If you have any interest in Real Estate these days, you are undoubtedly aware of the term Short Sale. A Short Sale occurs when property is sold and the lien holder (lender) agrees to release the lien while accepting less than is owed. Not all lenders will accept short sales or discounted payoffs, especially if it would make more financial sense to foreclose. It is also important to understand that frequently, the servicing entity that collects payments and is the point of contact on the loan does not own the debt and is only the mouthpiece for an unknown investor.
Whether you are a Buyer looking for a bargain or a Seller that can no longer afford mortgage payments, deciding whether to pursue a Short Sale may be worth your time and money when considering alternatives such as bankruptcy or foreclosure proceedings. On the other hand, it may not!
In a Short Sale, the main players are the Buyer, Seller, Realtor and Lender. I examine important points for all 4 below.
As a rule, lenders do not forgive debt to borrowers unless forced to do so by a judge. If a Lender believes the homeowner can handle the mortgage payment, there's little motivation to allow a short sale. Typically, Lenders will not even consider a Short Sale if payments are current but this seems to be changing. When a Lender believes that foreclosure is imminent, they will do what is best for the bank to minimize loss. This is where negotiations become a “who blinks first” scenario. For this reason, most experts consider it essential for Sellers to consult with a Real Estate attorney, a tax expert and a well seasoned Realtor. Poor decisions made during a Short Sale can negatively affect a Seller’s financial affairs for years to come.
It’s also important to understand the situation if the home has a second mortgage with another institution. For example, a homeowner may owe the first secured lien holder $400,000 and an additional $100,000 to a 2nd lender. If the homeowner receives an offer of $450,000 for the home, the first lender is very happy because their debt is retired and the 2nd lender bears the brunt of the short pay! Sellers have to analyze their specific situations to determine which (maybe both!) lender needs to be involved in approving a short sale. In some circumstances, it is not unusual to find primary lenders negotiating with secondary lenders to complete the short sale.
While getting a lender to agree to a short sale may seem like an ideal solution, it should be only considered when the only other option is foreclosure. Homeowners with short term financial problems would probably be a better served working with the Lender to restructure the debt or ask for forbearance.
As opposed to in the past, some Lenders now allow a Homeowner/Seller to provide them with everything except an Offer prior to listing the home. This can save a great deal of time in a tedious situation. You’ll need to fully and honestly document your financial situation with a Hardship letter, proof of income/assets/debts along with last 2 year’s tax returns. (DANGER: not a great idea to plead that you only make $15/hour as an Administrative Assistant when you previously stated you were the VP of Sales for the company making $125K/year when you applied for the loan!) You’ll also need a seasoned Realtor to help you provide an articulate assessment of the value of your home known as a Comparative Market Analysis (CMA). A Lender will not tell you what offer they’ll accept but you’ll get an idea if they are open to a Short Sale after reviewing your finances, how much is owed on the home and the approximate value per the Realtor’s CMA.
Another essential advisor is a Real Estate attorney familiar with Short Sales. They can help you in the negotiations with the Lender and ensure that all agreements are in writing, that no deficiency judgments will be filed and that your credit is protected as much as is possible. Some experts estimate that Foreclosure proceedings will lower your credit score by 250 to 280 FICO points and will remain on your credit profile for 10 years. Short Sales, on the other hand, generally show up as a pre-foreclosure in redemption status resulting in a loss of 80-100 FICO points and only remain on your profile for 7 years. Personally, I believe that the biggest hit to a homeowner’s credit comes from the rolling 90 day lates that tend to accrue in these situations.
Last but not least, consult with a tax professional! Frequently, but not always, a forgiven debt will incur tax ramifications in a form of a 1099 issued by the Lender to the Seller. The tax concept is that if a lender gives you $100,000 and you only pay them back $80,000, you have realized $20,000 in income. Fortunately, on December 20, 2007, President Bush signed H.R. 3648 (Mortgage Forgiveness Debt Relief Act of 2007). This act generally relieves Sellers from owing federal tax on forgiven debts for PRIMARY residence sales that occur from January 1, 2007 going forward for 3 years. It does not provide tax relief on 2nd homes and Investment property sales but a tax accountant can be instrumental in advising on those situations.
As a rule, Buyers prefer to get a good deal on property they desire to purchase whether it is for a new primary or for an investment purchase. They have their own set of circumstances on when they want/need to buy, how much they can afford and general level of tediousness they are willing to endure. If you’re looking for a potential great deal, a Short Sale may be the ticket. Just remember, it's not as simple as you may believe, and very few can close in 30 days or less.
Do your research before making an offer to purchase. Your agent can find out who is on title, whether a foreclosure notice has been filed and how much is owed to the lender(s). All of this along with an assessment of recent sales in the neighborhood is important to determine how much to offer.
Although Buyer’s Agents represent Sellers, having a Buyer’s Agent with experience in short sales will help expedite the transaction. Equally important is working with a Listing Agent that has Short Sale experience. Inexperienced agents very often lead to protracted or delayed closings. This is why many Buyers and their Agents shy away from Short Sale listings in which the Seller and/or the Listing Agent have not done their homework.
Once the seller has accepted your offer, it must be sent to the lender for approval. You do not have a deal until the lender accepts and this may take several weeks from submission and will most probably try to negotiate certain items. Make your offer contingent upon the lender's acceptance and give the lender a time frame in which to respond, after which, you will be free to cancel. If the lender is under no pressure to make a decision, they will handle other priority work first! In addition, the lender may want to verify that you are paying cash with no contingency or that you are pre-approved for a mortgage so be prepared to provide this documentation.
Finally, as with any real estate transaction, it is extremely important that a buyer obtain a home inspection and make your offer contingent upon a satisfactory finding.
Frequently, Sellers try to rely solely on their Listing Realtor and that is a mistake. Although seasoned Realtors are well versed in most facets of a Short Sale, they should not be providing tax and legal advice no matter how well intentioned it may be. In a sense, the Listing Realtor should assume the role of Project Coordinator. In this role, they help keep the Seller on point and speaking with the specialists needed to protect their interests. They are also vitally important in helping the Lender understand the true value of the home based upon their market analysis.
The Buyer’s Realtor on the other hand, has a different perspective. Their research should determine who is on title, whether a foreclosure notice has been filed and how much is owed to the lender(s). This is important because it will help determine how much to offer. Remember, just because a property is a Short Sale does not mean that it is a good deal!
Buyers tend to limit how much of their time they are willing to spend on a property search and dealing with inexperienced Sellers can be a serious setback. For this reason, a good Buyer’s Agent will pre-screen listings prior to showings to determine where in the process the Seller is. A Seller who has previously made contact with the Lender and who has submitted an offer that was turned down, has a much better understanding of where the next offer needs to be if they are to have any hope of it being accepted. A Buyer’s Realtor can get a sense of most of this from conversation with the Listing Agent.
Last but certainly not least, Realtors work on commission and regardless of the commission the seller has agreed to pay, the lender is actually the entity paying the commission. In the past, many Lenders balked at paying Realtors a full commission. This seems to be changing as Lenders are more and more beholding to Realtors for keeping these deals together.
Lenders are in business to make money. As opposed to many years ago when S&L’s and Building and Loan lenders were the norm and one could expect a bit of compassion when times were rough, today’s corporate behemoths are beholding to Wall Street and anonymous investors who demand performance. Within this framework it is easier to understand a Lender’s perspective if you know all the factors they are dealing with.
Although it has taken them a while to get on board, more and more lenders are now allocating resources to deal with Short Sales and Foreclosures because it is saving them money. It’s important to note that the employees of the lender that are negotiating the sale ARE NOT there for the benefit of the seller. Their primary goal is to collect as much of the debt owed as possible and make no doubt about it, they are becoming much better informed about the bottom line loss associated with a foreclosure in today’s marketplace and trying to collect as much above this amount as they can. It’s also not uncommon for managers of these departments to have their compensation tied to the amount of money they can collect.
For instance, many Lenders insist that they will not write off deficiency amounts but will take a promissory note at wonderful terms ($50,000 over 10 years at 0% interest according to one Realtor source I heard from recently) otherwise they will foreclose. Per my source, the Seller called the lenders bluff and provided a letter from their attorney stating they would qualify for a bankruptcy. Amazingly, the lender called the seller the next day saying they would reduce the promissory note and write off $30,000 of the debt to which the Seller stated he would just go ahead with the bankruptcy. Two days later the seller received a written offer that the lender would completely forgive the debt and simply report it as 1099 income.
Finally, NEVER EVER ASSUME THAT A DEBT THAT YOU OWE A LENDER IS GONE UNLESS YOU HAVE THE DETAILS OF THE RELEASE OF THAT DEBT IN WRITING. Lenders will always want ALL their money accounted for somehow. NEVER assume something is written off unless you have a formal, signed, written, unconditional release of lien and/or judgment from the lender specifically stating that no further action to collect this debt will be taken.
In closing, Short Sales can be a good deal for everyone involved in a difficult situation. Sellers need to be well informed and represented in order to protect their interests now and into the future. Buyers need to understand that not all Short Sales are good deals and that these closings take more time than usual. As with most real estate situations, an experienced professional Realtor increases the odds of a successful low-stress closing.