One of the greatest myths in the world of real estate is that buying a home that’s in a pre-foreclosure state, or one that has already been foreclosed upon, will get you the very best deal possible. This is inaccurate for a number of reasons, though if you know what you’re looking at you can sometimes snag a bargain. There are a few things you need to know before making that leap the first time.

What is a Short Sale?

Short sales happen because a homeowner is in big trouble financially and needs to unload their house. They may be in a negative equity position (underwater) or simply lack the equity to sell their home. There was a time when homeowners had to miss a few payments before lenders would consider a short sale, but today there are conditions, like a sudden loss of income, that can make a short sale possible faster.

Short sales save the homeowner from a long and potentially credit damaging foreclosure. They save the bank from having to get lawyers involved to collect the home that’s collateral for the mortgage that’s in default. They don’t do anything for a buyer by design (that’s not to say that you can’t benefit from them, they just didn’t really consider buyers when creating this out for homeowners in trouble).

Buying a Short Sale Home: The Basics

To successfully navigate a short sale, you’re going to need a few things:

1. An experienced real estate agent. Writing a contract for a short sale is not like writing a contract for a standard home. There are usually a variety of clauses that must be included, as well as knowledge of what will and won’t be accepted in said contract to consider. Your interests have to be protected, which can really bloat a standard purchase agreement with a lot of extra verbiage.
2. A really good home inspector. When people ask their banks for permission to sell short, they’re not doing it because they’ve been spending all their extra money fixing up the place. Often, these homes are in some amount of disrepair due to neglect. When finances are tight enough to get a short sale approved, you can bet home improvements are far from the current owner’s mind.
3. Patience. It can take a very long time to get a short sale approved. If you’re looking to buy one as an investment, that wait might not matter, but if you want a place to call home, it’s going to be frustratingly long. This is because not only does the homeowner approve the contract, the bank has to, as well. If there are two or more banks involved, so much more the trouble. Buckle in, because it can take six weeks – six months — to close.
4. Liquid or liquidatable assets. Depending on the state of the home, you will likely have to put some money into it right away. A leaky roof and HVAC with issues aren’t cheap to fix.

It is highly recommended that you use a real estate agent to purchase a short sale. This point cannot be stressed enough. Short sales are not always deals, as stated above, because banks know what their property is worth — they’re not going to let you steal that house for a song. The banks involved are also unlikely to make repairs or give you any sort of concessions.

How Can Banks Afford to Do This?

The next time someone tells you that mortgage insurance is a waste and does nothing for anyone but the bank, remind them that MI is what makes short sales possible and often prevent long-term credit damage during a foreclosure. When a home qualifies to be a short sale, the bank is using proceeds from a claim against the mortgage insurance to make up the difference between what the sellers owe and what a buyer is giving.

MI can help prevent something known as a “bleeding foreclosure.” This is a foreclosure (or short sale) that has sold, but has a balance remaining that cannot be forgiven. Not all homes sold short will “bleed,” but it’s a potential in many states, especially if you’re not carrying MI on your mortgage. So, rather than pay extra every month for MI, you’ll be paying monthly for the outstanding balance on a house you no longer own.