In a seller’s market, buyers can struggle to find good deals on properties. This leads many people to seek alternative buying options. As such, people often ask me: Ryan, is buying a short sale house a good idea?
For investors, buying a short sale house can provide a great deal on a fix & flip property. But, they typically take an extremely long time to close. For primary residence buyers, most short sales are distressed properties. This means that many traditional lenders won’t approve a mortgage for one.
In the following article, I’ll dive into some more considerations of buying short sale houses. Specifically, I’ll cover:
- What is a Short Sale Purchase?
- Primary Home: Is Buying a Short Sale House a Good Idea?
- Investment Property: Is Buying a Short Sale House a Good Idea?
- How to Find Short Sale Opportunities
What is a Short Sale Purchase?
Frequently, people use the terms short sale and foreclosure interchangeably. The two are different, but both involve a mortgage borrower struggling to repay a loan.
With a foreclosure, the bank actually takes possession of a house due to a borrower’s inability—or unwillingness—to repay a loan. Then, the bank sells the property in some sort of foreclosure auction, with procedures that vary by location. The proceeds from this sale go to paying off the outstanding loan balance.
Frequently, banks want to avoid the hassle of a foreclosure. The process requires a tremendous amount of time and additional cost. As such, many lenders instead prefer a short sale—a type of alternative to a foreclosure. Simply put, with a short sale, the lender agrees to take less (or “take short”) than the amount owed on a mortgage. This scenario arises due to two reasons:
- The borrower is so far behind on payments that they won’t be able to catch up.
- The housing market has dropped significantly, meaning the borrower owes more on the loan than the value of the property.
When a borrower faces both of these scenarios, he or she (or a representative) will approach the bank and request a short sale agreement. Essentially, the homeowner asks to sell the property, with whatever proceeds from the sale settling the outstanding mortgage. But, it’s important to note, the lender needs to ultimately accept any buyer offer during a short sale. As such, just because a seller and buyer agree on an offer doesn’t mean the lender will approve the sale.
Prior to accepting a short sale request from a borrower, banks will run a cost analysis. This will involve some home inspections and local market reviews. Basically, the bank needs to determine whether it’ll be more cost efficient to accept a short sale than foreclose on the property and sell it on the open market. This cost analysis generally results in a clear price point that the bank will accept. For example, after running an analysis, the bank may decide that it’ll accept any short sale offers of $115,000 or higher but reject anything lower.
From a buyer’s perspective, pros and cons exist to pursuing short sale purchases. I’ll outline these considerations for both primary homebuyers and investors in the next two sections.
Primary Home: Is Buying a Short Sale House a Good Idea?
As with so many real estate questions, no clear answer exists to this question. Rather, if you’re looking to buy a short sale for a primary residence, you should first consider the below pros and cons.
Potential Deal (Pro)
Short sales don’t guarantee good deals – the bank still wants to recoup as much as possible through the sale. But, for homebuyers, short sale properties frequently offer great price points, meaning you may be able to afford a property in an area via short sale where you would struggle to otherwise purchase.
Financing Challenges (Con)
Often, short sale properties require a significant amount of repair work. This can make securing a mortgage extremely challenging. Unfortunately, traditional lenders generally will not provide home loans for distressed properties. For this reason, even if you find a great short sale deal, if it requires major repairs, you likely will not be able to secure a mortgage. Alternatively, a lender may require those repairs to be completed before approving the loan. And with a short sale seller typically in financial trouble, this would mean the buyer needing to pay for those repairs, which may not make sense.
Furthermore, financing issues can arise with a short sale even with houses in good repair. Due to the fact that short sales can take a long time to close, a buyer’s loan pre-approval may expire during the closing process. While this may not completely derail the deal, it can create additional time and headaches for all parties.
With a typical home sale, three parties need to agree: seller, buyer, and buyer’s lender. As discussed, short sales require the approval of a fourth party: the seller’s lender. This can create major delays during the closing process. If homeowners need to move into a new home by a certain date, short sales may create too much ambiguity. Too much can go wrong, and buyers and sellers can’t always realistically establish a closing date.
Investment Property: Is Buying a Short Sale House a Good Idea?
Next, I’ll discuss buying short sale houses from an investor’s perspective, as many see short sales as great opportunities to buy fix & flip properties.
In many respects, investors will face similar pros and cons to primary homebuyers. First, short sales offer the potential upside of a great deal. For fix & flip investors, this can mean getting into a rehab at a great price point. Second, investors need to deal with the same time considerations as any short sale buyers. Prior to closing on a purchase, A) investor and seller need to agree, and B) the seller’s lender needs to sign off on the sale. For investors on tight timelines, this additional approval requirement may not work.
Lastly, investors also face financing challenges with short sales, but they face different considerations than primary homebuyers. As discussed, traditional lenders won’t provide a mortgage on a distressed property, regardless of whether it will be owner-occupied or an investment. Accordingly, investors will often need to purchase a short sale with cash or a hard money loan.
Hard money loans offer outstanding financing opportunities for fix & flip investors. But, investors should understand how these loans work before making an offer on a short sale purchase, as this’ll put them in a far better position to close.
How to Find Short Sale Opportunities
After reading the above, investors may decide that the pros outweigh the cons of short sale purchases. If so, you next need to figure out where to find short sale opportunities. This isn’t an all-inclusive list, but here are a few strategies for finding short sale deals:
- Partner with fellow investors interested in short sale properties.
- Work with a local real estate agent who specializes in short sale deals.
- Review public records, as many municipalities will report pre-foreclosure information at local courthouses.
- Work with a local property wholesaler, as these investors frequently find these sorts of deals.
And if you decide to purchase a short sale house, feel free to drop us a note to discuss hard money loans. We’d love to help!