The purchase market is suddenly hot here in the Chicago area, and one of the big reasons is because buyers are lining up to buy in time to take advantage of the home buyer’s tax credit. Home buyers have until the end of April to get their new home under contract, and they have until the end of June to close. So there should be plenty of time to find a home, get a contract and close by the end of June, right? Maybe. But it depends.

A major part of the market is now made up of distressed properties, that is, short sales and foreclosures. A lot of home buyers (especially first time home buyers) are focusing on these homes because buying distressed properties can often mean you are buying at a bargain price. Foreclosed properties are homes the bank has already taken back. They are vacant, boarded up and often in rough condition. It sometimes takes imagination to see the potential in these homes (I’ll have an article on this, soon). On the other hand, short sales look like any other home on the market, but the price is often much lower than comparable homes. But the asking price is just an opening in what could be a long process. I have worked with buyers who closed on a short sale in just over a month, and others who have waited over six months and still don’t have an accepted offer. Short sales are a big factor in the home buying market now, and I expect this will be a bigger factor over the next few years until the housing market stabilizes. If you are considering a short sale, make sure you know what is involved, and what you can do to help your position.

What is a short sale?

A short sale is a home where the owner owes more to the bank (or banks) than what the home is worth. These are often considered pre-foreclosed homes. Buying a short sale is a two-step process. The first step is to negotiate an agreement with the home owner. The second step (the harder one) is to get the bank to approve it. A short sale should be a win-win-win situation. The home owner is able to sell while avoiding a foreclosure, taking a lower hit to their credit rating. The buyer is able to buy a nice home at a lower than market price. And these transactions are in the banks interest too. They win by selling a home quicker and without all the legal costs of taking the property back. By avoiding foreclosure they also don’t have to deal with the property damage and marketing issues which can lead to big bank losses. But even though it is usually in the banks interest to work with buyers, the reality is more complicated. Banks are overwhelmed with short sale requests, and though they have staffed up over the last year, and they are getting government pressure to be more responsive, inertia and bureaucracy often mean that nothing gets done quickly, or efficiently. The bank that holds the mortgage is usually just a loan servicer. The actual mortgage is often held by Fannie Mae, Freddie Mac or could be part of a securitized pool of mortgages. The bank will need to follow these investor’s procedures. Also, the case manager is not a decision maker. They gather the information and then send it up the chain for the approval. Whether the bank will approve it, and how fast they will respond, is usually determined by how far the bank is into the process.

The Short Sale Process

When a Realtor lists a short sale home for sale (or the homeowner often does this before putting the home up for sale) they need to prepare a short sale package and submit it to the bank’s loss mitigation department. The bank will want to see all the financial information on the seller, including tax returns for the last 2 years, pay stubs, bank statements and a list of all the other debts. They will also require a hardship letter showing why the home owner can no longer afford to make payments on the home. The Realtor needs to put together an analysis of what the home is worth in the current market, and the bank will need a proposed settlement statement showing the costs of the transaction and how much they will net from the sale. In a perfect world, the bank would review this information and make a decision if it would work for them to take a short offer, or not. In the real world it is a little messier.

Here are some things to consider if you are thinking about making an offer on a short sale:

How short is the offer? If you are making an offer close to the mortgage balance, this means a smaller loss to the bank, and they should be able to jump through hoops for a quicker response. An offer much lower than what the bank is owed could still make sense, but they are more likely to weigh the offer, and let more time go by hoping they get another offer before responding.

Has the bank assigned a case manager to the file yet? This is crucial. If you are putting an offer on a property which doesn’t have a case manager, expect a long wait. The bank has to go through their due diligence, and if they are starting from scratch it could take a while.

Have there been any other offers on the property which went in for bank review? If the bank has had another offer they are often already moving on the process. I have been involved in some sales where the buyer came in and made an offer after another buyer had tried, and grown tired of waiting. These transactions moved much quicker. If there is a new buyer, this is a change, and the process is supposed to start over, but there is often more in place, so you are starting over from a higher level.

Is there a second mortgage n the home? If there is more than one mortgage on the home, expect more road blocks. The second, or junior loan, won’t get paid a thing until the first mortgage is satisfied. So if there isn’t enough equity to pay off the first mortgage holder, the second mortgage holder won’t get a thing. That means they don’t have a lot of motivation to sign off and could throw up issues so they make something off the sale.

How quickly do you need to close? If you are planning on taking advantage of the tax credit, you have to think hard about committing to a short sale. Again, it could be approved in weeks, or it could take months. Decide if the possibility of a better deal on the short sale is worth the extra wait and uncertainty.

If you are going to go the short sale route, make sure you do what you can to make your offer a success:

Do your home work – Find out what you can about the seller and their situation before making an offer. If you know what the situation is for all parties, you are in a better position to see if your offer is likely to come together.

Put in a time limit – The bank won’t necessarily abide by it, but if you make your offer good for only a set period of time you have more leverage and can get out of the transaction easier if it isn’t coming together.

Work with a Realtor who understands how the system works – If your Realtor has worked with short sales before, they will know more of what to expect and can guide you around the land mines. Check and see if the listing agent has done this before, too. Communication is the key here, and you want to make sure that someone is communicating with the bank and moving the process along rather than just sitting and waiting for them to respond. Being a squeaky wheel can be an advantage in getting these transactions closed.

Be prepared to walk if you don’t see progress – If you put in an offer months ago, and you are still waiting for a response, how much longer are you willing to wait? If you aren’t moving forward you aren’t likely to suddenly get back on track. At some point you need to move on to something with better odds of success.

Even when the bank approves the offer, you could still be in for a bumpy ride. There are all sorts of moving parts when working with a short sale, and when one thing changes it could set off a chain reaction of other changes. Short sales will be a fact of life until the real estate market and the economy are back on firmer footings. So I expect that the process will be streamlined and easier to handle over time. But for now, short sales do take extra time, But if you are in a position where you can wait, the rewards may be worth the extra effort.

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