Short sales. Buy pennies on the dollar. Instant equity. A lender’s loss is your gain.
A couple years ago, your pocketbook could only afford you a modest house with three bedrooms, now with the same pocketbook, it appears can afford a mansion with five.
Before you get your hopes up and your heart set on getting your dream house for 50 percent off, remember that short sales typically have a 30% success rate. Sellers change their mind, buyers walk from the deal, or banks disapprove of terms.
So before you put in an offer, arm yourself with information that your agent may (or may not) be telling you.
Myth #1: I can buy a home pennies on the dollar.
Before banks approve a short sale they must order a broker’s price opinion (BPO). Real estate agent or appraisers create BPO’s in BULK to determine the price. Since these agents don’t spend all day evaluating the value of the home, these BPO’s are rough estimates of value. They will look at homes that closed recently, but may not adjust for views, great floor plans, corner unit (for condos and townhomes) and other unique characteristics. As you know, of course, elements like these can have HUGE impacts on price.
The fundamental flaw with BPO’s: heterogeneous homes do not lend themselves to quick valuations. No two homes are exactly the same. This means for areas such as Seattle – where a $1 million home and $200k condo are located on the same block – huge margins of error may result. Conversely, newer developed areas like the Issaquah Highlands where most homes consist of new construction (built after 2004), BPO’s are less likely to get mispriced.
After the BPO is ordered and received by the bank, the bank decides how much of a discount they will give off the BPO. After talking to industry experts, I found out that near the end of 2009 banks were approving short sales at 12-15% discount to BPO, but now they’re only discounting 7-10%.
Of course, there are exceptions.
Areas in which the “right” side street or the “wrong” side of the street can create 15% price swings, create nice opportunities for the buyer. In these situations, a mispriced BPO can allow you to get a home for a deal and I’ve even seen people buy for 80 cents or better on the dollar. However, you’ll have to search for these jewels, be less discriminating with location, and fight for the property as other buyers see opportunity as well.
That is the exception. For the most part however, banks will not rollover and approve a short sale pennies on the dollar.
Myth #2: Short sales won’t work if there are multiple liens on the property.
It does NOT matter.
First lien holders are foreclosing left and right which means junior liens are getting wiped out. For example, you purchase a home and use US Bank for your first mortgage. Later you find you need some extra cash and get a second mortgage known as a home equity line of credit (HELOC) from Bank of America. US Bank is the first lien holder (senior lien) and Bank of America is the second lien holder (junior lien).
In the event of default on the first lien, US Bank has the right to foreclose. If US Bank forecloses for less than what it is owed, US Bank will take a loss and Bank of America (BofA) will not get a dime from the foreclosure.
Now, in many cases Bank of America will likely obtain the right to go after you for what’s known as the deficiency, however, the key is BofA’s lien gets wiped out.
As a result, junior liens will likely cooperate and get SOME money for their lien rather than risk getting NO money.
In most cases, the second lien holder gets only 10% of the note amount (or amount owed). Perhaps earlier in the “bust” cycle of homes, second lien holders believed that they would recoup the majority of their lien position. Now, junior liens understand that if they’re difficult to work with and don’t approve a short sale along with the first lien holder, the first will just foreclose and wipe out the second.
Let’s take a look at an example. US Bank has a first lien of $200k and Bank of America has a second lien of $100k. The short sale price is $190k, and US Bank approves to pay Bank of America $10k (10% of the loan amount) from the proceeds of the sale. If BofA accepts the offer, then the deal can move to close. If BofA gets stubborn and refuses to accept 10% for its lien position, US Bank can exercise their right to foreclosure which will mean BofA will get nothing from the collateral.
Something is better than nothing. Junior liens smell the coffee (as bitter as it may be).
Myth #3: Never work with Bank of America.
Yes, Bank of America is huge and has tons of problems (like other major banks). There is much talk about how IMPOSSIBLE it is to get a short sale approved by the bank. Like any short sale, it takes work. If you put in the work, you will find that Bank of America can and does approve short sales.
If you plan to buy a short sale and you’re working with Bank of America, no worries. They approve.
Myth #4: Since the property is FHA approved, I can get an FHA loan.
Since FHA is the only place you can get a loan with 3.5% down, it’s important to understand the hoops you’ll have to jump through to get an FHA loan.
Often times buyers get excited when they see “FHA approved!” only to get disappointed when they CANNOT get an FHA loan. The word “approved” can be misleading. Properties are technically “eligible” and only approved when it meets all FHA requirements.
In order for FHA to approve the property, the property condition must meet guidelines. FHA approval guidelines catch many buyers by surprise. In straight sales (a non-distressed sale), sellers usually maintain and take care of the property. When you purchase a distressed property however, often times the abandoned property has been neglected by the seller for months. A small leak becomes rot and mold (you get the idea).
Required repairs are limited to those repairs necessary to preserve the continued marketability of the property and to protect the health and safety of the occupants, aka the three S’s:
- Safety: protect the health and safety of the occupants
- Security: protect the security of the property (security for the FHA insured mortgage.)
- Soundness: correct physical deficiencies or conditions affecting structural integrity
Items that may produce “health risks”.
- Inadequate access/egress from bedrooms to exterior of home
- Leaking or worn out roofs (if 3 or more layers of shingles on leaking or worn out roof, all existing shingles must be removed before re-roofing)
- Evidence of structural problems (such as foundation damage caused by excessive settlement)
- Defective paint surfaces in homes constructed pre-1978
- Defective exterior paint surfaces in home constructed post-1978 where the finish is otherwise unprotected.
As you can see, the property needs to meet many requirements in order to obtain financing. Financing is the number one deal killer. Make sure you (or your agent) understand FHA guidelines if you plan to buy short sales. This will save you tremendous time.
Myth #5: I can expect the seller to pay for basic repairs.
Many buyers don’t realize this, but BUYERS usually pay for SELLER’S repairs before closing. The seller gets absolutely no money from the short sale and has no incentive to put money into the house to repair broken windows or replace missing roof shingles.
In accordance with all short sale agreements, there’s a provision that explicitly says the seller cannot receive ANY funds from the sale. The theory, since the bank is taking a haircut, the seller shouldn’t receive a penny.
While this makes total sense, this gives sellers no incentive to put money (or much effort) to close the deal. “Why throw good money after bad money?”
As a result, buyers should budget $300-1500 for minor repairs needed to get clearance from FHA inspectors.
Next time you plan to go look at short sales, be prepared. Know what it takes and decide for yourself if you want to travel this route. It definitely requires more work, but it could be well worth it.