Short Sales: Are They Worth a Buyer's Time?

Yes. No. Maybe. If you’re looking for an absolute, don’t bother reading this post. I’ll go out on a limb and say usually it’s a waste of a buyer’s time—the odds are certainly against it.

What is a short sale? It’s a sale where the debt owed combined with the costs associated with the sale exceed the property’s market value. Creditor(s) MAY be willing to agree to allow the property to be sold for less than the loan amount.

You can recognize these listings by key phrases in the comments section such as “short sale” or “third party approval required” or “lender approval required.”

As a seller, how do I go about a short sale?
Every bank is different. At a minimum, you will need to establish that you are financially incapable of paying the loan(s). You must submit W-2s, bank statements, tax returns, a “hardship letter” stating the reason the credit should consider granting a short sale, and other financial statements outlining your assets and liabilities. The hardship letter is particularly important. Stating that your house isn’t worth what you paid for it is NOT a hardship. You must establish why you are no longer able to afford the payments.

As a buyer, I keep hearing that Short Sales don’t close. Why not? Can I do anything about it?
Some close, but it’s true that most do not. A quick search of the local listings showed 282 active short sales. In the past 90 days, only 35 closed. That’s a very poor hit rate. Short sales are typically priced at or just below current market value, and that’s reflected in the close price of those 35 homes—average closed price was $367K versus an average list price of $373K—98% of asking!

The overwhelming majority of short sales don’t sell and/or close because of one of these reasons:
(1) They aren’t priced competitively so don’t get any offers. On the flip side, sometimes they are priced at a low price that the bank will never accept!
(2) The sellers have not met the lender’s requirements to approve a short sale (e.g., have not submitted a hardship letter or otherwise proven that they can no longer afford the payments
(3) A secondary or tertiary lien holder has not approved the sale (if the first lienholder isn’t getting paid in full, the guys behind him are making nothing, and so have zero incentive to sign off on a deal). Often in this situation they will ask for a personal Promissory Note from the seller. If the seller refuses, it will scuttle the entire deal.
(4) The lender has received all of the paperwork but is “stringing along” the seller to collect a few more payments
(5) The lender has received all of the paperwork but is planning on foreclosing and collecting the mortgage insurance.


Buyers have no control over any of these reasons. Sellers have limited control over some. But it only takes one of these to prevent a short sale, so the odds are against it. In particular, if the bank is bound and determined not to approve a short sale (reasons 4 and 5), then no one can make them. If a seller is determined that they do not want to attempt to repay any of their debts (reason 3) then it’s not going to happen. Reasons 1 and 2 have a much better chance of closing. But why would a homeowner and agent list a home when it’s either overpriced or when the paperwork isn’t in? Lots of reasons: naiveté, ignorance of or inexperience with the process, denial. Why would an agent waste their time with a listing that won't sell? In most cases, there’s no real ‘cost’ to them. Agents decide individually how they want to market properties and how much they'll spend doing so. So they choose to spend nothing, and infact, they still get some free advertising via the yard sign and mere existence of the listing.

How can buyers identify a short sale that is more likely to close? Agents can put basically anything they want in the comments, but a few key phrases give you slightly better odds:

• Bank already approved price of $x/Short sale already approved
• Only one lien
• No waiting/bank ready to close/can be closed immediately
  
• Paperwork already submitted
• Quick Response/Turnaround in x hours/days/weeks
  

And of couse, you should have your buyer agent contact the listing agent to see what the status of the paperwork is. If the agent doesn't know or doesn't return the call, it's likely to be a waste of your time as a buyer.

Buyers, remember that, just like with foreclosures, timing is a big issue and so taking your chances with a short sale isn’t for everyone. With every passing week, banks are getting more efficient at processing these, so we might see more short sales and foreclosures closing. There’s also speculation that banks have too much real estate owned (REO) on their balance sheets, which impacts their regulatory capital requirements; so they may very soon be more amenable to short sales in the months to come.

Read More: Foreclosure Risk Series

Read More: Understanding the Difference Between Short Sales, Foreclosure Auctions, and Bank Owned Properties (aka REO)

Foreclosure Risks: Title Defects

One risk of buying an REO (bank-owned) property that you rarely hear about is the potential for title issues. Buyers incorrectly assume that since liens are typically extinguished in a foreclosure, that the title is free-and-clear. Not always so!

Let’s discuss the process. Lenders require buyers to obtain title insurance on the property. These policies protect the lender, and if you opt for extended coverage, the buyer. (See my post on how to save money on a title policy on a non-REO purchase here.) The policy protects against defects in the title, competing claims, etc. To issue this insurance policy, the settlement attorney’s office will perform a title search, issue a commitment to insure (sometimes called a binder).

The REO addendum (see post on risks of that addendum here) is usually written such that the bank is protected even if the title they convey isn’t perfect, so you can’t come after them if you determine later that there is a title issue. More importantly, the addendum requires only that they convey insurable title, not marketable title, as is required in the standard Regional Contract. Remember that the addendum trumps the contract, so don’t go relying on that paragraph in the offer that requires marketable title.

What’s the difference between insurable and marketable titles? Marketable means it’s free from threat of litigation. Insurable does not guarantee clean title, but rather simply requires that there is a title insurance company willing to “insure over” the defect. (Ever wonder why bank addenda require that you use their title insurer and settlement agent?)

Why should you care about insurable versus marketable title? Because when YOU go to sell down the road, you won’t have the benefit of that trump card, the REO addenda, nor will you have a settlement attorney in your pocket that will “insure over” defects. It’s possible that the price on an REO deal will be such that you don’t care about the insurable versus marketable difference—but make sure you review, and ask lots of questions about, what is being “insured over,” or you may find yourself paying to cure title defects years later when you sell.

What can a buyer do to protect himself? First, choose your own settlement attorney. Have them perform a title search as quickly as possible to identify any problems early. If the bank insists on using their title company, consider shelling out the few hundred for your own concurrent title search. Many foreclosures have significant title issues, and many bank addendums provide a very tight timeframe for identifying and objecting to them. An example of an issue that might be identified would be if the listing included a parking space, but upon searching the deeds, the bank didn’t actually own the parking spot—how can they convey what isn’t theirs? Second, review that title search and make sure you understand all the possible defects. Finally, buy the best title insurance you can--it's a one time cost at closing that may save you many times more than the cost of the policy.

Read more: Beginning of series on Foreclosure Risks

Resource: A great local settlement attorney - Ekko Title

Search for foreclosures

If you're interested in learning more about REO and foreclosures, or thinking of buying one, I'd love to advise you on the home buying process.

Foreclosure Risks: Financing Complications

Buying a bank owned property creates a multitude of financing risks—not because a buyer may have any particular problems with their credit or loan otherwise, but simply because the transaction is complicated and timing is difficult to control (read previous post on timing difficulties in buying a foreclosure here.)

It’s critical that buyers protect themselves with appropriate financing contingencies (and make sure that the protections you want are not negated by those pesky bank addenda – read post here.) Buyers take on enough risks in buying a foreclosure—don’t expose yourself to unnecessary interest rate risk as well. Let’s take an example. You make an offer on April 1 (no, there’s no hidden message there just because I’m using April Fool’s Day as my example) when rates are at 5.875%. The bank takes four weeks to get back to you, at which time rates have jumped to 6.25%, or even worse, the 10% down program you were planning to use is no longer available and now you need 15%, which you may not have. Sure, you can still back out of the contract (the upside of having to sign off on the bank addenda mentioned earlier), but obviously the situation is far from ideal. Let’s take a riskier situation: the contract is ratified and the buyer has signed off on the bank addenda. The buyer locks into a rate for 30 days, and settlement is scheduled for day 27. But the week before settlement the bank has a problem with the deed, and needs to delay settlement for a few days/weeks. So much for that rate lock—now your financing is floating with the market, and you take on all that interest rate risk.

Another pitfall to look out for is inconsistencies between your type of financing and the property condition. FHA is a great example; FHA loans require that repairs for issues that “rise above the level of cosmetic defects, minor defects, or normal wear and tear.” In a “normal” sale, the seller has to pay for those repairs. But, as we’ve discussed before in the property condition post, the bank is not about to take their time to hire plumbers and electricians to come in and fix those items—the sale is “as is.” The bank won’t pay. You don’t own the property so even if you wanted to repair it yourself, you’d have some hoops to jump through. So the property needs repairs, the bank won’t do them, and so FHA won’t fund your loan. (There may be some creative ways to still make this happen, but I can’t give all the secrets away here, can I?)

So to wrap up, don’t underestimate the financing risks you take on in buying a bank owned property. It’s not a bargain unless you’re adequately compensated for that risk, in the form of a lower-than-market price.

Read more: Foreclosure Risks: Unpredictable Transaction Timing

Read more: Foreclosure Risks: Bank Addenda

Read more: Foreclosure Risks: Property Condition and Inspections

Foreclosure Risks: Property Condition & Inspections

One of the most common scenarios in a bank owned (or REO) sale is that the property is “as is.” But most people don’t understand exactly what this means, or how to protect themselves from buying a home that may need tens of thousands in repairs.

Let’s back up a moment, and put “as is” in the context of a “regular” (i.e., non-REO) sale. “As Is” is a commonly misused term. We first must understand the home inspection process and one particular paragraph in the regional sales contract – the Property Condition paragraph, also known as paragraph 7 (because it’s literally paragraph #7 in the contract…sometimes we agents aren’t all that creative.) Paragraph 7 indicates that the systems of the house, including plumbing, electrical, and appliances, must be in “normal working order.” Unless the parties agree to strike through this paragraph, that means the seller must ensure all of those systems work at the time of settlement.

Beyond that, buyers may wish to also get a home inspection (highly recommended). If the home inspector notes items related to plumbing, electrical, or appliances that are not in “normal working order” then the homeowner must fix these—they’ve already agreed to based on paragraph 7. Any OTHER items the home inspector may find—e.g., foundation problems, roof problems, window/door problems, etc.—are negotiable.

Sometimes a listing will be marked “as is” but technically, unless they’ve crossed through paragraph 7, or unless an addendum supersedes paragraph 7 (see Bank Addenda post here.), then the seller is still obligated to fix those systems of the house indicated in that paragraph. They’re simply telegraphing to potential buyers that they will not repair or provide a credit for any additional items.

In a foreclosure, banks always say “as is”, and most Bank Addenda trump any inspections that you may think you’ve negotiated. The last thing a bank needs is the back and forth negotiating to give a buyer a small credit for some electrical problem—they’re way too busy and have tons more foreclosures to get off their books. Most banks though, do not have a problem with you having a home inspection; they just want a “go or no go” decision immediately following. You either take it as it is with the inspection findings, or void the contract. Tip: Even when a bank allows you to do an inspection, make SURE it includes a “right to void” based on the results!

You should always try to get an inspection so you know what you’re getting into with an REO property. It’s a sad fact that many frustrated borrowers take out that frustration on the property on their way out the door. (Read a WSJ posting discussing that approximately half of all bank-owned properties have "substantial" damage inflicted by angry homeowners prior to vacating. ) Often the repairs are simply cosmetic—a good scrubbing, some patched drywall, missing cabinets or appliances, or a fresh coat of paint—and those are good opportunities for a quick bargain. But structural and mechanical issues can easily run into the tens of thousands of dollars. And once settlement occurs, you have no claim against the seller, even if there was a problem that wasn’t disclosed to you (unlike other transactions). So remember that taking on that additional risk requires an additional reward, in the form of a very discounted price; otherwise that bank owned property isn’t such a good deal after all.

Read about some other risks of foreclosures here:
Foreclosure Risks: Title Defects
Foreclosure Risks: Bank Addenda
Foreclosure Risks: Unpredictable Transaction Timing
Foreclosure Risks: Financing Complications

Foreclosure Risks: Read Those Bank Addenda!

I get a lot of questions on foreclosures. How could I not? Some neighborhoods are flooded with them (though some are not...see the graph in my post on Beyond Auctions.) Buyers want to know if they’re a good deal, what the risks are, and how they can get in on one.

I’ve decided to write a series of posts on the risks specific to buying foreclosures—trust me that there are too many risks to put into one post! Some risks can be mitigated, some can be eliminated, but most remain; that’s part of the trade off you make in deciding to buy a foreclosed property.

First, a quick overview on the process. (For a review of how a home moves from short sale to auction to REO, read the post “I want to buy a foreclosure.”) Once a home is foreclosed upon, also known as Real Estate Owned or bank-owned, it is usually listed in the MLS with a listing agent, similar to any other home for sale. It will usually be noted right in the comments that this is a “bank owned property” or “special addenda required.” What is this special addenda?

When you decide to make an offer on a foreclosure, you put together the offer using the standard regional forms, just like any other resale (though not the same as new construction—for those you use the builder’s contract.) You include any contingencies or other negotiables you want—home inspection, seller subsidies, etc. Then you send it off to the listing agent, who sends it to the bank. The bank’s representative may respond right away, they may throw it into a pile to see what else comes in, or they may not do anything. (So controlling the timing becomes a big risk of a foreclosure, but I digress.) Let’s say they get back to you and let’s assume they even agree to all of your terms. They’ll return it all with a copy of their own Bank Addendum. An addendum is simply the legal term for a condition that amends the main contract. Even “regular” resales have a half dozen addenda-- for home inspections, appraisals, and to meet jurisdictional requirements. Bank Addenda are written by the bank’s lawyers to protect themselves during foreclosure transactions. Any guesses on which side they favor?

Every bank’s addendum is different, and it’s critical that you read and understand every clause prior to signing it. Because it’s an addendum, which amends the main contract, it doesn’t really matter what you think you negotiated—anything in the addenda trumps the main contract. Think you negotiated an inspection but the addendum says no? Or what if the addendum says you can inspect but not void? The addendum wins the day. A lot of good that inspection does you if the home inspector says the place needs to be demolished by you aren't allowed to walk away.

Unless you sign the addendum, there’s no deal, so you can still get out if you don’t like what you read. Occasionally, on some clauses, you may be able to negotiate certain clauses, but that increases the likelihood of slowing down the process—after all, some guy in a cube in Idaho (no offense, readers in Idaho) has to get that change sent to the bank’s lawyers to review, and I guarantee that those lawyers have their hands full with all their other foreclosures right now. If you decide to live with the clauses, then once you sign the addendum, the contract proceeds as is more typical.

There are many examples of egregious clauses, but here are a few of my favorites:

- The bank may not own the property and may not be able to go to settlement. You may be required to go to settlement even if the bank cannot deliver the deed at that time.

- The bank may guarantee only insurable title, not marketable title (more on that in another post)

- The bank may give themselves the right to change their mind and walk away at any time up to settlement for no penalty

- There may be easements or restrictions on the property that aren’t recorded; if you find one, the addenda may prevent you from backing out of the contract as a result

There are many more, as these addendum often run about ten pages. Because they are written to apply nationwide, there are occasionally even clauses that are illegal in Virginia!

So read those addenda carefully, and caveat emptor on this foreclosure pitfall. It’s a doozie.

I’ll continue the series with future posts on these other critical risks:

- Lack of control over turnaround and the dependent risks it creates for buyers (and not just your move date)

- Inspections, repairs, and warranties

- Financing complications (Don’t rely on using an FHA loan!)

- Title and deed issues

- Condo/HOA docs

Have another risk you want addressed? Add it in the comments and I’ll write about it.

Are you thinking about buying a foreclosure and want to know the risks you’ll face? Contact me to discuss the risks and some mitigation strategies.

Read the second post in the series, about the challenges in controlling the timing of a foreclosure transaction, here.