My family bought a short-sale property last year. What an incredibly rewarding experience - plenty of ups and downs. We waited 7 months for the deal to go through, and in the end we got a great deal. Since then, the market has fallen a bit further, but we are in our long-term dream home for a song!
If you can find the right property, and aren't fazed by bureaucracy gone mad (why did Bank of America decide to lose $100,000 by waiting 6 months?) or are buying as an investment home and are not emotionally attached it can be really worthwhile.
Before we start - it is important to acknowledge a feeling of guilt you may have at profiting from someone else's financial distres. What really helped me was to remember that while it is sad that people have arrived at a terrible financial point, by helping them achieve a short sale you are helping them get back on their feet more quickly. This is because it is better for your credit recovery to discharge through a short sale, rather than walk away, be foreclosed upon and then years later still be held as deficient and have to pay the debt anyhow.
What is a Short-Sale and Who Are the Parties in the Transaction?
A short sale happens when a property is sold, and the previous_loan-to-saleprice ratio of the property is larger than 100%. That is, the sellers' house loan is larger than the value of the house - the sellers are said to be "underwater".
Normally in a real estate transaction, there are the buyers, sellers, buyer's agent and seller's agent. In a short sale, the contract-of-sale is an agreement between the buyers and sellers with their respective agents as usual, but the sale is subject to approval by the investment institution(s) that own the mortgage. Many larger institutions hire a 3rd-party contrator who is called a "negotiator". The negotiator sits between the (buyer/seller) and the institutions, and is generally responsible for the gathering of information from buyer and seller, and assembly of offers for presentation to the investing institution.
The difficulty in achieving a short sale is to obtain contract approvals, via negotiators, from all interested investment institutions. This is compounded by the fact that there is no effective negotiation - many institutions take a "this it it" stance after one round of offer/counter.
In what ways does a short-sale differ from a regular sale from a buyer's perspective?
- You really are (indirectly) dealing with the investors not sellers. (Although Seller commitment is important - see later.) The fewer investors, the better. If they are large banks expect to have long periods of inactivity followed by disappointing offers. If they are investment consortiums it may be very hard to get everyone to agree to losses of large magnitude. So as a buyer there are many ways for a deal to fall through through no fault of your own. The offer you write needs to be attractive to the investors, NOT the sellers.
- You are subject to the resources the investors are putting in to handling short sales. At one stage, I think there were 600 short-sale contracts/deals for each staffed short-sale investigator at Bank of America – an impossible workload. You have to think about how to stand out in that crowd, so over-asking, they are never-gonna-get-a-better-deal and perhaps an injection of personal information (e.g. “my child will miss the start of school if we don’t close soon”) all help.
- It will be harder to make offers successfully on other properties if you are in contract on the short-sale property. This makes it very important to be sure you want the short sale property. We tried to compete on other houses while we waited for the short sale. Make sure you talk with any potential buyer's agents about this, and find out what the law says in your state.
- Sometimes mortgage and home-equity divisions at institutions are separate, so that they count as multiple investors. For example, Bank of America have different loans and home-equity departments. So even though it appears as if there is one institution, there are many in practice.
The Short Sale Process
This is an experience article, so the following is a summary of the short sale process my family went through.
- Make an initial offer with a reasonable 3% deposit as usual and have it accepted by the sellers. Make it contingent on the bank's responding within a certain time.
- Paperwork submitted to bank by the sellers, who have to document that they have no money to pay the mortgage. Make sure the sellers include this full statement of distress with the original paperwork, and as many other documents like tax returns, otherwise it will slow things down later.
- Don't do inspections yet.
- The contract / original escrow date will likely pass by with no bank response. Chill out.
- Extend the contract timeframes by having buyers and sellers sign addendums. Weekly or bi-weekly depending on how much you love scanning/signing. Chill out.
- First bank offer arrives through selling agent. The offer will be terrible. You will counter. Consider splurging for an appraisal to help justify any counter for your own peace of mind. Chill out.
- Offer/counter back and forth at most once more. On their second offer it is usually a take it or leave it stance from the bank. Months turnaround. Chill out. Take it or leave it :-)
- Paperwork goes to Bank #2 etc until all investors sign off. Unless there is only one loan. Chill out.
- Only get inspections done and contingencies removed after all institutions signed off, unless you need to do them earlier to remove contingencies to show you are serious.
- Proceeds as normal through escrow at the end.
- Beware that any other debtors of the sellers can make a claim against the escrow, up until the last minute. At that point, the sellers cannot pay since they are supposed to be distressed, so it will be up to you as buyer to pay. (for example, the IRS blocked the sale until some back-business-taxes were paid in our case, so I ended up paying the back-taxes through escrow to ensure the deal).
- Close and throw a party!
Where does the Stress Come From?
The stress that people talk about manifests in these ways:
- not knowing the process before you start
- when you feel like you are waiting too long with no response from sellers or institutions
- discovering there are more investment institutions than you realized that need to weigh in
- thinking that the bank is anything but a number-crunching heartless creature by personifying them or rationalizing their behavior (it's all just numbers, baby! but is has to get to the right person's desk first.)
- worrying the sellers may let maintenance of the property go downhill or damage the property, or remove fixtures while you all wait. (logically, there is no point worrying about something you cannot control. Write a clause and hope for the best. emotionally, this is what was hard to deal with when fixtures are removed and a pool starts going green and scaly).
How can I prepare for buying a short-sale property?
Reading the above is a good start! Before you start, you have to find a property(!) and make sure you've discovered all there is to know about the agents and the sellers. You will all be working together for some time, so this is worth it.
- Find a property. This is the hard part always :-).
- Research the selling agent. You are not buying the house from the sellers, but rather the institutions invested in the mortgage. However, you still need committed sellers and a great relationship with the SELLING agent who needs to be as transparent as possible, because ALL communication with the institutions goes through them. We found out about the business dealings and partners of the selling agent, their recent track record and their relationship with the seller (how did the seller find the selling agent?).
- Research the seller. Do they owe any back-taxes from previous businesses? Are there any debts that they are not disclosing to the institutions? This information can be hard to find, but it will save much stress if you can look at their finances/debts early, to try to determine if they are trying to hide some assets or debt. Have the sellers filed tax returns for previous years? All of these factors can slow down the deal for weeks at a time if everybody is not being straightforward. How committed to the short sale is the seller? Will they just walk away while the banks ponder? Why not?
- Find a buyer's agent who has experience with short-sale buyers. I was lucky in that we had a great agent from an office with plenty of experience. Make sure that your agent has a great relationship with the selling agent. If you are in the Bay Area, ask me and I'll give the reference of the best agent around.
- Line up a friendly mortgage broker: Work with a broker who can issue fresh approvals easily, because after 90 days where I live you need to get re-approved usually. Keep your credit clean through the entire short-sale, and originate the loan only after all contingencies have been removed as usual.
Now that you know the people involved, it's time to dig in to some specifics on the property, asking price and the sellers.
- Were there any prior recent listings of the home, or any recent bank offers? Oftentimes there may have been a previous short sale process that fell apart. Depending upon the reason it fell apart, you may have a large advantage and skip some steps at the bank, because they already have stated a position on what they can accept. If it fell apart because the buyer pulled out, having got a final offer from the bank, you have skipped about 2-3 months of waiting. If the deal(s) fell apart because the bank refused a buyer counter-offer, you at least have some data to work with. The easiest way to find this out is from the selling agent, if they are kind enough to share...
- How did the selling agent arrive at the asking price? How does this relate to comparable homes in the neighborhood? How many loans are current on the property, what are the values and what kinds of institutions hold the loans?The selling agent needs to carefully justify the asking price. Investors are unlikely to accept large losses. The exact formula varies apparently. It is wise to be the highest cash offer, and above asking if the comparables determine so. You might consider paying for an appraisal (I did) to work out if your offer (especially if over asking) is justifiable.
- Are there other offers on the table right now, or other interested parties? If you make an offer, will they still look at other offers with less cash? Once you make an offer, it helps if the seller chooses to reject other offers, especially if they are for less money. Multiple offers confuses the institutions and causes delay. Ideally the selling agent simply presents one (best) offer, above asking, and at a high repayment percentage for the investors.
Short-sales offer fantastic potential, with many ways to fall through. If a deal sounds too good to be true - it is. Do the research on the asking price, get an appraisal to double-check you are not wasting money.
Make your offer appealing to the investors: a sole offer that is over asking and comparable with other recent sales seems to work well.