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How to Buy and Finance a Short Sale Property (Without Losing Your Mind or Wallet)

August 15th, 2011

What is the latest craze in residential real estate? Without a doubt, hunting for bargains and buying distressed properties. Purchasing a distressed property can be both profitable and rewarding, but it also can be a trying endeavor. A distressed sale transaction can involve any one of the following:

 

 

  • Short Sales - properties sold for less than the balance(s) of the existing mortgage(s)
  • Foreclosures (trustee's sales) - properties sold by lenders at public auctions
  • Real Estate Owned (REO) - bank owned foreclosed properties

 

This discussion will focus specifically on purchasing Short Sales. According to the latest statistics, in some markets a majority of home listings and sales are those of distressed properties, however, numbers can vary depending on the state and location. For instance, in Las Vegas as many as 64% of all residential listings are distressed homes (ZipRealty, 2011). In Phoenix they represent 49%, San Diego 23%, Dallas 10%, and in New York just 5%. A recent study conducted by RealtyTrack (2011) estimates that there are over 1 million unsold bank-owned properties (REO's) and over 550,000 likely short sales.

So, how does one go about buying and financing a distressed property? First of all, it depends on the type of the distressed property, the transaction, and how the buyer intends to pay for it. The following is a quick overview of purchasing and financing short sale residential properties of 1-4 units.

As mentioned above, a short sale is a transaction that involves seller(s) of a property with a market value below the balance(s) of the existing loan(s). Since the lender holding the mortgage on the property is going to be paid less (short) than what is owed, its approval of the short sale is necessary for the deal to go through. Due to sometimes complex procedures and a huge volume of requests, lender short sale approvals take months, with 6-12 months not being unusual.

The existing lender needs to figure out the market value of the property and whether the sellers (its borrowers) have a legitimate financial hardship to qualify for the short sale. Another complicating factor is that most of the time the servicing lender, that is the lender which sends the monthly mortgage statements and collects the payments, is not the investor which actually owns the loan.

At the same time, the servicing lender is typically the only point of contact for the short sale sellers. For the sale to go through, not only the servicing lender but also the loan investor(s) must consent to the terms of the transaction. All of this takes time, paperwork, and lots of patience.

Realistically, the sellers of the short sale property should be pre-approved by their lender(s) for the sale. Also the buyers of such property should be pre-approved for the purchase financing by their own lender before they write a purchase offer. That does not apply to "all cash" buyers who can show a proof of sufficient liquid assets (cash or cash equivalent).

Buyers' loan pre-approvals are good for about 90 days, and then the borrowers will likely need to provide updated financials to their mortgage lender in order to keep the loan pre-approval current. Once the short sale is approved, the buyers will have to go through a final loan underwriting process, in order to finalize their loan and close the escrow.

A key point to remember is that buyers' loan Pre-approvals are done before the property is appraised by their lender's appraiser. The final loan Approval is subject to acceptable property appraisal report, including sufficient value and acceptable physical condition, as well as satisfactory title search.

In some cases, if the property is in a poor physical condition, it may not qualify for a conventional (non-government) financing, even if the buyers were pre-approved for the loan. This is usually the case with heavy fixer-uppers, which require a lot of work before the property can be deemed as "livable." However, this is not as prevalent with short sales as it is with foreclosures and REO's.

Of course, short sales, and all other types of distressed real properties, can be bought without any financing in "all cash" transaction. Cash is more commonly used by smaller investors buying single family properties or by large institutional or non-institutional investment hedge funds purchasing multiple properties in bulk (mainly REO's).

Buying and financing a distressed property involves preparation, risk, and lots of patience. Why bother then? Because it can pay off. On average, distressed properties sell for much less than the non-distressed ones. For example, according a recent study quoted in Money Magazine (2011), homes in upscale Miami suburb were selling for the following prices per square foot:

 

  • Non-distressed: $248
  • Short Sales: $224 (-9.65%)
  • Foreclosures: $196 (-20.97%)

 

In conclusion, when it comes to purchasing and financing short sales, preparation and patience can definitely pay off. There is no need to jump into the first available deal as there is usually an ample supply of distressed properties. Short sale transactions can be complex and it is recommended that buyers proceed with caution and work only with experienced real estate and mortgage professionals who can guide them safely through the buying and financing process.

Robert W. Dudek is a Chief Lending Officer at Statewide Home Loan Corporation, San Diego, CA, USA. Statewide Home Loan Corp. is a mortgage brokerage company specializing in mortgage planning services and providing real estate financing to purchase and refinance residential and commercial properties located in California and Hawaii. For more information visit http://www.shlc.com or call 1-800-507-9990.

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