Solid analysis identifies great opportunities, and wading into the troubled waters surrounding “distressed” properties certainly provides no exception to this maxim. In fact, the need for careful market research and realistic planning and preparation are even more compelling when a buyer considers purchasing a distressed property. Let’s begin with a couple of definitions:
What is a Short Sale? A short sale occurs when the net proceeds from the sale of a property are not sufficient to pay the total mortgage(s) secured against the property, together with costs and commissions, and the seller is unable or unwilling to pay the deficiency. This is very different from a “foreclosure” or “REO” (”Real Estate Owned” by a bank or other lender after foreclosure) because, in a short sale, the original homeowner still holds the title to the home and is still directly involved in negotiations with buyers for the sale of his or her home. After an agreement is reached between this seller/homeowner and buyer, the contract is submitted to the lender(s)/mortgage holder(s) for approval. Why do the seller’s lenders/mortgage holders need to approve the contract? The answer is that, if the sale is completed, the lenders will receive some amount LESS than what they are actually owed on their mortgage(s)– sometimes significantly less. If the lender(s) do not approve the transaction and agree to release their mortgage(s) against the property, the contract cannot close because good, clear title to the property cannot be conveyed to the buyer.
What is a foreclosure? A foreclosure is the legal process that results in the lender/mortgage holder (usually a bank) taking legal title to, and possession of, a property. This occurs when a homeowner is in default of the mortgage loan. After the legal foreclosure process has been completed and title to the property has been transferred to the lender, the property becomes an “REO” or “real estate owned” by the lender/bank. (It also can be a significant liability of the lender, requiring upkeep and insurance, at a minimum.) In this case, the buyer negotiates directly with the bank for the purchase of the property because the former homeowner’s ownership interest in the property has been legally “foreclosed” or extinguished.
Why would a lender/bank entertain a short sale offer, rather than simply filing mortgage foreclosure proceedings and taking title to the property itself? The simple answer is “cost.” A short sale is a “short sale” because market conditions have affected the value of a property negatively. The property is worth less now than it was when the lender approved the loan for the purchase of the property by the original owner. No matter what the the homeowner owes on paper under the mortgage, the property is no longer worth enough to fully satisfy the mortgage. No amount of threatening or wishful thinking can change that market reality, and the lender knows this. Since the property itself is the “security” for repayment of the loan, if it is now worth less than what is necessary to satisfy the loan, the lender has to make a hard decision. Should it go to the additional time and expense of resorting to the legal process to “take” the property in foreclosure, or would it actually be less expensive for the lender to agree to release its mortgage(s) for less than the full amount it owed? Very frequently, the lender decides a short sale is “the lesser of two evils,” by comparison to foreclosure. Either way, the home seller and the lender lose money, but in a short sale, the lender may lose less, and the homeowner’s credit will be damaged less, than in a foreclosure.
Having said that, it is very important to note that NOT ALL SHORT SALES REPRESENT GOOD OPPORTUNITIES TO BUYERS. The same market conditions that caused the property value to decline may not have subsided– the property may still be declining in value. Further, short sales can be time consuming and frustrating for the buyer. It is not uncommon for a short sale to take anywhere from one to seven months and more to be accepted by the lender/mortgage holder. And during that time, the buyer may be missing even better opportunities.
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