Short sales are commanding a lot of attention these days, but from the Buyer’s perspective are they a bargain, or a bust? This article discusses a few things a buyer may want to consider before making a short sale offer.
Let’s start with the basics. What is a short sale? A short sale is one where the price being paid by the buyer is not enough to pay off the seller’s mortgages, hence the purchase price is a little “short.”
A short sale is a little more complicated than a traditional sale because agreement must be reached not just among the buyer, seller, and buyer’s lender, but must also include the agreement of the seller’s lender, who is taking a loss. Without the agreement of all of these parties the sale cannot occur. The seller’s lender must agree to accept a loss by getting less than full repayment of its loan to the seller. It must accept a “discounted payoff.”
Timing of a Short Sale
Short sales take longer because an application must be made to the Seller’s lender to accept the discounted payoff. The banks these days are taking their sweet time to investigate and approve, or not, the short sales. Typically the seller’s lender will want an appraisal, as well as financial information from the seller, in order to verify how much “under water” (over encumbered) the property is. The short sale approval process can easily be sixty days or longer, sometimes much longer, often four to six months. Meanwhile the buyer is typically unilaterally committed to the purchase – meaning the buyer typically cannot withdraw if, for example, the buyer finds a property the buyer likes better.
Because of this only a buyer who can afford to be patient should consider a short sale purchase. If a buyer must secure a new residence within a prescribed time, a short sale is not appropriate.
The banks usually insist on being presented with any competing offers that are received by the listing agent during the time the bank is considering the short sale application. To the buyer this means that they could be contractually on-the-hook for months, only to have a better offer beat them out at a late date.
The buyer should ask about both the lender’s and the listing broker’s policy on backup offers that may be written during the approval period. Some lenders may not want backup offers, as it might slow things down, keeping the bad loan on their books. Some listing agents may wish to discourage backup offers (if permitted by the seller and the seller’s lender) because they may cause the pending deal to fall apart – thus no commission.
There are a couple of things that a buyer can do to minimize the disadvantage to them of backup offers. One thing is to consider carefully the date that the buyer inserts into the contract for automatic expiration of the contract. In a non-short-sale transaction a buyer usually puts in something along the lines of 24 to 72 hours that the seller has to accept the offer or it becomes null and void. In the short sale contract the buyer can require the seller’s acceptance within such a time period, but must allow a much longer period for the bank’s approval. I am suggesting that the buyer consider carefully how long they are willing to be in limbo, contractually committed while waiting for the bank to make up its mind.
Another thing a buyer can do is to include a term that if a back-up offer is presented to the bank during the approval period, the buyer must be informed and has the right to be immediately released from the contract. That way the buyer can move on if it appears that the competition for the property is getting too keen. Alternatively a buyer could include a term that in the event of a backup offer at a higher price the buyer has the option to match the higher offer.
A buyer may wish to ensure that contingencies remain open and the time within which contingencies must be removed will commence upon the bank’s approval of the short sale. That way if circumstances change during the waiting period, the buyer will still have the opportunity to withdraw from the deal if unacceptable conditions are discovered.
Because the short sale process takes a long time, a buyer should also consider what might happen to the value of the property while waiting. If the value continues to go down the buyer may nonetheless remain contractually bound to purchase. Is this a risk the buyer is willing to accept? Will it affect the buyer’s ability to qualify for a loan if the value goes down but the purchase price is already established in the contract – it may mean the buyer will have to come up with more down payment.
Another stumbling block that is showing up is that many banks are conditioning their approval of the short sale on their borrower (the seller) agreeing to be personally liable for the shortfall or waiving any defenses to the bank pursuing the shortfall in a later action. If this comes up at the last minute and the seller is unwilling to agree to that, it may cause the transaction to fall apart. A buyer may want to inquire whether this is the bank’s policy, before wasting a lot of time waiting for an approval.
A buyer may also want to ask the listing agent for some financial information about the seller’s loans. How many loans are against the property? If there is more than one it is far less likely that both lenders will agree to each accept some of the shortfall. The senior lender will want the junior lender to take all the shortfall, and the junior lender will be unwilling to walk away with little or no repayment on its loan. How short is the sale? If the seller is hugely underwater it is less likely that the lender will accept a sizeable loss. The buyer should ask these questions of the listing agent.
These are only some of the issues that can affect a short sale, and this article is written from the buyer’s point of view. A short sale seller has additional issues, not the least of which are tax and credit ramifications. If our office can help you or your clients with these or any real estate legal matters, please give us a call.
Peter N. Brewer, Esq., is a California real estate attorney with thirty years’ experience, and is the owner and managing partner of Brewer Offord & Pedersen LLP, in Palo Alto, California. The firm serves the legal needs of homeowners, real estate and mortgage brokers, agents, brokerages, title companies, developers, investors, and other real estate professionals and their clients. Mr. Brewer and his firm also represent clients in debt collection, creditor representation in bankruptcy proceedings, breach of contract matters, and other litigation and transactional work. The firm’s clients include homeowners, brokers and lenders, and other real estate professionals throughout Northern California.