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Tips for Protecting Buyers with Short Sale Contracts

Updated on May 22, 2011

Reduce your risk with terms that allow you to cancel your short sale contract.

If you're looking for a real-estate bargain, you may be considering purchasing a short sale -- a pre-foreclosure that will sell for less than the owner owes on his mortgage. Although the low price makes a short sale an attractive option at first glance, caution is warranted. Many short sales have maintenance issues caused by neglect. The seller, who is coming to terms with the loss of his home, may be uncooperative in submitting required financial documents. And the seller's lender is likely to try the patience of both parties as it drags its feet in making a decision about the buyer's offer. The best protection for the buyer is to structure the sales contract in a way that minimizes her risks.

How Does a Short Sale Work?

In a short sale, financial hardship forces the homeower to sell her home. The early phase of a short sale is much like any other real estate transaction. The seller contracts with a real estate broker to list her home for sale. They may set the price according to the amount the seller needs in order to pay off her mortgage loans, pay the broker's commission and cover closing costs, with the understandng that the home is overpriced and will need to be reduced once the lender tentatively approves the short sale.

Once the home has been listed, the seller contacts her lender to discuss the possibility of a short sale. She documents the financial hardship that prevents her from paying her mortgage loan, as per the lender's instructions, and she gives her lender permission to speak with her real estate agent. The lender may give preliminary verbal approval, but it's almost certain to refuse to definitively approve a short sale until a prospective buyer has made an offer. Once an offer is on the table, the seller accepts it first, and then her agent relays it to the lender. The lender may let weeks, or even months, pass before it gives an answer. If the lender approves the sale, it sends an addendum to the contract specifying additional terms, and the sale proceeds toward closing.

The Short Sale Contract

The agreement of sale is the contract that defines the terms of the sale and explains the buyer's and seller's rights and responsibilities. The contract is binding only on the buyer and seller. Even though the lender has final say, it is not a party to the agreement. The contract specifies the price, sets deadlines for various transaction milestones and sets forth the conditions under which either party may cancel the sale. If a short sale addendum is included, it describes the short sale process and specifies for how long the buyer is bound by the agreement in the event the lender doesn't respond to the offer in a timely fashion.

Short Sale Contract Contingencies

Contingencies are conditions under which either party may cancel the sale. They protect a buyer in a number of ways. Inspection contingencies allow the buyer to cancel the sale if the inspection results are unsatisfactory. The mortgage contingency allows the buyer to cancel if he's unable to secure financing. An appraisal contingency ensures that the buyer can walk away if the home doesn't appraise for whatever amount of money the contingency specifies -- typically, it's the purchase price. The more contingencies she elects, the more protection the buyer has.

Short Sale Contract Clauses and Addenda

The buyer can use the short sale addendum to limit the amount of time she'll wait for the lender to give an answer. In addition, she can make the sale contingent on the seller submitting required financial documentation by a specific date. The buyer can also include an attorney review addendum that gives her and the seller the right to cancel the sale within a specified period, like seven or 10 days, under the advice of their attorneys. Finally, the buyer can limit her losses by making it a term of the contract that the seller is limited to retaining deposit monies as damages in the event the buyer breaches the contract.

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