Understanding the Real Estate Short Sale

Due to various economic factors, many Americans today are upside down on their mortgage and not able to make their monthly payments. Up until a few years ago, their only option was letting the bank foreclose on the property. But a foreclosure could be the worst credit-damaging event to appear on your credit report. And what is worse is that it will remain there and affect your score for at least seven years.

Another option distressed home owners now have is a real estate short sale. Normally short sales are used in stocks and other finance related transactions but they are becoming increasingly popular in the real estate industry as a way to avoid foreclosure. In a short sale transaction, the lender agrees to accept less than what a homeowner owes on a mortgage. The home is listed by the owner and sold. This is opposed to a foreclosure where the bank takes legal action against the homeowner when they stop making their mortgage payments. The deed of the home is transferred back to the lender.

So, how does a short sale affect each of the parties involved? A big negative for the seller is it will damage your credit almost as bad as a foreclosure would. A recent study published by VantageScore, a credit scoring company, showed that there is only about a 10 to 20 point difference between someone going through a foreclosure and one going through a short sale. In addition to a mark on your credit report, sellers may also find themselves owing taxes on the difference between what the home sold for and what they owed on the loan. For homeowners going through such a process and not being able to even make their mortgage payments, this is especially devastating. The good news is if you are able to negotiate the short sale quickly and successfully you can minimize a lot of this negative impact. The major advantage of a short sale for the seller is it gives them the ability to return to home ownership much sooner than a foreclosure would. It is possible that it will only take about 18-24 months before the seller is able to qualify for another mortgage at a reasonable rate where a foreclosure could take well over 7 or 8 years.

As for the buyer, they will get the property at a reduced price but it will likely be sold "as is" and have its share of problems. Due to the seller's financial distress, they may not be able to make any repairs and the lender may not be willing to do so either. Another disadvantage for the buyer is the long approval process. Not only do many short sales take a long time to close but also it can take months to even get a reply back from the lender on your offer. This is especially frustrating for the buyer when their offer has been rejected and they need to start their search all over again with many months lost in the process.

Banks choose short sales over foreclosure because the financial burden is much less. Some experts predict that banks may actually make 20% to 30% more on a short sale over a foreclosure.

In the end, short sales present a better option for distressed sellers but it is important that they seek legal and tax advise before they proceed. Buyers serious about purchasing a short sale should make sure they are patient and prepared for what may be a long approval process. If they need to close within a certain period, they should weigh the risks before beginning negotiations.