Buying a Short Sale? Some Rules of the Road
Sellers who owe more on their home than it is worth often choose to try a short sale, which requires approval from the bank to sell for less than what is owed. These deals can be good for both the buyer and seller, but before entering into one, there are some important considerations a buyer should ask.
What is the time frame? While the approval process is shorter than it has been in the past, buyers on strict timetables should think twice before signing a contract to purchase a short sale. These deals can take 60-90 days on average to approve, and sometimes more. Buyers needs to be aware of this and plan accordingly.
Be sure there is an escape hatch: These deals require third-party approval (e.g. the seller’s payoff bank) so the contract must have a provision making the deal contingent on receiving this. But don’t leave it open-ended. Typically the contract provides for a 90 day window to get the approval, after which the buyer can terminate the contract and receive a refund of the contract down payment. Without this important provision a buyer could be stuck in limbo indefinitely while the payoff bank deliberates over the deal!
Transaction costs are not refundable: Buyer costs like inspection, appraisal, survey, title search and legal fees are not refundable in the event the deal does not close. In a typical non-short sale transaction, buyers are willing to expend their resources since the seller is bound to sell once the buyer’s financing bank is ready to go. But in a short-sale, even a willing seller cannot force the payoff bank to approve the deal. So there is a risk for buyers who expend fees in preparation for a deal, only to have a short sale bank reject the deal. Due to this, careful buyers must remember two points here: (i) there should be a price concession in exchange for this, and (ii) the short sale deal must be within the realm of reason. Short-sales are arms length transactions valued at market, but it is typical to have some price concession in exchange for the additional risk that a buyer incurs with non-refundable expenses and the increased timeline to close. But the “short-sale discount” cannot be so large that the bank will not approve the deal. The seller’s payoff bank will either engage their own appraiser or use a broker’s price opinion to ensure that the price reflects something close to fair market. Be sure the contract contains a provision that permits the buyer to unilaterally increase the purchase price in the contract if the payoff bank comes back with a counter-offer. Without that, the seller would have to consent to a change in price. While most sellers in that case will, the right to increase the price should be the right of the purchaser in the contract without having to get the seller’s consent.
Is the seller really in financial hardship? Banks will only approve short-sales with a financial hardship. Simply owing more on the house than it’s worth will not be enough. Careful buyers should inquire on the nature of the hardship, and include representations in the contract supporting this.