Taking The Short Route

Short sales have become huge. Lawrence Yun, the eternally optimistic NAR economist, now estimates that short sales and foreclosures comprised 35 – 40% of all nationwide real estate transactions in October. They’re certainly becoming more common throughout the Chicago area – even in the more upscale neighborhoods. That’s one way to deflate a real estate bubble.

So what exactly is a short sale?

A short sale is a home sale where the proceeds of the sale are not going to be sufficient to pay off the mortgage. Consequently, the sale contract requires the bank’s approval. Exactly how a short sale is executed and how the payoff shortfall is resolved is something I’ll address another day.

So why should a seller pursue a short sale?

First and foremost a seller will want to consider a short sale when it becomes clear that they are not going to be able to sell their home at a price which will allow them to pay off the mortgage in its entirety and they don’t have the money to make up the difference. While the decision to conduct a short sale should only be reached after seeking appropriate legal and tax advice, generally it is seen as preferable to going through foreclosure. It can certainly be resolved faster, since it can be pursued prior to the lender completing the foreclosure process. The other way that it is seen as preferable to foreclosure is that it is believed to have less of a negative impact on your credit record, though I find conflicting information on exactly what the difference is:

• The NAR refers its members to the CBS News site (isn’t it odd that the supposed authorities on real estate refer people to CBS?), where they claim:

While in both cases, short sale and foreclosure, the delinquent mortgage will negatively affect their credit rating, at least short sellers avoid having a “debt discharged due to foreclosure” on their credit reports. Mortgage and credit experts say that, after bankruptcy, having a foreclosure on your credit report is the worst result and will reduce your credit score by over 250 points. You could also have to wait up to three years to qualify for a mortgage at a reasonable rate.

Short sales show up on a credit report as a “pre-foreclosure in redemption” status and can result in a credit score reduction of 100 points or less. After the sale, the mortgage may show up as “discharged.” People who successfully complete a short sale may also qualify for a mortgage at a reasonable interest rate in as little as 18 months. So, if buying a home is a future goal, then a short sale is the better option for many.

• Unfortunately, About.com indicates that the credit score impact is the same on a short sale as it is on a foreclosure, though they seem to agree with the CBS report on the other aspects of the differences.

And why should a buyer pursue a short sale?

Short sales can offer great values because the property is heading towards foreclosure, which is an expensive process for the lender. Consequently, the rational lender should be willing to accept a bargain price. Of course, we do not live in a rational world. If we did we wouldn’t be deflating the housing bubble right now. I hear countless stories of banks turning down short offers one day to only end up foreclosing many months later for even less money than they originally turned down.

Then there are the realtors who don’t even want to mess with short sales because it often takes forever to get an answer from the lender and sometimes commissions get cut. In fact, one national, discount real estate brokerage will not “support short sales” because “the chance of success is extremely low.” While there are elements of truth in all these concerns it’s not really right to short change a buyer by ignoring 40% of their opportunities.

Of course, the less that rationality prevails in the short sale world the better the values are for the rational players. I know of some exceptional values out there right now.