What’s a Pre-Foreclosure or Short Sale?

You’ll learn “pre-foreclosure,” “short-sale,” and “short payoff;” why they’re often listed more cheaply than other homes, and sale process for both buyers & sellers.

Pre-foreclosures, short payoffs and short sales are the same thing – a “short sale” is when an owner wants to sell their house but the house is worth less than what’s owed to the bank. The seller is having financial trouble, so the home becomes a “distressed asset” and when they sell, the homeowner “shorts” the bank As you can imagine, banks hate to lose money, so generally lenders take 3 to 9 months to approve a short sale (and they do try to raise the price to the new buyer) so generally it takes patience, time, & maybe more money than than the online asking price. As a buyer’s agent, I’ve been in contract for multiple short sales, and because the lender takes so long (and tries to squeeze my client for more money, my clients have always found another house they liked they could close on faster.

As a buyer, it’s always smart to notice how long any house has  been on the market because you can infer a lot of information from the “DOM.” With short sales, another thing to keep in mind is that because the seller is having financial trouble, they’re probably not making mortgage payments.  If the house has been on market for a long time, they’ve not been paying their mortgage for that long or longer, so the amount of debt to the bank has been increasing. It becomes more difficult to satisfy the bank on short sales that have been on market for a long time.  Realtors can check public records to see the mortgage amount, and subsequent HELOC’s, but we have to estimate how much the seller stills owe on the loan and how long they haven’t been paying their mortgage.

From experience, the bank may renegotiate the price of the short sale during the appraisal process, even though there’s an accepted contract between the seller and the buyer. Because the bank has to approve the sale, there is the chance that they will ask the buyer for more funds during escrow.

You’ll see short sales less frequently in the SF Bay Area because the market has been up since early 2012. Because the seller and potential buyer are asking a lender to accept less than what is owed for the sale of the property, while the lender can agree in return for avoiding foreclosure costs, the 3-way negotiation takes longer than a regular sale, even longer than the purchase of a full foreclosure.

It’s been estimated that when a bank foreclosures on a home (takes a foreclosure process full term, takes ownership of the property, preps it for market, markets, sells it), the bank nets as little as 40% of the original appraisal. While banks can be convinced to lose less money, and to save some credit loss for the seller, it’s an unknown variable how long the process of negotiating will take.

Now, here’s how it looks from the seller’s perspective; how a “short sale” begins. A homeowner starts having serious trouble paying their mortgage. Maybe they lost their job, and they have to move to find work and when they realize how much their home is worth vs. how much the payoff balance of the mortgage, there’s nothing left or a negative balance after payoff. If they sell the property now, the market price generates a loss to the lender.  Nonetheless, they find an agent who can list the home for sale, and during the marketing period, the bank has little to do with the short sale.  Any agent worth their salt will contact the bank up front to make sure the bank will consider the short sale, and open a pre-foreclosure file.

The bank is only interested in negotiating once a buyer offer is received.  The listing agent will probably price this home a little bit less than market value, so they can get an offer and send the purchase agreement contract to the bank for review.

Many things will be required by the bank from the seller of a short sale at that time.  First, when considering a request for a short sale, the bank requires proof of hardship.  Obviously, this financial disclosure document should be truthful, and sellers include a description of the full extent of their financial woes. Lenders require a letter of explanation telling why they need a short sale, which includes reasons for moving, how long the property has been on the market, failures with previous real estate agents, and any other situational complexity that has caused a relocation and prevented the sale of the property.

Much like the pre-approval process for a buyer, short sale sellers are required to submit employment verification, pay stubs, two-years of federal tax returns, verification of deposits, and/or bank statements for the last three months so the bank will consider releasing the seller from the loan. These documents will be required from the seller when there’s a real buyer offer in hand, but short sale listing agents gather them in advance so that they can be submitted immediately. Buyers can lose interest in a long short sale transaction process, but if the buyer has found “the one” and they have the tenacity to wait out bank negotiations, they could end up with a pretty good deal on a house.

Comments & questions always welcome at monika.getrealestate(at)gmail.com