What is a Short Sale and How Does it Work?
A Short Sale transaction occurs when a mortgage lender agrees to accept less money than the amount owed by a defaulting borrower as full satisfaction for the mortgage loan. Banks have certain risk factors that motivate them to accept less than the total principal, accrued interest, and fees owed on a defaulted mortgage loan in foreclosure. Lenders usually accept Short Sales for first mortgages on properties with little or no equity, or on a physically- distressed property to eliminate their liability due to its poor condition. Mortgage holders in junior positions typically accept much deeper discount offers regardless of property condition or relative equity.
The mechanics of a Short Sale are as follows: After you and the property owner agree to work together, you negotiate directly with the lender for a reduction in the mortgage loan payoff. You, the lender and the seller work together until a satisfactory "net" amount due the bank is reached (or not). If all parties are in agreement, a short sale can be closed. The result is that the seller avoids foreclosure, the lender gets rid of a "non-performing asset" and the investor gets a great buy, or fee for facilitating the short sale for a third party.
You make your money on a short sale by creating equity from the bank- approved mortgage reduction, then buying the property, usually at a wholesale or lower value. Then you either keep the property and rent it, or sell it to a third party at a higher price. Savvy investors also make money “in the middle” by facilitating the ultimate sale of the property to a third party.
Short sales require no upfront money, making them low-risk (financially), but they tend to be one of the more complex profit models due to your having to "negotiate" with the bank. Since you aren't getting financing or putting up money, Short Sales can be a great way to get your feet wet in real estate by just "jumping in."
MATRIX RATING: Low Risk, High Complexity. The overall Risk is low because no up-front money is required. The Complexity is high because even with a great system, you are subject-to the whims, personalities and foibles of the banks Loss Mitigation Employees. Each bank also has its unique variation of policies. Significant interpersonal communication skills, patience and persistence are required to successfully execute short sales. Dealing with defaulting borrowers is difficult enough - dealing with the banks just adds another level of "drama" which you, as the investor must be prepared for.
INVESTOR LEVEL: Experienced investor, comfortable negotiating with banks and has closed a handful of transactions. Intermediates and Novices can also do short sales, but they are not recommended as first-time transactions.
WHAT'S REQUIRED: You don't need any significant cash if you are acting as a Foreclosure Consultant, but you do need lot's of patience, persistence, finesse and "intestinal fortitude" to negotiate with banks successfully.
WHAT'S OPTIONAL: Credit - only if you are paying cash to the seller with equity lines or credit card cash advances.
WHAT'S ADVISABLE: Short Sales are one of the prime ways you can "create equity" out of thin air. If you are acting as a Foreclosure Consultant, you will want to find a buyer for the property- concurrent with your negotiations. If you are purchasing the property as a Landlord or Dealer, you will of course want to get your financing ready prior to reaching a short sale price with the bank.
ASSESSMENT: With the dramatic rise in domestic mortgage foreclosures, Short Sales are very popular these days. In hot, dramatically appreciating real estate markets, lenders are less prone to accept short sale offers. However, with the "bursting of the housing bubble" and general downturn in regional real estate and mortgage lending markets, banks are eager to unload "non-performing" assets. This is the time to get deep discounts from the banks, to buy and hold properties long term. Right now, in early 2008, interest rates are still low, anticipated to rise in the coming months. Now is the time to acquire, hold and rent for cash flow and other traditional benefits of real estate if you can manage to get financing. Short Sales are also popular with Foreclosure Consultants, because they do not require any cash, and a deal can be negotiated for a Landlord or Property Dealer as a contract assignment.
BENEFITS: The most dramatic benefit of Short Sales is the fact that no cash is required to effectively "stop a sale." The foreclosure is usually put on hold while the Foreclosure Consultant negotiates with the bank, thus buying time for the investor-buyer and the homeowner. During bank negotiations, the consultant can find an investor to "sell the deal to" or get financing to buy the discounted property. The other huge benefit is the fact that an investor can in effect "create equity" through the loan discounting made possible with short selling. This dramatically reduces risk, because the investor can name his/her price with no cash commitment, and walk away with only lost time if the bank does not accept their short sale offer.
CHALLENGES: Negotiating with the bank adds a whole new dimension of complexity to Short Sale deals versus other real estate strategies. They are great because you really do not require any money to execute and close a transaction. Your challenge will be finding out what each particular bank wants in terms of documentation, and then in trying to establish a relationship with someone at the bank's Loss Mitigation department. Since you are negotiating with a bank, these transactions can get drawn out. Closing a deal can take many months. Also, from the Seller side, banks typically don't want to see the defaulting borrower get more than $500.00. Foreclosure Consultants therefore usually have to find creative ways of compensating a seller or otherwise enticing them to participate in a Short Sale transaction |
