Buying a Short Sale: What It Is, Where to Find One & How to Finance It

A short sale is a real estate sale in which the profits made are less than the existing loan on the property. A short sale typically occurs at or below market value and is successful only when the lienholder agrees to accept less than what’s owed. Short sales commonly occur when a seller is in financial distress.

LendingHome is a hard money lender that helps investors finance short sales with short-term loans. Interest rates are typically between 7% to 12%, and its loans can finance renovations. It offers loans up to 90% loan-to-value (LTV) ratio and up to 75% after repair value (ARV).

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How a Real Estate Short Sale Works

A short sale is a great opportunity for real estate investors to buy underpriced assets. However, many investors have trouble understanding how to buy a short sale. To help, this article discusses buying a short sale, including what a short sale is, and how to finance it as well as the general short sale buying process.

A short sale gets its name because the seller is “short.” This means that the amount owed on the home is more than its fair market value and that the borrower is in financial distress. For example, if a borrower has an existing loan balance of $200,000 on a property appraised at $150,000, they are short by $50,000.

When this occurs, lenders will sometimes be willing to let the borrower list the house for sale at a price that’s lower than the debts currently owed. This is because a short sale typically means that a seller is 90 or more days delinquent on their loan payments, and lenders want to recoup as much of their investment as they can.

For this reason, short sale proceeds go directly to the lender. In the example above, the borrower would sell the property for $150,000. The entire $150,000 sales proceeds would then go to the lender as compensation for the short sale.

When a seller is short, they can list their property as a short sale using a normal listing agent. It’s common for short sales to be listed below market value since sellers aren’t held liable for the amount they’re short, and buyers are looking for a deal.

However, while a seller can list a short sale without their lender’s approval, the lender must agree to accept less than what’s owed on the current loan and can deny a buyer’s short sale offer. Lenders are motivated to recoup as much of their investment as possible and thus like to see offers at-or-near fair market value, if possible.

Therefore, when buying a short sale, three separate parties must agree on the sale:

1. The short sale seller
2. The short sale buyer
3. The short sale lienholder

If any of the above parties fail to agree, the short sale falls apart. However, because of financial distress, banks and other lienholders are typically in the driver’s seat when it comes to a short sale. Therefore, it’s common for a buyer and seller to agree to a short sale but much harder to get a lender to agree to take a loss.

Short sale properties are sold as-is. This means that a property can be in either good or poor condition. Further, a short sale can take anywhere from 1 – 6 months to receive approval from a lender.

Buying a short sale is therefore right for the following people:

• Fix-and-flip investors looking to purchase, renovate, and sell a property
• Long-term investors looking to purchase and renovate a rental property
• Long-term investors looking for an underpriced asset in good condition
• Short-term investors looking for an underpriced asset in good condition
• Investors who can afford to wait up to six months for short sale approval

Let’s look at how people like the ones above find a short sale investment.

How to Find a Short Sale House Listing

Short sales are listed for sale like any other type of property available for sale. This means that you can find a short sale listing through normal means, such as with real estate agents or listed in online databases. Let’s look at the two main ways you can find a short sale house listing.

1. Find Short Sales Using Real Estate Agents

The best way to find a short sale listing is to use a real estate agent as if you were looking for a normal investment property. Real estate agents should be able to set up a short sale search in the multiple listing service (MLS) and send you properties based on your criteria.

Real estate agents are typically the most knowledgeable when it comes to current listings. This is why it’s typically best to engage a real estate agent before you start searching for short sales on your own. Benefits of using a real estate agent to find a short sale include:

• Minimize the amount of time you have to invest in the search
• Gain access to MLS databases to see a large number of short sales
• Agents have relationships with lenders and know about possible short sales
• Real estate agents can help with the short sale buying process

2. Find Short Sales Using Online Sources

Another great way to find short sale listings is by doing a little of your own legwork. With online platforms such as Zillow and RedFin, it’s possible to see short sale listings yourself. These platforms typically list short sales along with suggesting an asking price.

Other listing websites such as Auction.com and RealtyTrac.com have short sales that you can search for yourself. Even Foreclosure.com has a section for “preforeclosure” listings, which is a fancy way of saying short sale.

The benefits of using online sources to find short sale listings include:

• Easy access to multiple listings
• Expand search from local short sales to national listings
• Specific search criteria that only shows you the right listings
• Online sources often provide helpful resources

However, these two ways to find a short sale aren’t mutually exclusive. Ideally, you’ll be able to both work with a real estate agent as well as search for short sale properties yourself.

How to Finance a Short Sale Investment

Buyers looking to purchase a short sale can typically finance the property using short-term loans as well as longer-term permanent loans. These loans include such things as balance sheet loans and hard money loans as well as cash-out refinances. This means that financing a short sale is very similar to financing other types of investment properties.

For example, while it’s possible to finance a short sale with a Federal Housing Administration (FHA) loan or something similar, investors typically don’t qualify. To help you understand how to finance a short sale investment better, check out the table of short sale loans below as well as detailed explanations of each.

Short Sale Loans: Costs, Terms & Qualifications

1. Balance Sheet Loan for Short Sales

A short sale balance sheet loan is a loan kept on a lender’s balance sheet as an investment. Balance sheet loans are different than other loans in that they’re not sold on the secondary market and are therefore more flexible. This makes them “nonconforming” loans that don’t adhere to Fannie Mae standards.

Balance sheet loans can finance single properties, apartment buildings, and multifamily properties as well as act as blanket mortgages that finance multiple properties together. Short sale balance sheet loans are right for many different types of investors. However, balance sheet loans typically can’t finance properties in poor condition.

Balance Sheet Loan Amount and Down Payment

A short sale balance sheet loan typically has a maximum loan amount equal to 80% of a property’s purchase price, known as its LTV ratio. Some lenders will also have a maximum dollar amount for their balance sheet loans, but not always.

This means that investors buying a short sale should expect to cover at least 20% of the short sale’s purchase price as a down payment. However, depending on the lender, it’s possible to receive a higher LTV amount and, therefore, a lower down payment.

Balance Sheet Loan Interest Rate and Fees

Short sale balance sheet loans typically have interest rates that range from 4% to 6%, on average. The specific interest rate will vary depending on the lender as well as the type of balance sheet loan. For example, an apartment loan or multifamily loan might have a lower interest rate than a loan that finances a single short sale property.

Short sale balance sheet loans typically have the following fees:

• Loan origination fee: 0% to 3%
• Closing costs: 2% to 5%

These costs are typically taken directly out of the loan. Balance sheet loans might also have a 1% prepayment penalty. However, since these balance sheet loans vary by lender, it’s important to check your lender’s specific fee structure.

Balance Sheet Loan Terms

Balance sheet loans have a lot in common with conforming loans such as Fannie Mae-backed loans. For example, balance sheet loans typically have terms between 15 to 30 years, making them a long-term permanent mortgage.

Also, like conforming loans, short sale balance sheet loans typically take 24 hours for preapproval and up to 30 to 45 days to receive financing. However, since it takes between one and six months for a short sale to get approved, the funding time is not a huge issue with financing.

Balance Sheet Loan Qualifications

While the qualifications on a balance sheet loan can vary, the industry has some standards for minimum qualifications. Specifically, investors should expect to see the following qualifications on a balance sheet loan application:

• Personal credit score: 640-plus (check your credit score for free here),
• Debt service coverage ratio (DSCR): 1.25-plus
• Occupancy: Three-plus months with 90% occupancy rate

Like with any property, lenders will most often conduct an appraisal of their own to ensure the sale price accurately reflects the property.

Where to Find a Balance Sheet Loan

Investors can find short sale balance sheet loans with most banks and lenders. This includes big banks, local banks, online lenders, mortgage brokers, and more. For example, Chase Bank has traditional commercial balance sheet loans specifically designed for real estate investors.

Other services, such as Rocket Mortgage, can help investors with online balance sheet loans. Even lender marketplaces, such as LendingTree, help investors by connecting borrowers with lenders who have balance sheet loans.

2. Cash-out Refinance for Short Sales

A short sale cash-out refinance occurs when an investor takes out a new loan on an existing property to unlock equity in that property. What typically happens is that an investor uses a new loan to pay off an existing property’s current lien. The difference between the new loan balance and the existing loan balance is pocketed as cash and used to make other investments.

Short sale cash-out refinances are right for longer-term buy-and-hold investors with existing properties. However, a cash-out refinance typically is only a good option if the investor has between 30% and 40% of the equity in an existing investment property. Cash from cash-out refis can be used to make a down payment, purchase a property all-cash, or cover renovations.

Short Sale Cash-out Refinance Amount and Down Payment

A short sale cash-out refinance typically has a maximum loan amount equal to 75% of an existing property’s fair market value. This is because a cash-out refi takes out a new loan on an existing property, and lenders aren’t concerned with the price and value of the new property being purchased.

Cash-out refinances technically don’t have a down payment since the loan uses an existing property as collateral. However, it’s important to note that an investor typically needs between 30% and 40% or more of equity in an existing property to make a cash-out refinance work.

Cash-out Refinance Interest Rate and Fees

Since cash-out refinances are offered by many different types of lenders, interest rates vary. For example, it’s possible to find cash-out refi with interest rates between 3% and 6% or more.

Cash-out refinances will also typically have the following fees:

• Loan origination fee: 0% to 3%
• Closing costs: 2% to 5%

Origination fees and closing costs are usually taken directly out of the loan. Even though you’re taking out a loan on an existing property, you’ll still need to pay closing costs because the lien will be a new one.

Cash-out Refinance Terms

A cash-out refinance typically has a term between 15 and 30 years. This is because the new loan taken out on the existing property is a permanent mortgage. The time to preapproval for a cash-out refinance can take as little as 24 hours, and funds can be received in 30 to 45 days.

Cash-out Refinance Qualifications

The qualifications of a short sale cash-out refinance are unique since it’s a new loan on an existing property. Specifically, the qualifications in investor should expect to find include:

• Minimum credit score: 640-plus (check your credit score for free here),
• Cash reserves: Up to six months
• Debt-to-income ratio (DITR): 36% to 45%
• Equity: 30% to 40% or more in existing equity

Remember that a good rule of thumb is that you should have at least 30% to 40% in existing equity if you want to use a cash-out refinance. Otherwise, the lender, even lending against the maximum LTV, would not be able to extend you much credit.

Where to Find a Cash-out Refinance

Cash-out refinances are offered by most lenders that have permanent-type loan products. For example, national lenders, such as Quicken Loans, offer cash-out refi options that can be used to purchase a short sale, put a down payment on a short sale, or renovate a short sale property. More traditional banks, such as Union Bank & Trust, also offer cash-out refinances.

3. Hard Money Loans for Short Sales

A short sale hard money loan is a short-term loan used by investors to purchase and sell a property within one to three years, if not sooner. Hard money loans are issued by hard money lenders who typically have low qualifications for approval. Hard money loans can come in the form of rehab loans that finance the purchase and renovation of a property.

This means that short sale hard money loans are best for short-term investors looking to fix-and-flip a property. However, hard money loans are sometimes used by long-term investors who need to renovate or season a property before refinancing. These properties can be purchased in good condition as well as in poor condition.

Hard Money Loan Amount and Down Payment

Hard money loans have maximum loan amounts based on a property’s purchase price or expected fair market value after renovations. A property in good condition can be financed up to 90% of its LTV ratio. A property in poor condition can be financed up to 80% of its ARV, which is the fair market value after repairs.

This means that an investor should expect to cover at least 10% of a property’s purchase price if it’s in good condition. If it’s in poor condition, investors should expect to cover at least 20% of the property’s purchase price plus renovation budget.

Hard Money Loan Interest Rate and Fees

Hard money loans typically have interest rates that can range from 7% to 12% or more. This is because hard money loans are short-term in nature and also have low qualifications for approval. Monthly interest payments are usually interest-only, and the principal is paid at the end of the loan’s term

Short sale hard money loans will also typically have the following fees:

• Loan origination fee: 1% to 3%
• Closing costs: 2% to 5%
• Extension fee: 1%
• Prepayment penalty: 1%

An extension fee is assessed if a borrower can’t pay off the full loan at the end of its term. Prepayment penalties also often exist to protect the lender against early repayment. Origination fees and closing costs are taken out of the loan while extension fees and prepayment penalties usually come out of pocket.

Hard Money Loan Terms

The typical term of a hard money loan is between one to three years. However, many fix-and-flip investors try to purchase, renovate, and sell a property within three to six months. This means that investors either pay the 1% prepayment penalty or work with a private money lender that doesn’t have a penalty.

The time it takes to get prequalified with a hard money loan can be as little as three minutes. The time to funding is typically between 10 and 15 days.

Hard Money Loan Qualifications

The typical qualifications of a hard money loan, also known as a private money loan, are comparatively less than when compared to a more permanent loan. For example, investors should expect to meet the following minimum qualifications:

• Minimum credit score: 550-plus (check your credit score for free here)
• Past rehab projects: Two or three (for renovation projects)
• No subordinated debt

This makes hard money a great alternative for investors who can’t qualify for a long-term loan. What some buy-and-hold investors do is use a hard money loan to purchase, renovate, and/or season a short sale property before refinancing to a permanent mortgage later.

Where to Find a Short Sale Hard Money Loan

Hard money loans are offered by hard money lenders and private money lenders. For example, if you’re looking at a residential short sale property, you can get a hard money loan from LendingHome or someone similar.

It’s possible to find an online hard money lender for almost any type of situation. For more information, you can read our guide on the best hard money lenders.

Why Buying a Short Sale Is Good for Investors

Buying a short sale is a good idea because short sales are commonly sold for less than a property’s fair market value. This means that real estate investors can purchase an underpriced asset and either rent it out long-term or fix-and-flip it as a short-term investment. There is good profit potential with buying a short sale.

This means that the benefits of a short sale come down to the short sale’s potential return. I spoke with Cedric Stewart, real estate consultant and team leader of Entourage RG at Keller Williams, who told me the following:

“Successful investors are primarily concerned with turning a profit and a short sale must, therefore, meet very specific criteria. Investors will ensure that a short sale’s acquisition price plus any necessary repairs allow for profitability. They’ll do an analysis to determine the after repair value of the property and subtract the purchase price and repairs from that number, along with all other fees, to arrive at their maximum allowable offer.”

This is why you don’t see many short sales going for a property’s fair market value. An investor is interested in getting the lowest possible price. While banks want to minimize their losses, lenders also know that they’ll make less in a foreclosure auction, which happens if a borrower defaults.

Since investors typically have a maximum allowable offer in mind, lenders will try to get as close to fair market value as possible but eventually settle for less. However, this doesn’t mean that all banks eventually accept a short sale offer. It’s not uncommon for lenders to refuse a short sale in the hopes of earning more at a real estate auction.

The Short Sale Process

There are typically eight steps to the short sale process. These steps make the entire short sale process, from searching for properties to closing the deal, takes roughly one to six months. Specifically, the eight steps include property identification, due diligence, funding prequalification, negotiations, short sale applications, short sale packages, and more.

1. Identify Potential Short Sales

The first step is to work with real estate agents as well as look online for potential short sale listings. You can reread our section on how to find a short sale above.

2. Do Your Due Diligence

The next step is to view the potential properties and assess their current conditions. For the properties you want to purchase, you’ll have to run a title search to see who the lienholders are.

3. Get Prequalified for Short Sale Financing

Once you’ve identified a short sale listing to purchase, the next step is to figure out your maximum budget by getting prequalified with a lender of your own. You can get either short-term as well as permanent financing.

4. Negotiate With the Seller

Two negotiations take place when buying a short sale. The first is the negotiation with the seller where you agree on a purchase price that’s below market value and the existing mortgage balance.

5. Complete Lienholder’s Short Sale Application

Once a price is agreed on by the buyer and seller, the buyer or buyer’s real estate agent will have to contact the lienholder’s loss mitigation department or resource recovery department and fill out a short sale application.

6. Submit Short Sale Package to Lienholder

After the buyer completes the short sale application, the buyer and seller will need to assemble a short sale package and submit it to the lien older along with the application. This proposal includes a purchase contract, a hardship letter outlining the seller’s financial hardships, the property’s appraised value, and a settlement statement.

7. Negotiate With Lienholder

It’s not uncommon for the lienholder to reject the buyer’s initial short sale offer. If this happens, the price is negotiated between the buyer and lienholder. It’s during this time that the lienholder will often get an independent broker’s price opinion on the property.

8. Close & Send Money to Titleholder

Once a sale price is agreed on between the lienholder and the buyer, the short sale closes, and the buyer wires funds to the titleholder. It’s up to the seller to settle their debts with the lienholder.

Bottom Line

A short sale is a real estate sale that helps investors purchase underpriced assets. This is because a short sale typically occurs at or below market value. However, a short sale is only successful when the existing lienholder agrees to accept less than what’s owed. Therefore, short sales occur when a seller is in financial distress.

LendingHome is a hard money lender that helps investors finance short sales with short-term loans. Interest rates are typically between 7% to 12%, and its loans can finance renovations. It offers loans up to 90% LTV and up to 75% ARV.

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