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Short Sale Investors are flooding the real estate market, purporting to help distressed home owners in the midst of foreclosure. These investors usually claim to be experts in “short sales” — sales where the bank holding the mortgage agrees to accept less than the full amount due. Some are, many are not, having no training and only the expertise of having lived through their own financial crisis.

How Investor Transactions Typically Work

The investor signs an offer to purchases the house at a discount and tries to convince the mortgage holder (the seller’s bank) to accept a short payoff. At the same time, the investor searches for a new buyer to purchase the home at a marked up price. In a typical example:

The investor will buy the house from the distressed seller for $100,000 and turn around and sell it to the new buyer for $125,000. These two transactions will close on the same day. This is known as back-to-back closings.

What is the Catch?

The problem is that this system may not help sellers and often hurts them. Sellers who use this Investor-Flip model rather than a typical sale with a Realtor, are often left with:

  • A greatly reduced pool of potential buyers
  • A larger deficiency (the debt still left owing to the bank)
  • Increased debts from other liens
  • An increased likelihood of foreclosure

Lets discuss each of these potential problems.

A Reduced Pool of Potential Buyers
The majority of lenders have a “seasoning” requirement. Seasoning refers to the length of time the seller owned the property before the purchase. Lenders want to make sure that the seller owned the property for a sufficiently long period of time: usually 60-90 days. The Investor buys the property and resells it on the same day, thus owning the property for only a matter of hours. There is no seasoning. This means that the distressed seller is limited to finding buyers with unique lenders or buyers willing to pay cash! Thus, by choosing “an Investor,” the seller most in need of available buyers has drastically limited the pool of available buyers.

A Larger Deficiency
A deficiency is any amount of money still owing after the mortgage is released. A mortgage is only a security interest against the property. When it is released or satisfied, it releases the property but it may not release the debt. Many banks will release the property but reserve a deficiency — the right to seek future repayment of any left over debt. Investors do not hide the fact that they will offer the lowest possible purchase price. After all, they need to make a profit too. In many cases, however, each dollar of profit to the investor is a corresponding extra dollar of deficiency.

Increased Debts
In most short sale closings, there is more than one debt to be paid. Often a seller has multiple mortgages, judgments, and other secured debts against the property. Investor transactions reduce the purchase price and thereby increase the likelihood of these debts remaining due.

Increased Likelihood of Foreclosure
Investors market that they can save distressed seller’s from foreclosure. Many do just the opposite. Because the seasoning and disclosure rules limit the pool of buyers and many foreclosing lenders prohibit investor-flip transactions, the odds of a foreclosure increase. Indeed, a typical short sale payoff contains the following requirement: This transaction may not inovolve any third party who received a deed from the seller at, prior to, or after settlement, and the purchase contract may not be assigned. This prohibits investor transactions. A distressed seller, working with an investor, may find out at the last moment that they have wasted their time. And when they do, it may be too late to avert foreclosure.

Finally, these double closings are simply much more complicated and, therefore, more likely to fail. Both the seller’s old lender and the new buyer’s lender need to be given full disclosure and approve of the structure of the deal. The property must have a low enough appraisal to satisfy the seller’s lender and a high enough appraisal to satisfy the buyer’s lender. And the closing instructions and payoff letters must not prohibit this kind of transaction. While this is all possible, it certainly is far more difficult than the traditional short sale.

Why Do Investors Get Involved?

The obvious reason is cash. While investor transactions are difficult and may not close, those that do close often net the Investor $15,000 – $30,000 with little or no overhead or risk. In addition, many investors will consider purchasing the property at the sheriff’s sale. Their involvement ties up the property and prohibits most, if not all, buyers from having a chance of purchasing. Then, the Investor can get an even better deal at the Sheriff’s auction.

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