What Is A Short Sale?

By | April 7, 2010

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Once upon a time, short sales were among the rarest of transactions. Houses tended to appreciate (heavily) over time and mortgages used to come with heavy down payments, leading to lots of equity for sellers. People could wait a few years, get a few tax benefits, and then sell for a profit.

Not anymore.

These days, more and more homes are marketed as short sales (the first step a house takes toward foreclosure.) High loan-to-value mortgages and unsustainable price appreciation led to an unprecedented drop in home values.  Here are some Sarasota, Florida market statistics for the last five years:

Sarasota median sales prices

Homes prices have plummeted to unbelievable lows, but the market has stabilized substantially over the last year (as of April 7, 2010).  Lots of homeowners remain upside down in their mortgages, however, and need to find a way to sell their property.

Enter the short sale.

What is a Short Sale?

A short sale is, simply put, a way for homeowners to sell their properties for less than what they owe.  It’s not a ‘get out of jail free’ card; short sale sellers take big hits to their credit, lose any money they’ve invested in their properties, and in some cases are required to repay some or all of their mortgage after the property has been sold.

For a short sale to work, the bank that owns the note (the instrument that binds the seller to repay the mortgage) has to agree to take less than what they’re owed.  In many cases, this can be hundreds of thousands of dollars less than the original amount.

Why Would a Bank Accept a Short Sale?

Money talks.

From a bank’s perspective, here’s the problem: borrowers owe lots more than their houses are worth and are unwilling or unable to make payments.  Mortgage payments are the bank’s primary sources of income.  When borrowers don’t make payments, banks don’t make money.

Once upon a time, banks would just foreclose on properties when the borrowers went into default.  This didn’t happen often, and when it did, the income from other mortgages more than made up for the loss – and in any event, the newly foreclosed home could be sold at market value and the banks might even be able to turn a quick profit in the resale market.

These days, when banks foreclose, they’re up against heavy competition to get a house sold.  The market values are so far below what the borrower originally paid that the banks will take a loss regardless of their actions.  If they do foreclose on a home they have to sell it at a steep discount and they take over all kinds of other payments – lawn service, taxes, HOA fees, maintenance, pool guys, and more.  These are all red marks on the bank’s balance statement.

On top of that, banks have to pay attorneys to foreclose.  And lawyers ain’t cheap.

A short sale is a way for a bank to trump all of those payments – homeowners will generally maintain their own properties as long as they live in the home, the banks won’t have to pay the courts thousands of dollars in fees and costs, and at the end of the day, the banks will actually net much more by allowing a borrower to walk on their mortgage.


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