How can you buy a home in a short sale?

With so many homeowners unable to pay their mortgages, some have turned to unconventional solutions like short sales to prevent foreclosure. See more real estate pictures.
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During the housing crisis that began in 2006 and 2007, a new term began to bubble up in the public consciousness. With so many homeowners unable to pay their mortgages, some began to turn to unconventional solutions like short sales to prevent foreclosure. A short sale is a real estate transaction that involves a homeowner getting permission from their lender to sell a house to a perspective buyer for less than the total value of the loan [source: Fontinelle]. The transaction is between the buyer and the seller, but it requires approval from the lender, who will forgive the unpaid balance and take a loss in order to get the troubled property off its books.

Lenders often make these deals when an owner has defaulted, to avoid foreclosure proceedings. For lenders, foreclosures involve making repairs, listing and marketing the homes for sale, and sometimes even evicting reluctant homeowners. All of that costs money, so if the lender thinks it can ultimately reduce costs by agreeing to a short sale, it will [source: Dempsey]. Short sales can also make a lender's financial performance seem more attractive to investors, since they aren't listed as foreclosures on lender balance sheets [source: Dempsey]. Of course, sellers would much rather make a short sale than go through foreclosure, because it is much less damaging to their credit, and buyers can benefit by getting a below-market price for a home [Source: Fontinelle].

But short sales aren't necessarily win-win situations. Lenders can be reluctant to accept them because they are guaranteed to lose money, by definition. Depending on the property and the condition of the local real estate market, the lender may choose to foreclose, instead, and try to make a profit by selling the house at auction. If you want to buy a home as a short sale, you need to convince the lender that it's a better idea for them to lose money in the short term instead of investing in a potential liability [source: Dempsey]. Making that case is a long process that involves large amounts of documentation and paperwork on your part. On top of that, short sales are always "as-is" transactions. So, once the sale goes through, you as the buyer have to pay for all needed repairs [source: Foust].

Short sales are definitely not for the faint of heart. But if you are in the market for a home and willing to sweat a little to save some money, read on to find out how to make a short sale application.

The Application Process

Make sure your contract includes a stipulation that says it only takes effect after the lender's approval.
Make sure your contract includes a stipulation that says it only takes effect after the lender's approval.
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When picking a short sale home, check your broker's listings, online search engines and local ads for listings of approved short sales. These are the best listings for the buyer, because the seller has already negotiated a price with the bank. Approved short sales will save the buyer most of the steps we'll describe next [source: Foust]. Most listed short sales will require bank approval, so it's a good idea to take listing prices with a grain of salt. They could be priced low to entice buyers, and you could end up paying more in the end [source: Fontinelle].

You should also consider what repairs might be needed, since they will be your responsibility. A dirt cheap listing might not be worth it if you have to spend thousands of dollars on renovations. Also, find out early about any secondary lenders on the house, including second mortgages. Secondary lenders will need to approve the deal, also, which can complicate the transaction [source: Foust]. When the time comes to negotiate a price with the seller, proceed like you would with any other home purchase, with one crucial difference. Once you agree on a price, make sure your contract includes a stipulation that it only has effect after the lender's approval, for your own protection [source: Fontinelle]. Purchase contracts are legally binding, so putting in that clause protects both parties from being sued by the other if the deal falls through [source: Evans].

After you agree on a price with the seller, you need to submit an application to the bank. That application will include the signed contract, a letter from the seller authorizing the lender to discuss the mortgage with a third party (you), your basic identifying and financial information, and an appraisal of the home's value. You should also submit detailed documentation, including photos and cost estimates, for any needed repairs. This will help persuade the lender that foreclosing would cost them more money than cutting their losses now. Finally, the seller will need to provide a hardship letter explaining why they will be unable to repay the loan, along with financial documentation to back it up [source: Dempsey].

Once you submit your offer and application, the lender can take its time replying. It might be months before you hear anything, and they could reject it without negotiating, or completely ignore it [source: Fontinelle]. So, be prepared to negotiate if they give you a counteroffer, and have a firm ceiling in mind [source: Dempsey]. While you wait to hear back, you might want to continue your search. Short sales, even more than other types of home sales, are never a sure thing.

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Sources

  • Dempsey, Bobbi. "10 Steps to 'Short Sale' Buying." Bankrate.com. (March 3, 2011)http://www.bankrate.com/finance/money-guides/10-crucial-steps-to-short-sale-buying-1.aspx
  • Evans, Mariwyn. "Sold up Short. How to Succeed in Short Sales." REALTOR Mag. June 2007. (March 16, 2011)http://www.realtor.org/archives/feat1200706
  • Fontinelle, Amy. "Purchasing a Short-Sale Property." Investopedia.com. (March 3, 2011)http://www.investopedia.com/articles/pf/08/purchase-short-sale-property.asp
  • Foust, Todd and Jennifer McNamara. "Top 10 Home Buying Tips for Short Sales - A Guide to Understanding Short Sale Foreclosure Real Estate." April 8, 2009. (March 3, 2011)http://realtytimes.com/rtpages/20090408_buyingtip.htm
  • Lawyers.com. "Buying a House in a Short Sale." (March 3, 2011)http://real-estate.lawyers.com/residential-real-estate/Buying-A-House-In-A-Short-Sale.html
  • RealtyTrac. "How to Buy Foreclosures." (March 3, 2011)http://www.realtytrac.com/foreclosure/how-to-buy-foreclosures.html