The Ultimate Guide In Investing in Short Sales

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Since real estate investors are always looking for affordable properties, short sale homes often spike their interest. However, their bad reputation sometimes makes beginner investors think twice before taking the next step.

What is a short sale in real estate? What’s so risky about short sales, and how can you as a real estate investor minimize that risk?

This article will help you understand short sales and decide whether or not a short sale home is the right fit for your next real estate investment. 

What is a Short Sale in Real Estate?

Short sale homes are distressed properties being sold for a lesser amount than what the owners still owe on their mortgage with the lender's approval. 

The sale proceeds go to the lending institution, and the lender may forgive the difference between the sale price and the mortgage amount.

Next, we’ll look at how a short sale works. 

How Does a Short Sale Work?

A short sale has many differences from other real estate sales. 

The borrower’s must document the hardship they are currently facing and why the loss of their house is unavoidable. 

They must provide a property valuation analysis — the closer the fair market value of the property is to the outstanding mortgage balance, the more likely it is to approve the short sale. 

They should also explain why they cannot afford to make payments, which can include:

• loss of income 
• illness
• death of a spouse
• divorce

The borrowers must then send both the file and a short sale application to the lender and list the property for sale. 

Keep in mind that it’s best to work with a real estate agent familiar with short sales to come up with a listing price and handle the transaction. 

Once the seller has an offer in hand, they will need to submit it to their lender along with the short sale package. 

The lender's loss mitigator reviews the offer and the file. It is often the lengthiest part of the short sale process since the lender has no incentive to rush along. 

They may either approve, deny, or negotiate with the would-be buyer until an agreement is reached. 

Real Estate Short Sale Example

If you’re still asking “What is a short sale in real estate?”, let’s look at a short sale example.  

Let’s say Buyer X buys a house at the peak of the market for $500,000. 

They borrow $400,000 from their bank to complete the transaction. 

However, three years later, the real estate market crashes. 

Borrower X loses their job and is therefore unable to make their mortgage payment. Besides, the market value of the property has dropped to $250,000. 

X still owes $300,000 on their mortgage, though. 

They reach out to the lender who approves the short sale for $250,000 and accepts to write off the $50,000 X would still owe on the mortgage. 

Then, a real estate investor comes in and, if the property is in good condition, has the opportunity to buy a property worth $500,000 for far less. 

Advantages of Investing in Short Sale Homes

Priced Lower

Short sale homes are often priced lower than other properties on the market, giving real estate investors a lower barrier for entry. 

Less Competition

Many home buyers also shy away from short sale homes since they typically take longer to close and are offered as-is. 

With less competition, real estate investors are also more likely to get a better deal at the price they are looking for. 

Helps the Tenants By Avoiding the Foreclosure Stigma

A short sale also allows sellers to avoid the stigma of foreclosure. 

Although their credit will still take a hit, the damages will be less, and they may be able to buy another house later. 

Disadvantages of Investing in Short Sale Homes

Time

Since the mortgage lenders are the ones to approve the transaction, short sale homes take much longer to close than typical real estate transactions.

They are more likely to fall through at the last minute, too.

Less Negotiation

Mortgage lenders are less likely to be willing to negotiate since they are already losing money. 

Maintenance

There may be significant deferred maintenance on short sale homes since many homeowners encountered financial difficulties before the sale, leaving a real estate investor with costly repairs. 

Uncertainty

Sellers will need to deal with the uncertainty of getting their short sale approved or denied. 

For example, the bank may prefer to deal with a foreclosure than short sale homes. 

Short Sale vs. Foreclosure: What is the Difference?

Though short sale homes and foreclosures have a lot in common, they are not the same type of real estate transaction, and it’s important for real estate investors to understand these differences.  

In both cases, the property is sold because the owners are unable to pay their mortgage. However, short sales are sometimes a better option for both the borrower and the lender. 

Here’s why: Short sale homes are sold before the lender has repossessed the property, and the borrower initiates the sale. 

With a foreclosure, the banks have to go through a lengthy process to foreclose and wait for the borrower to vacate the building. 

Short sales homes are typically occupied until the transaction is complete and are more likely to cooperate with the lenders. 

For homeowners, the short sale process has a lesser impact on their credit score than a foreclosure, which stays on their report for seven years. 

Short Sale Red Flags For Real Estate Investors

Here are a few red flags that you as a real estate investor should keep in mind when looking to invest in short sales. 

Property Damage

Short sale homes often suffered from deferred maintenance since the property owners were short on money before the sale and not invested in maintaining a house they were about to leave. 

Some of these issues may not be immediately visible. 

Make sure you have a thorough home inspector before deciding to buy the property. 

Mitigating Uncertainty with Buying the Property

Short sale homes require a significant amount of paperwork and take a long time to close. 

To avoid additional delays, check if the short sale was preapproved by the lender. 

If the sellers did not take care of all the steps involved, the lenders might cancel the sale. 

Owed Taxes

Beware that, by law, sellers are not allowed to require buyers to pay any back owed taxes for the right to buy a short sale home. 

Avoid any “outside of escrow" or "off the settlement statement" payments. 

How to Buy a Short Sale Property in 5 Steps

If you find a short sale property that you want to invest in, here’s how to purchase it step by step. 

Step 1: Financing

The first step in buying a short sale property is financing. Get preapproved for a mortgage unless you are buying cash. 

The lender will not consider your offer for a short sale home without financing.

Step 2: Find the Right Realtor

Find a real estate agent familiar with short sales since these transactions involve a considerable amount of paperwork and a different negotiation process than buying a regular home. 

A realtor with experience in short sales can save you both time and money. 

Step 3: Make an Offer

The next step is to make an offer. 

Keep in mind that low ball offers and excessive contingencies, such as requiring the seller to fix anything, are likely to be turned down. 

You may need to negotiate with the lender’s loss mitigation department or resource recovery department, which will decide to approve or deny your offer. 

Remember that it can be a lengthy process. 

Step 4: Inspections

Ensure that the house is thoroughly inspected since previous owners may not have maintained the property properly. 

In this critical step, use this checklist to avoid overlooking any part of the property. 

Keep in mind that a short sale is an “as-is” purchase. Don’t expect the seller to lower the asking price if your home inspection reveals costly issues. 

On the other hand, an inspection can show issues that may be costly enough for you to not buy the home.

Step 5: Be Flexible

Remain flexible while buying a short sale home. Since you are dealing with a bank, it may take a lot longer for the lender to reply to offers and inquiries, and you will not be able to contact them outside of business hours. 

Short Sale FAQs

Next, we’ll look at some of the most commonly asked questions regarding a short sale. 

Q. How long does a short sale take?

Short sale timelines vary depending on your location and the situation of the house you are trying to buy. 

It takes on average 60 to 90 days for the lender to approve a short sale, but delays can extend to over a year for particularly complex deals. 

Q. What are common mistakes short sale buyers make?

Short sales are different from typical transactions since you are negotiating with the bank. Your file should be thorough and complete, delays may run a lot longer, and the deal will fall through if the lender does not approve the short sale. 

Your real estate agent should have experience with short sales to help you negotiate the process, meet any deadlines, and communicate effectively with the bank negotiator. 

You should also be thorough with your home inspection since any unexpected issues could put your profit into jeopardy. 

Q. Where can you find short sale listings? 

Most short sale homes are listed on the Multiple Listing Service (MLS). 

You may also find short sale homes by contacting specialized real estate agents or reviewing courthouse filings for "pre-foreclosures" in your area. 

Short sales may also be advertised in local newspapers or craigslist listings. 

Short Sale: The Bottom Line

Short sales come with plenty of unique profit opportunities, but there are risks involved.

The best way to minimize your risk and maximize your profit with short sales — and all forms of real estate investing — is to grow your real estate education.