Short sales help homeowners reduce or eliminate the financial pressure of their mortgage. They also present an opportunity for buyers.
When a person sells their home, they usually hope to get as much money as possible from the sale. But first, they must pay off the remaining balance on their mortgage. Ideally the home has increased in value so they will have money left over after paying their mortgage and other closing costs.
Sometimes, a home’s likely sale price will not give the homeowner enough money to pay the full mortgage balance. A short sale is a type of real estate deal that could give the homeowner relief from the mortgage debt that the sale will not cover.
The following is an overview of short sales, how they work, and when they might be a good idea.
What is a short sale?
A short sale is when a home is sold for less than what’s owed to its mortgage lender. The lender either writes off the unpaid portion of the mortgage or works out alternative payment arrangements with the seller. The remaining payment may turn into a new, smaller loan. Dues may be delayed to a later time. Short sales are meant to help sellers in financial distress while minimizing the losses to a mortgage lender.
The buyer gets a home at around market value free of the lender’s lien. The seller gets some relief from financial distress. The lender avoids various risks associated with distressed properties, such as the possibility that a seller with an “underwater” mortgage may walk away and allow it to go into foreclosure.
» READ MORE: The Foreclosure Process
The financial crisis that began in 2007 saw many short sales as home prices dropped below their outstanding mortgage balances. The lender must agree to the short sale since they would be accepting less money to close out the mortgage. They might do this in order to avoid the hassle and expense of foreclosure.
How does a short sale work?
In order to conduct a short sale, the mortgage lender must agree. Typically, this requires proof of two factors:
The seller is underwater on their mortgage. A lender will want to see information on recent sales of comparable properties to establish the home’s market value.
The seller is experiencing financial hardship that prevents them from paying the remainder of the mortgage after sale of the home.
Once the seller and the lender have worked out an arrangement, the seller may proceed to list the property and look for a buyer. The lender will receive a reduced payoff at closing, and then they will release their lien on the property.
Some real estate investors use short sales to purchase distressed properties that they can fix and flip. They may use a variety of means to find homeowners who could benefit from a short sale. They may also take the lead on negotiating with the seller’s lender.
What if the lender doesn’t agree to the short sale?
Mortgage lenders are not under any obligation to agree to a short sale. In almost any situation involving a short sale, they will be receiving less than the amount owed to them under the terms of the mortgage. The main benefit to a lender is avoidance of an even greater hassle.
What are the alternatives to a short sale?
Short sales tend to occur when a homeowner is in dire financial straits. It might not be the only recourse, though, especially if the homeowner doesn’t want to sell. Depending on the circumstances, a homeowner might have other options.
The most important step in the short sale process is convincing the lender to agree to a reduced payout or a substantially modified payment arrangement. It might be possible for a homeowner to negotiate modified loan terms, such as reduced monthly payments, while they get back on their feet.
» READ MORE: Mortgage Forbearance and Deferment
Private Mortgage Insurance
Lenders require homebuyers to purchase private mortgage insurance (PMI) in various situations. For example, if a buyer’s down payment is less than 20% of the purchase price, they must obtain PMI. If a PMI company believes that the homeowner’s financial situation will improve, they might be willing to cover their mortgage payments for a time.
Pros and Cons of Short Sales
For buyers, a short sale offers the opportunity to obtain a home at a relatively low price.
The lender avoids various risks associated with distressed properties, such as the possibility that a seller with an underwater mortgage might simply walk away and allow it to go into foreclosure.
For sellers, they no longer need to be concerned about paying the mortgage.
Short sales can take longer to complete other home purchases because of all the approvals that must come from the lender. This may be discouraging to a buyer.
Buyers may find that properties involved in short sales tend to be distressed.
The process of getting approved for a short sale as a seller can be expensive. It may require an appraisal and various other services.
Whether a homeowner does a short sale or gets a loan modification, it will have a negative impact on their credit score. Buying a home after a short sale may require waiting some time, making a larger down payment, having less debt, and more.
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Buying a home can be a complicated process, especially where financing is concerned. With the right guidance from an experienced mortgage advisor, you’ll be educated on the risks and many advantages of home ownership. The professionals at The Wood Group of Fairway are here to help. Get started on your free pre-approval today by answering a few questions.