Investing Trends

What is a Short Sale?

A short sale happens when a lender is willing to sell a property for less than the total amount owed by the borrower. The property is worth less than owed therefore, has no equity and the homeowner is seriously behind in payments. In many circumstances more than one lender is involved. Even if the property is worth at or slightly above the amount owed, the owner could still be upside down when other factors are considered such as agent commissions, delinquent taxes, homeowner dues and other standard closing costs. A short sale could offer a workable solution for all parties involved, helping the distressed homeowner avoid foreclosure.

Who are the players?

Let's say you have a motivated seller who absolutely must sell otherwise face foreclosure. They have missed many payments and yet do not want the property to go into foreclosure. The seller consents to the buyer or agent negotiating with the lender to accept a short sale. What needs to take place in order for this to happen? The process can be somewhat complicated however, many say worth the hassle since discounts are often in the tens of thousands of dollars. Intrigued? Read on.

Why are lenders giving away instant equity?

Foreclosures are skyrocketing and most experts agree that this trend will only increase in 2007 and beyond. In fact, The Center for Responsible Lending conducted a study in which predicts that 1 in 5 sub-prime loans issued in the past two years will enter some stage of foreclosure. Since sub-prime loans account for approximately 25% of all mortgages issued, the expected impact is thought to be staggering.

Lenders do not want to be stuck with houses they cannot move. Since lenders are not in the property management business, they figure it is better to accept a discounted amount than to take the property back in foreclosure and risk having to hold it for an indefinite period of time. If they do foreclose, aside from costly legal fees, they also face high carrying costs including tax payments, insurance, homeowner's dues and other maintenance issues. In addition, vacant properties sitting for long periods of time are at risk and more costly to insure.

Additionally, lenders need the cash reserves and bad loans on the books also affect their borrowing power. Adjustable rate loans are resetting and homeowners are not able to meet new monthly payments. Initial low rate terms are coming due and already strapped homeowners are not able to keep up with payments.

Therefore, short sales can be a win/win/win situation for all parties involved. These conditions allow for many bargains to be snapped up by investors who are paying attention and are at the ready to purchase the undervalued properties. The seller is able to avoid foreclosure, which can be a very detrimental mark on their credit and the lender is able to move the property off their books and avoid costly legal fees. There are however, tax implications that the seller needs to be aware of before agreeing to a short sale. All borrowers should consult with tax and legal professionals to understand the tax and/or legal ramifications involved in their situation before agreeing to a short sale.

Show me the money? Let's look at an example.

Let's say a property was purchased for $500,000 with anticipated repairs of $45,000 and after value repairs estimated at $615,000. Now, after 1 year's time and a declining market, the property is worth only $495,000 after the repairs were made, and an offer comes to the table of $435,000 from Mr. Investor. There are two lenders involved and both agree to take a loss just to sell the property and get it off the books. Between the two lenders, over $65,000 is discounted off of original purchase price. This does not account for a significant amount of other closing costs also paid for by the lender. Many opportunities like this exist in short sale investing however, just like any investing tactic, does not work for all situations. Yet, who can resist coming in with $60,000 of instant equity which is why short sale experts believe this is a tactic worth pursuing.

Generally, the buyer/investor gets a property well below market. Not to mention the benefit to the agent(s) in commissions if one is involved. Short sales are a great tool for those investors looking for undervalued properties (isn't every investor) because the lender(s) are willing to take a significant discount so long as the sale adheres to their guidelines. Most investors recognize that their profit is made in the purchase and, when they walk in with instant equity, they have many more options available to turn a profit.