What is a Short Sale in Real Estate

Glen Gallucci
September 2, 2008 — 1,236 views  
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A short sale in real estate is when a lender accepts a discount on a mortgage where the outstanding loan balance is greater than the amount of the market value of the property. A lender will accept a short sale to avoid a possible foreclosure auction or worse, the homeowner declaring bankruptcy. With a short sale, you are still buying the house from a seller, but you are purchasing the mortgage directly from the lender for a discount.

For example: A homeowner, who is facing foreclosure, has an existing first mortgage of $300,000. The house may only be worth $275,000. You write an offer to the lender for a lower amount like $220,000, which is accepted as full payment for the loan. This is a short sale.

Why are banks willing to take such a discount? There are several reasons. First of all, banks do not like excess inventory and bad loans on their books; therefore, if they see an opportunity where they can sell the property, even with a reasonable loss, they will do it.

Secondly, lenders know they could lose a lot more money if the property goes to auction. There are so many fees involved if the property goes to auction, that they would be better off taking the discount beforehand and be finished with the headache of it all. These fees include legal fees, eviction, and potential damage to the houses, paying taxes and insurance and the possibility of the homeowners going into bankruptcy which can cause major delays in recouping the lenders funds.
At the time of this writing, foreclosures are at an all time high, which basically translates into more opportunities. Since foreclosures are increasing, this is the perfect time to jump into this because there will be more and more lenders discounting properties. It is safe to say that most lenders will accept a short sale, however, you may come across one or two lenders who will not discount the amount owed. If the numbers work out for the lender they will do it. If not, they will counter your offer with the amount that they will accept for the short pay off, or short sale.

It is best to do a short sale when the property is in the pre-foreclosure state. There are two stages within pre-foreclosure. The first stage being those individuals who are behind on payments and the second stage are those who are behind on payments with a notice of default.

In order for this to work properly and for you to successfully get a short sale, you must find the homeowners who are in the second stage of pre-foreclosure or more than 3 payments behind on their mortgage. Once the notice of default has been recorded, banks become motivated as well, so you are more likely to get a discount. Until that time, very rarely will a bank ever discount a mortgage that soon. Why would they? The homeowners still have time to cure the loan and make up the back payments. And even in a declining market where a house may not be worth what is owed, unless the loan is in default, lenders usually do not entertain short sale requests.

It does not matter what type of house or condition it's in, all mortgages can be discounted. The best properties to perform a short sale on are the houses that need lots of work and repairs because lenders will give you a bigger discount if they see they are less attractive to potential buyers. This is especially true for homes priced for first time buyers as usually first time buyers don’t have the added funds to fix up some of these distressed properties.

When calling the bank to ask for a short sale, they will usually require that the homeowner completes certain documentation. These documents include a hardship letter written by the homeowner to the lender stating why they are not making their mortgage payments. Sometimes they will ask for two months previous bank statements, pay stubs, financial income statements, and so on. You must be prepared to send them everything they ask for otherwise your request will not be accepted. They will also always ask for a HUD-1 and a real estate purchase and sales agreement. This is to ensure that if the bank accepts a short sale, the homeowner will not receive any funds from the sale.

While all this sounds great, don’t be too surprised if many of your short sale offers are not accepted. This is because unless you give the lender good reasons why they should accept your offer, they will stick to the suggested listing price which was given to them by the real estate company who preformed the analysis. This analysis is called a “BPO” or Brokers Price Opinion. And unfortunately many times the BPO is always higher than it should be. And a short sale can often be a complicated process, and can be lengthy, sometimes taking upwards of 3-4 months to get the short sale done. This is especially true if the person working the short sale is not experienced. But like many good opportunities, working short sales is a numbers game. Some get accepted favorably and some don’t.

In today’s declining market, savvy investors and experienced real estate agents still get short sales accepted. And for real estate agents who work short sales, well it could mean all the difference in the world of them getting listings for their clients as well as selling those houses that are in an upside down position, meaning they owe way more money than the house is worth.

Glen Gallucci

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Glen Gallucci, also known as "A Seasoned Investor" actively buys, rehabs and sells residential properties. He has invested, renovated and built numerous residential and commercial projects during his 30-year career. A well diversified businessman; Glen is also engaged in real estate education. From the trenches, and with his down to earth "tell it like it is" teaching style, makes Glen the "real deal" and a sought after speaker around the country as his business experience proves invaluable for the beginner as well as the seasoned investor regarding the successful structure of starting a wholesale or rehabbing business as well as securing private lenders when investing in "quick turn real estate."