Most people, at some point in their lives, know the meaning of hard financial times. For a homeowner, that might look like not being able to make mortgage payments for a period of time. Unexpected setbacks and misfortunes happen, whether that stems from a dramatic housing market downturn, getting laid off, or any other wrenches that life (or a worldwide pandemic) throws into your plans.
No homeowner wants to go through a foreclosure. If a homeowner falls behind on their mortgage payments, a short sale is one potential way of correcting course. It’s certainly not an ideal situation, but it can have fewer repercussions for the homeowner-turned-seller, and from a buyer’s perspective, it can be a great deal if you’re willing to wait for it.
That being said, the home purchase process is a lot more complicated and drawn out with a short sale because it all hinges on the oversight and approval of a third party: the mortgage lender. Short sales operate according to the lender’s approval, requirements, and timeline. These properties are typically sold as-is, without the option to negotiate repairs, and as the buyer, you’re unlikely to get the seller and their lender to agree to cover your closing costs.
Whether the lender agrees to pay some, all, or none of the closing costs depends on their bottom line and what you are bringing to the table as the buyer. If you’re interested in a short sale opportunity, get a better idea of what you’re in for and what closing costs you can get covered.
Short sales 101
Let’s start with the basics: What even is a short sale?
A short sale happens when a homeowner owes more on a house than the house is currently worth … but they still need to sell the house. So in a short sale, the homeowner’s mortgage lender agrees to settle the mortgage loan for less than what the seller still owes on the house.
Sellers could owe more on the house than the home is worth due to decreases in home values, overextending the home’s equity, or other financial or economic hardships.
To be more specific, a homeowner could owe more at the time of sale than what the house is actually worth because there was a drop in housing market prices, or because the owner purchased at a high point in the housing market with an adjustable-rate mortgage (ARM), which raised the mortgage loan interest to an unaffordable amount.
The benefits to a short sale (for buyers)
There are some solid advantages to buying a short sale home, depending on your situation. For one, the buyer usually pays the true fair-market value of the home at that time and not an inflated price (which may have led to the short sale in the first place). Furthermore, the price could be listed below market value in an effort to attract offers, presenting a potentially great deal for buyers.
Other short sale benefits for buyers might include:
- The offer price will be locked in, even if there is a long approval process.
- The lender handling the short sale may also agree to finance the buyer, cutting out the mortgage lender search.
- Short sale homes are often in better condition than foreclosures because the owners are still living in and maintaining the home.
- There is less competition for short-sale homes because the homebuying process tends to be longer and more complex.
The drawbacks to a short sale (for buyers)
A short sale requires the mortgage lender to approve and facilitate the transaction. Get comfortable, because this could take a long time.
“I tell my clients: short sales should be called long sales. If they have a time issue — let’s say they’re in a rental and have to be out in 60 days — a short sale is not the right choice for them, because short sales can definitely take a lot longer. I’ve had them take up to 10 months,” says Laura Snyder, a top-selling Bel Air South, Maryland-based real estate agent with extensive short sale experience.
Another caution to buyers going into a short sale agreement: Short-sale homes are typically sold as-is, so the buyer is on the hook for any repairs that come up in the inspection process, not the seller or the lender.
Protect yourself, don’t wreck yourself
The real estate contract is where you can protect yourself should any major issues come up during the homebuying process.
For example, let’s say you complete an inspection of the house in question and discover some significant problems that aren’t worth the time or the money.
“At that point, you have the right and the ability to get out of the contract if you’ve written it that way,” says Snyder.
You can protect yourself with contract contingencies, which are clauses in a real estate contract that allow you to back out of the deal if certain conditions aren’t met. An inspection contingency lets you terminate the contract if major issues come up during the home inspection.
One other drawback in a short sale for the buyer is that you will likely have to pay the full buyer closing costs. With a more traditional home purchase, you can often negotiate with the seller to have them cover some closing costs. But in a short sale, buyers are rarely afforded this concession.
The bank probably isn’t going to pay your closing costs because they’re trying to recoup as many costs as possible on the loan. However, if contributing to closing costs seems reasonable based on the buyer’s offer, in the interests of avoiding foreclosure, the bank may decide to do so.
“It depends on the short sale bank because they all have their specific requirements on what they’re willing to give,” explains Snyder.
Typical closing costs
Buyers usually pay between 2% and 5% of the mortgage amount in closing costs. Lender and broker fees as well as third-party fees make up the lion’s share of closing costs.
Lender and broker fees include things like the loan application fee and the loan origination fee. Third-party fees encompass mostly everything else required in a home closing, like the appraisal and title fees, among other fees.
To secure and accelerate the purchase, both parties can negotiate who pays for what closing costs when finalizing the purchase agreement. If closing costs exceed the down payment, or if covering some closing costs can help the buyer fulfill their down payment, the seller may agree to a closing cost credit.
The seller has their own closing fees they’re responsible for. These commonly include:
- Real estate agent commission: The standard agent commission is 5% to 6% of the home sale price, split between the buyer’s and seller’s agents.
- Any home-related balances due: Unpaid HOA or real estate taxes must be paid at closing. These are typically paid at the end of the year, so the seller will owe the balance for the period of time they’ve owned the home.
- Transfer and title fees: Sellers may or may not be responsible for state or county transfer fees and fees accrued from the title company or attorney’s closing services, depending on the location. “It can vary state by state, but in Maryland, we split the transfer cost between seller and buyer,” says Snyder.
- Mortgage loan balance: This is one of the biggest motivators for selling a home. Under normal circumstances, the seller would use the money from the sale to pay off the remainder of their mortgage, and any extra money left over is profit. However, with a short sale, there not only will be no profit, but the money from the sale will be less than the mortgage payoff amount.
Short sale closing costs
In a short sale, you’ll be negotiating closing costs with the bank, more so than the seller. Keep in mind that the bank is just trying to protect their bottom line by preventing a foreclosure, so they’ll contribute to closing costs if it accomplishes their goal.
For example, if a property isn’t generating any offers, and the bank has to lower the asking price once or twice, they may consider covering the closing costs for an interested buyer.
“We do see a lot of people asking for it in short sale negotiations, and that bank just wants to net a bottom-line number, so if they are going to meet that bottom-line number with giving closing cost help, they don’t really care, as long as they are getting the number they’re looking for,” says Snyder.
There are a couple of other situations when a lender might consider paying closing costs, and they depend on your offer and your financing abilities. Essentially, the more money you have to put toward the house upfront, the less likely it is that a lender might cover any closing costs.
If a lender is eager to sell the home and gets an offer from a buyer with less cash up front and a lower down payment, they may be willing to cover some closing costs to get the deal closed. On the other hand, if the buyer is paying cash for the home or has a down payment of 20% or more — or there are multiple possible offers on the home — the lender will likely assume the buyer has sufficient funds to pay their own closing costs, or will instead choose an offer from a buyer who can pay closing costs.
Another instance in which the buyer might have a higher chance of closing cost assistance is if the offer is close to fair-market value instead of below, allowing the lender to recoup as much as possible on the sale, minimizing their loss on the transaction.
Set yourself up for short sale success
Clearly, short sales are not short and sweet. They require a lot of time, paperwork, and negotiations with the lender, who has the ultimate say-so. The key to getting through the short sale purchase process unscathed is to use the guidance of a skilled, experienced real estate agent.
Because short sales have unusual processes and requirements, clear communication and setting expectations are crucial. A real estate agent who is familiar with short sales will be able to explain all their quirks, from the timeline to the potential risks, and making an offer that will not only be accepted, but ideally allow for closing cost negotiations.
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