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Short Sale Risks

Short Sale Risks

The following article, covers a list and explanations of some of the risks that might be faced in a real estate short sale. There are certain risks involved which, though inevitable, can usually be avoided with careful and appropriate scrutiny of the solutions and the property in question.
Scholasticus K
The concept of short sale chiefly covers, the sale of securities, assets or any investments, which are not directly owned by the seller. However, the actual owner has given his consent to sale. This complex transaction is carried out after receiving the consent and approval of the person holding the lien and right to ownership. In recent times, short sales have come to be associated with real estate transactions, rather than the sale of all conventional assets or investments. The following article presents an overview of the short sale of real estate, and the risks which are associated with it.

Short Sale of Real Estate

A short sale of real estate chiefly involves the sale of a real estate which has been purchased with the help of a mortgage loan and which is pledged as a collateral or a security against the same loan. In certain conditions, when the borrower of the loan starts suffering from financial hardships or anticipates financial hardships, with the consent of the lender sells off the said real estate. It must be noted that the short sale procedure, is often initiated after the borrower receives a warning, or drastically falls behind his repayment and installment schedule or receives a letter notifying foreclosure.

In such a case, the entire transaction can be characterized by the following features:
  • The total sale price of the property is usually lesser than the total mortgage loan amount that is owed to lender. However if the borrower is lucky, then he may also sell the property for more than what he owes to the lender.
  • The second most important feature is that after the sale, the lender officially forfeits his lien or right to ownership of the said property. This is very important as during the initial pledging of the real estate, where the said real estate is pledged as a collateral/security, the lien or right to own is transferred to the lender, who can exercise it in cases where the borrower defaults his loan.
  • The third feature in the short sale of a real estate is the high probability of the risk and loss, which we shall be viewing in due course. A short sale, done properly and lawfully has one big risk that the mortgage lender and the borrower are going to lose a certain amount of money. In some cases, though the borrower and the lender agree upon some terms and conditions where in the borrower pays off the remaining amount, or the deficiency to the lender in a later period, against the consideration that the credit report of the borrower won't be affected.
Apart from the aforementioned summarized risks, there are several other minor probabilities and possibilities of risks and problems which often come into the picture.

Risks Involved in a Short Sale

All the three parties which are involved in the short sale transaction, tend to be vulnerable to some short sale risks. It is hence, recommended by several industry experts to initiate and execute an entire short sale transaction, sale, transfer of lien and rights to the buyer and the realtors operations, by the book. The lawful nature of the proceedings, thus ensures that a substantial volume of risk is reduced from that transaction. One of the best ways to curtail the risk is to appoint a specializing attorney to oversee the short sale.

1. Risks Faced by the Lender
Under normal circumstances, assuming that the short sale is conducted for a sale price which is less than what the borrower owes, the following scenario would be observed:

Short Sale Price < (less than) Total Principal amount unpaid (+) Interest Unpaid (+) Other Fees

In such a scenario, the biggest risk that the lender faces is that he won't be able to recover the deficit/deficiency, which can be calculated as follows.

Deficit/deficiency = Short Sale Price (-) Total Principal amount unpaid (+) Interest Unpaid (+) Other Fees

In some cases, where the borrower is in a relatively better and capable financial position, the lender and borrower reach upon a legally enforceable and obligatory agreement where the borrower is to pay off the deficit after the short sale. Here another risk is that due to financial hardships of the borrower or a bankruptcy would result into further loss, for the lender. On the whole, the lender is subject to a maximum risk.

2. Risks Faced by the Borrower
The following are some of the common risks which are faced by the borrowers opting for short sale or planning to opt for the same.
  • First off, one risk cum problem is that the lender may simply not agree for a short sale and would refuse to hand over the consent, the lien and the right to ownership.
  • Secondly, it is often difficult to find an appropriate and adequate price or a buyer who is willing to pay the sum, thereby increasing the chances of a high deficit/deficiency amount.
  • Thirdly, a short sale remains on credit report for quite a long time, depending upon several factors of the deficit/deficiency. Apart from that the credit score can go down by as high as 300 points, again depending upon the said scenario.
  • Fourthly, the lender may also refuse to consent to the short sale and instead may take up a foreclosure proceeding.
3. Risks Faced by the Buyer
The buyer faces only one risk while buying a short sold property, assuming that the sale has taken place by the book. There is a chance that unsolicited lenders, the original lender or other private lenders may claim the right of ownership or lien on the property, which is not exactly a problem but is more of a headache.

The sad thing about the short sale is that the borrower loses his property in which he has been investing for a quite some time. From the point of view of all the parties to the transaction, if it is done by the book, the short sale should go fine and the risks would be reduced.