I often find myself trying to quickly explain short sales to clients. I teach a 3 hour class on selling and buying short sales… it is not a subject that lends itself to quick explanations. But, here is the short version with some of the main points:
Short sale definition
A short sale is a transaction on the sale of a property; where the net proceeds from the sale will not cover your total mortgage obligation and closing costs, and the seller does not have other sources or money to cover the deficiency.
Short sale example
Owed on First Mortgage $280,000
Owed on Second Mortgage $ 25,000
Seller Concessions $ 6,250 (2.5% of sale price)
Sales Cost $ 25,000 (10% of sale price)
Total needed to close $336,250
Sale Price $250,000
Shortage ($ 86,250)
If the seller does not have $86,250 in cash that they can use to overcome the shortage, this would be a ‘short sale’.
What is the pre-requisite to a short sale?
You must have some hardship that prevents you from continuing to pay your loan: divorce, job loss, death, illness, etc.
Why would a seller consider a short sale?
There are lots of reasons, but the main reasons are:
- It may be the only way to sell the property when you have to sell for some reason (job change, illness, divorce, etc.)
- A short sale is far better for your credit rating than a foreclosure
- In Washington state, the 2nd mortgage holder can come after you for the balance due after foreclosure, and the seller is typically asking the lien-holders to forgive some or all of the debt.
Why would a lender approve a short sale?
It may be financially better for them than foreclosing on the property. Foreclosing costs the banks money, and they probably can’t sell the house for any more after foreclosing. In Washington state, in foreclosure, the 1st lien-holder can’t go after the owner for the difference between amount owed and the price the property sells for at auction. So, approving the short sale may just make financial sense (especially if the government helps cover the loss).
Why would a buyer purchase a short sale?
Price – short sale properties typically sell at a discount to ‘market’. This is to overcome challenges we list out below. Buy purchasing a short sale you can typically get a property for a better price, and possibly get a property you could not afford otherwise.
Why do short sale properties sell at a discount?
- Long transaction time – It can take a long time to get the bank approval for the sale (you don’t get the approval upfront, typically). Many buyers are unwilling to wait the time it takes… in some cases, up to a year. This also tends to mean the price negotiated upfront assumes a downward trend in the market over that period.
- Deferred maintenance – In many cases, an owner who can’t afford to keep a property can’t afford to maintain it either. So, the property may have some deferred maintenance. You want to make sure the price makes up for the extra costs of fixing these items.
- Competition and market trends – Some neighborhoods have many short sales and/or foreclosed homes. This creates competition and pushes prices lower and lower. If there are few short-sales in a neighborhood, the 1 or 2 that are there may not be discounted much.
For more information, check the page for our Short Sale class.