Short sales have been in the news a lot lately. We’ve been hearing about the rise of short sales, and how they are becoming more common in the market than foreclosures. I’ve recently been reminded that short sale is a common term for those of us who work in this business, but might not be for everyone. Let’s take a look at what they are.
Let’s start with a “normal” transaction. Most homes are purchased with borrowed money. The owners make monthly payments to the bank to chip away at the balance of the loan. The difference between the value of the property and the loan balance is called equity, and hopefully that figure is greater than zero, and growing as the years go by. Building equity over time is a good thing, and that’s what happens when the value of the property goes up and/or the loan balance goes down.
After a time, most people feel the need or desire to move on, so they put their home on the market. It’s important to note that the value of the property is completely unrelated to the loan balance. Buyers do not care how much the seller owes on the mortgage; they only know what they are willing to pay for the property. As we’ve learned over the last few years, what buyers are willing to pay — what the market will bear, in other words — is not always greater than it was last year.
In a normal situation, what a buyer is willing to pay for a property is greater than the amount owed on the mortgage. In some cases, however, and it is becoming increasingly common, the value of the property is actually less than the mortgage balance. This is called being under water. When the property is sold, the proceeds of the sale fall short of the amount needed to pay off the loan that was taken out to buy the home in the first place. In that case, we have a short sale situation.
That’s really all a short sale is: the balance of the mortgage(s) is greater than the value of the property.
When this happens, and the property is sold, the sellers need to bring cash to closing to make up the difference and get the loan(s) paid off and released completely. Traditionally, if the sellers couldn’t do that, they would have to let the property go into foreclosure (or just give the deed to the bank in lieu of foreclosure) and deal with the consequences. The amount that can’t be paid off in a short sale is called a deficiency.
When a deficiency happened, it was usual for the borrower to be held liable for the deficient amount. In other words, the sellers had sold their house, but still owed a part of the loan to the bank.
Recently, though, it has become more common for the banks to fully release the seller in short sales, and not enter a deficiency. Why would they do that? In a word, economics. It is usually cheaper for the banks to process a short sale and settle for less than the full amount owed than to the send the property into foreclosure and/or deal with getting a deficiency judgment, which is a very expensive process in both time and money. With all the lawsuits being filed because of the way foreclosures were handled, it is usually in the banks’ best interests to accept a short sale and avoid foreclosure.
What does all this mean to a buyer? Truthfully, it means you’re about to enter into one of the most aggravating real estate transactions known to the modern world. Although it’s getting better, the process of buying a short sale home has not been efficient. Brokers spend hours commiserating about these transactions; they are the “war stories” of our times. Buyers need patience, intestinal fortitude, and great faith that it will all get done, however slowly.
The house itself, which you are about to make your home, is usually just a house like you find in any transaction. The fact that it is a short sale does not automatically alter or degrade the property. The short sale factor is strictly a “paper” issue, and the short sale allows the value to be reset to reflect the current market conditions. Still, though, get an inspection. Buyers should always know what they are buying, short sale or not.
So what’s next? Take your pick.
Yeah. You should probably do at least one of those things right now.