3 tips for buying a short sale

December 21st, 2010

In many housing markets across the country a significant number of the homes for sale are "short-sales." In the short-sale scenario the current owner of the home is not making the final decision as to sales price and terms, an employee of at least one bank is deciding whether to accept your offer or not. With interest rates rising you do not want to get yourself in a position where you have waited two or three months, or longer, before finding out you will be unable to close on a home that you thought you would purchase. Before transitioning from using mortgage calculators to writing an offer on a short-sale here are some tips to prevent problems later in your transaction.

Tip 1: How much is owed to how many lenders?

Before writing your offer, have your real estate agent search title to determine how many mortgages are filed against the property. For every loan there will be another approval the sellers will have to obtain before the transaction is clear for a short-sale.

Some of the longest delays in getting short-sales approved for closing are the properties with a first and second mortgage. The delay arises as the holder of the second, often a home equity loan or line of credit, negotiates with the lender in first position to take a lower payoff and increase the funds for the second mortgage lender.

You figured the cash to close using the closing costs calculator and are ready to go, but on the $250,000 offer on the property with a $265,000 first mortgage and $28,000 second mortgage, is the second going to approve getting as little as 10 percent of the outstanding balance? Be prepared for them to hold out for more as the sellers keeps missing payments and increasing the costs for the first.

It can become a game of financial chicken as the second lien holder refuses a payoff figure from the first, hoping to get more but knowing if the first mortgage lender forecloses then they, the second, get nothing. As the first waits for the second lien holder to accept a payoff amount they, the first lender, begin to calculate the costs of foreclosure, taxes, costs of sale, etc if they do not reach an agreement with the second lender.

Finding out who is owed how much on the property can help determine if you wish to pursue an offer on the property or not. Weigh the length of time it may take for an approval from any lenders involved versus the rising rate market, which means a higher monthly payment, and the other homes on the market in the area.

Tip 2: Is seller subject to other taxes or costs?

It is no secret that income tax laws are very complicated, increasingly so when it comes to the tax liability of a property owner who is foreclosed upon or who goes through a short-sale where debt is being forgiven. In the example above where you are purchasing a home for $250,000 that has $293,000 in liens against it, the seller is looking at a minimum of $43,000 in debt forgiveness.

Depending on the sellers' circumstances they may see that as income that is taxable by the IRS and/or state and local tax authorities. If one or both of the mortgage were not used to acquire the property, or if the property is not the primary residence of the sellers then the obligation could be even higher.

Are the sellers of the property aware of the possible tax consequences of accepting your offer and a short-sale from the lender(s)? If not what happens to your transaction if/when the sellers discover they may be faced with a very large tax obligation as the result of the sale?

Before writing your offer ask your real estate agent if she has a disclosure form for the sellers to sign acknowledging they are aware of the any possible tax ramifications from their sale and if the short-sale is agreed to by the lender(s) the sale will continue.

Tip 3: Who pays for repairs, condition improvements?

Get an agreement in writing with your offer and acceptance as to who will pay how much for any needed work required by a termite report, mold inspection, code violations, damage to the property or conditions requiring correction by the appraiser or underwriter.

Have a limit for the costs for repairs submitted to the lender(s) for approval with the rest of the short-sale offer. Have a clause that if the bank(s) refuse to perform any work requirements that the seller submit to the settlement agent funds to be held in reserve for any required and necessary repairs. Otherwise go back to your closing costs calculator and include an estimate for repairing any conditions called out by an appraiser, underwriter or inspector.

Not all short-sale transactions are lengthy; many close in a reasonable time frame and you are able to use current rates and costs with the mortgage calculators. Some short-sale transactions do drag on for months, often because either the buyer or seller, or both, were not properly prepared for the transaction. Do your homework and protect yourself in this volatile mortgage rate environment if you are considering purchasing a short-sale.

Posted By :
Dennis C. Smith is co-owner and broker of record for Stratis Financial in southern California. He has over twenty years' experience in the mortgage industry.

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