The Dangers of Purchasing a Short Sale with a VA Loan

A VA loan guaranty is like insurance on your mortgage. With this protection, the VA will buy the mortgage out of default from a private lender if you cannot pay your mortgage. If this occurs, the VA will then foreclose on the property and sell it to cover the outstanding debts. When the asset does not recover enough to repay the debt, you are on the hook for the remaining sum. The risk of this occurring can be greater with a short sale situation.

Short Sale Basics

It is necessary to understand a short sale prior to entering into a contract with a short sale seller. In this situation, the seller is unable to continue making mortgage payments on the property. As it nears foreclosure, the lender would prefer to simply unload the asset completely instead of foreclosing on it, listing it for sale and incurring the fees associated with the foreclosure process. The lender agrees to take a small loss on the loan by allowing the borrower to sell it for less than the remaining debt, and both parties walk away free and clear.

Risks of Using a VA Home Loan in a Short Sale

You can use a VA home loan guaranty to purchase a short sale property. The benefit of this option is to purchase a home at a decreased price; most short sales do offer very competitive prices. However, the VA will have specific appraisal requirements on the loan. The VA does not want to issue insurance on a property only to find the property's value is much lower than the insured value. This would cause a loss for the VA. Thus, the VA will independently appraise the property. If it does not meet standards, the loan will not go through. Short sale properties are often under-maintained, increasing this risk.

Defaulting on a VA Home Loan with a Short Sale

If you succeed in purchasing a short sale property with a VA guaranty, the risk of default on the loan is high. In most short sales, the reason the home is being offered at a price less than the outstanding balance on the loan is that its value has fallen since the loan was issued. This can happen due to a bad economy or problems with the property. If the problems continue, which they often do, your home could be worth less than its insured value in the future. If you default, you would owe the VA the difference between the insured value and actual value of the home.

Alternatives to a Short Sale Property

If you are looking for a deal on your property, it may be wiser to consider properties in transitional areas instead of short sale properties in expensive areas. The short sale properties have lost value, while the transitional properties have gained value in the same period of time. If you were to have difficulty making payments on a property with a greater value than when you purchased the home, you could sell the home to cover the cost of the loan in its entirety, avoiding default.

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