You’re most likely familiar with the wholesaling process. And you probably know the basics of what’s involved in a fix & flip, and maybe you know about the buy & hold strategy too…
But what about short sales?
Yep, just as I suspected… I hear crickets.
So in today’s post, I want to clear up some confusion about short sales by explaining what that process entails and how that type of deal can benefit everyone involved.
Short sales have been done for years and years, and they’ll continue to be done forever. Why is that? Well, although it’s certainly unfortunate, there’s always going to be that situation where a homeowner – for whatever reason – is unable to make their mortgage payments.
The timeframe before the property goes into the foreclosure process is when the short sale can occur.
We’re going to get into the nitty-gritty details of short sales in a minute, but I first want to touch on foreclosures so you can understand how the two differ.
A foreclosure is not a short sale.
When a homeowner can’t make the payments that were agreed to in the terms of their loan, the lender has the right to foreclose on the loan.
What that means is the lender can physically sell that house at a public auction (through either a trustee or sheriff sale – depending on the state) to recoup the money that they lent on the house. The reason they do that is because it’s really the only recourse the lender has…
It’s not like the lender can slap a judgement on the homeowner for say, $250,000 – the homeowner obviously doesn’t have the money, which is evident by them not paying the mortgage.
So instead, if a homeowner is late by 60-90 days, the bank holding the mortgage will send the homeowner a Notice of Default. This notice will say something like:
“You’re behind on your mortgage payments. If you don’t make your payments current or contact us for another arrangement, we will initiate the foreclosure process.”
If after that letter, the homeowner doesn’t comply, the lender will escalate the loan and initiate the foreclosure process. The amount of time the foreclosure process takes varies. In some states, it’s lickety-split – foreclosure properties can be sold on the courthouse steps in just 21 days.
Helpful Tip: Market to these leads before the lender initiates the foreclosure process because you might not have enough time to reach the homeowner if it’s a 21-day foreclosure state. You want your marketing to get to that homeowner before they’ve received the Notice of Default so you have time to negotiate with the homeowner and get your paperwork in order before the formal foreclosure process begins and the property goes to auction.
So, when a lender takes the house to foreclosure, they’ll get an appraisal and pay a local real estate agent to do a drive-by of the house and to look for comps to determine the price of the property.
Let’s say that price is $250,000. The lender might set the starting bid at the auction at $190,000, thinking it can sell quickly at that lower price at an auction (and partly because people at auctions are looking for deals).
Bidders will usually come to the auction with info they’ve found on the local government’s website that lists all the foreclosure properties with details. The auction is literally at the steps of a courthouse or public building, and the bidders will be standing around, listening and bidding as the auction caller (also known as the “crier’) calls out properties.
If no one buys that house at the foreclosure auction, it goes back to the lender, who now owns that house. But here’s the issue – the lender is not in the business of owning and managing property and doesn’t want to be in those businesses – it’s in the business of collecting your money.
So, when the property doesn’t sell at the auction, the bank takes back the property as an REO: Real Estate Owned. Adding fuel to the bank-owned fire – when banks take REOs, the government penalizes the lender for doing so – basically because foreclosing hurts everyone involved and ideally foreclosure would be avoided.
Let’s say the bank foreclosed on $10M worth of property – the government takes a piece of that and says the bank can’t loan out XX% of this $10M for X months. It might be something like the government saying the bank can’t loan out $3M for 6 months – that hurts the bank because it doesn’t earn any interest on that money – the bank has to just sit on that money and wait the time out.
So not only does the bank own a house that they have to try to resell, they’re financially penalized as well. Now you can see why lenders aren’t in favor of foreclosures.
That’s what happens if the property doesn’t sell at auction.
Here’s the flip side – if the property is bought…
Well, things aren’t so rosy for the lender if the property does sell at auction. Let’s say the property ended up being sold at the auction for $199k. (Remember, the lender gave it a value of $250k but started with a lower bidding price simply to get it sold quicker.) So if it sells for $199k, that means the bank is taking a big fat $51k hit plus other associated fees, which are usually in the thousands.
Simply put – the lender takes a serious loss on the property. The bank is darned if they do and darned if they don’t – sell, that is.
So, how are both of these foreclosure situations avoided?
You guessed it, short sale to the rescue…
Short sale saves the day.
A short sale deal is arranged before the property goes into the foreclosure process. And you’ll soon see why a short sale is preferred over a default on the mortgage.
See, a short sale gives everyone an opportunity to get away from foreclosure, which no one wants. The short sale is a better option and benefits everyone and with less loss. Much less.
The homeowner obviously doesn’t want a foreclosure – for tons of reasons – #1 being that the foreclosure will sit like a black eye on the homeowner’s credit for 7-10 years. Speaking from my own personal foreclosure experience in 2001, foreclosure is not a happy place.
As we now know, the lender certainly doesn’t want a foreclosure because it loses so much money.
With a short sale – yes, the lender will take a loss, but that loss will be the same as or less than it would have been if the property were to go to auction.
The lender is definitely taking less of a loss if it sells before it becomes a foreclosure because they won’t have to deal with all of those penalties from the government or pay the other associated fees. And what’s more – they’re done with the property – not stuck with the house sitting in their portfolio while they try to figure out how to get rid of it.
So, here’s what a short sale is: A short sale works when the lender takes less than what’s owed for the property – maybe much less – basically, in order to be done with it.
The lender is selling the property/mortgage short of the actual amount owed. For example, let’s say the house is worth $250k, but the lender is willing to take just $210k for it. That’s certainly short of the full value.
Now, there are a couple ways a homeowner who’s late on their mortgage payments could avoid having to sell at all:
- The homeowner could get a loan modification of some sort or a forbearance agreement.
- The homeowner may get some kind of windfall that enables them to bring the mortgage current.
Usually though, these 2 options are not common and the homeowner will not only have to sell but will want to sell to get out of this potentially disastrous situation (foreclosure).
I’ve worked with many of these homeowners who are happy to do a short sale because they just want this big ‘ole monkey off their back. This financial burden has kept them up at night, causing fights with their spouse and created a significant amount of stress and anxiety.
With a short sale, homeowners usually realize they can finally wash their hands of this huge problem – a house that’s upside down yet they still owe a ton of money on. They’ll most likely go rent a place for a few months or stay with family and work on starting over.
The short sale is actually a breath of fresh air to most homeowners and they benefit from it by avoiding foreclosure.
To be continued…
Okay, since we’ve covered the basics of a short sale – in my next post, I want to really dive in to the details…
I’ll cover, specifically, how I do short sale deals, what a Broker’s Price Opinion is and why it’s so important, how to close a short sale deal and more helpful tidbits.
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