buyer. It’s just unfair to the original contract holder who’s losing a good buy on a home.

Buying a home on “short sale” can result in a MAJOR savings, but it can also be time consuming and very frustrating. If you decide to buy a “short sale” home, you need to be prepared for heartache and very long time delays by the bank.

As a result of today’s pretty bad housing market, the borrower may choose to just go into foreclosure, instead of hassling with bank in a “short sale” that may or may not go through. This is especially true today when the “hit” on the credit score is about the same. This happens more and more all the time. (And foreclosure also has its privileges.)

I’ll talk about the “foreclosure” process in another blog.

Good Luck!