If you are in the market to buy a home, you have no doubt heard the term “Short Sale“. No, this does not refer to sellers who are under 5' tall. A “short sale” is industry jargon for a seller who owes more on the property than what it is worth. The seller in this situation needs the lender to accept a “short” loan payoff, or in other words accept less than the full amount due on the loan. So how does that effect you the buyer?

First of all, short sales require the lender to agree to the reduced pay off of the mortgage. Therefore, when you negotiate on a short sale, you are negotiating with two parties: The seller who owns the property, and the lender who holds the loan. You need the approval of both parties to get your offer accepted. It is important to make sure the seller has received preliminary approval from the lender, because if the lender does not agree to the terms you will have no contract. Therefore, it is important to question the seller and/or the seller’s agent to make sure the process is in place, and that the bank will cooperate. This process requires the seller to submit documentation to the lender demonstrating hardship, along with evidence that the market value is less than the outstanding loan.

Secondly, be prepared for a long process. Dealing with banks in a situation like this can sometimes be comparable to getting allergy shots… it can be a long, drawn out, and ultimately aggravating experience. Often, you are dealing with layers of bureaucracy, and this can slow the process down. So short sales usually require patience on the part of buyers. It is also important to have interest rate protection during this process. In a normal transaction, buyers will typically lock in interest rates for 30 to 60 days. That may not be enough time for a short sale, and you want to avoid being 45 or 60 days into the sale only to find out that your rate lock expired, and your interest rate just went up 1/4%. Plan for the worst case. It is good practice to include in the purchase agreement a time frame for lender approval, with a clause that gives the buyer the right to cancel the transaction if the lender does not approve the sale after a certain period of time. This way, as a buyer you are free to pursue other properties if the lender is dragging their feet.

Thirdly, be prepared for potential issues at close of escrow if the owner is still living in the home. Often times, sellers in this situation are angry and frustrated, and on occasion can damage the property, remove appliances, fail to maintain the landscaping, leave the property dirty and full of debris, or take other actions that will cost you money. Be sure to do a walk through prior to close of escrow. Since the seller theoretically has no money, any issues at close typically have to be negotiated with the bank.

Lastly, lenders like to sell properties “as is” in these situations, as they do not want to get into negotiations over property repairs. This is okay, but make sure you as a buyer have the right to inspect the property to your satisfaction, and the ability to cancel the contract if the inspections uncover issues with the property. And if there are issues that come up, you can certainly request that the bank resolve them. They are under no obligation to do so, but if the request is reasonable and it makes business sense for the bank to agree, they usually will.

Short sales can be fairly straightforward, or very complicated. This depends on the stance of the lender. Some banks are much easier to deal with than others when it comes to short sales. As always, you should seek out an experienced, professional real estate agent to help you navigate these waters.

Of special note is any non-arms length transaction involving a short sale.  A non-arms length transaction is a sale in which the buyer and seller are related.  For example, a son buys a home and then falls behind on his mortgage.  The parents want to step in and bail him out so the home does not get foreclosed.  In a common sense world, it would only make sense that the parents could do this and prevent a foreclosure, thus saving the son from a foreclosure on his credit report and the lender from losing additional funds trying to sell the home after foreclosure.  However, with the fall of the subprime market and the increasing scrutiny of mortgages, I recently had such a transaction turned down by three major investors.  They simply will not touch a non-arms length short sale.  The parents ended up having to secure the loan from their investment banker and not use a traditional mortgage.