Risks of a Short Sale

Buying a home listed as a short sale can result in dramatic savings—but it’s not without risks. Despite the name, short sales can be a long process, taking months to complete, and there’s a risk of losing the deal and the money invested.

A short sale is when the lender agrees to let the owner sell the home for less than the balance owed on a mortgage, and the process has become more common since the housing market in 2008--in some markets these sales make up 30% to 40% of the available inventory.

These days, lenders are more willing to agree to a short sale as an alternative to foreclosing to keep the owner in the home during the process to maintain the property. Foreclosed properties are vacated and sometimes vandalize and no maintained.

One of the major downsides of a short sale is the time it takes to get to closing. According to Chuck Whitehead, a real estate broker at Coldwell Banker Real Estate, it takes on average seven months for a short sale to close, and has seen one sale take more than two years.

While lenders want short sales to go through, the process is cumbersome and complex. However, Whitehead says the short sale approval process has become automated, making it smoother. “It’s made a huge difference. The banks aren’t losing paper work, you have a point of contact, it has really improved.”

A long process can mean homebuyers miss out securing a low interest rate. There’s also a risk that the lender won’t accept the offer, which means they’ve wasted time and other opportunities.

“I’ve seen some buyers spend four or five months working on a short sale and it falls through,” says Tony Geraci, broker and owner of Century 21 Homestar in Highland Heights, Ohio.

An approval from the bank on an offer price, doesn’t mean the deal is done. There’s another risk: Many lenders will require the buyer to pay for the inspection, appraisal and make necessary repairs before even reaching closing.

Some lenders even want the utilities turned on ahead of time.  “The lender requires repairs because it wants to know it’s lending on something good and solid,” says Whitehead. “A FHA requirement is it needs to be in a livable condition.”  He notes that even some conventional lenders can be tough when it comes to repairs on a short sale, he points to one short sale where the lender required the buyer to fix 28 items before closing.

In short sales, the buyer is often required to pay those costs upfront even without the keys. While most short sales do end up closing, there’s a risk the deal could fall apart and the buyer would be out that money.

Banks often lay strict terms on sellers in short sales, like a hard deadline to sell. If the closing doesn’t happen before the date, the bank is apt to foreclose. “The biggest risk in going through the sale process is that you get approval from the bank and about three days before closing the bank forecloses on it,” says Whitehead. “You pay the appraiser, you pay for the inspection and they foreclose on it for no reason.”

Since buyers can save a lot of money on a short sale, they need to weigh the risks with the gains before going down that road. If time isn’t an issue and the risk of losing money isn’t budget breaking, a short sale might make sense. But if you need to be in a place by a specific date and/or funds are limited then the better choice may be to avoid a short sale.

“It comes down to: Are you willing to wait eight months to get a really nice property?” says Whitehead. “If you need to move in the next 90 days you need to buy a bank repo or a standard sale.”