1. What is a “short sale”?
- A “short sale” is a common term used by those in the real estate business meaning a negotiated sale of a mortgaged property, with permission of the Lender, for an amount which is less than the amount owed to the Lender.
- It is a tool that may be available to you if you are having trouble selling the property, making your mortgage payments, or having some other financial stress in your life at the time.
- It is beneficial to Realtors, Sellers, Buyers, and Lenders.
- A means of avoiding a foreclosure of your mortgage. However, keep in mind that you must negotiate keeping in mind your mortgage and your promissory note with your lender.
Typical Example: (Negotiations)
Initial purchase price $500,000.00 Current Market Value: $350,000.00
First Mortgage: $400,000.00 (try to negotiate 80% ($320,000))
Second Mortgage: $50,000.00 (try to negotiate 18% ($9,000.00))
Purchase Offer: $345,000.00 ($21,000.00 Realtors Commission)
*Remaining Debt Forgiven (or not) Seller brings $5,000.00 to closing or not.
2. What are the benefits of a short sale?
- Seller - A short sale will permit the seller to escape a bad debt or the debt service which they can no longer pay and permit them to sell their property even if they owe more than they receive in the sale. It will permit the Seller to transact their property at or near the current market value and may be forgiven all or a portion of any remaining debt owed for the property. Market value must be realistic!
- Buyer - A potential Buyer can contract to purchase property at a great price without the worry of any mortgage liens or foreclosure expenses lingering on the property. They can rest assured that the property has been maintained as opposed to a foreclosure or REO property which may have remained vacant without utilities, maintenance, or pest control for many months before the sale. They will know that they are purchasing the property at the lowest possible price. Market value of offer must be realistic!
- Realtor - A Realtor can finally be able to move a property. Many of us now are faced with “unrealistic” Sellers who think they should get what they paid plus for their property. Many Sellers are afraid to market their property due to current market conditions and the size of their mortgage on the property. This can remedy those situations. Realtors can attract more Buyers with reasonable market prices, attract more Sellers (listings) by allowing Sellers to sell at market prices without concern over a mortgage payoff or out of pocket commissions (which are included in the purchase price and deducted from the mortgage payoff).
- Lenders - A Lender has to understand the upside of a short sale. If the Borrower is having trouble with the current mortgage payments, then the situation will very likely only get worse with time. If it gets worse then the outcome is probably foreclosure or bankruptcy or both. In either case, the Lender will be stuck with a property which has a value well below the loan amount, with additional costs of obtaining the property and with months of valuable time gone by. The short sale loss realized by the Lender is usually less expensive than the costs to obtain the property through foreclosure or the costs and hassles of bankruptcy. Also, the liabilities to the Lender of holding REO property for several months, insurance costs, liability exposure, damage to the property improvement, mold and pest infestation. Lenders not in first position also may benefit by being a part of the negotiations to receive a portion of the sales price now as opposed to little or nothing in a foreclosure later.
3. What is the downside of a short sale?
- Seller - The Seller has to convince the Lender to permit a short sale, has to make sure that he has fully negotiated all of the debts under his mortgage AND promissory note, AND that he understands any tax ramifications that may occur as a result of the short sale in terms of debt forgiveness.
- Buyer - Has to make sure he understands the transaction, reads the contract, knows the entire deal is contingent upon the Lender’s acceptance, or others, and is certain that there will not be any liens on the property. Typically “as is” transaction. Transaction will take 60 - 120 days to close if approved.
- Realtor - Should consult with a real estate attorney! Must understand both sides of the transaction and make sure that their client is fully informed about all of the ramifications to them. May need to negotiate (have attorney negotiate), with the Lender on their client’s behalf to make the deal close. Should understand the ramifications of the debt under the mortgage and note, and the taxable consequences to the Seller. Must make sure that the closing attorney is aware of the short sale and checks title very closely to ensure no other liens exist. Is there any debt forgiveness for the Seller? Other issues to consider: 1) how much time is necessary; 2) when do you propose a contract; 3) when do you list; and 4) what do you have to disclose; 5) what financial documents will the lender require; 6) understand your liability and limitations.
- Lender - Must consider whether this is a cost effective and reasonable means of resolving this debt. Other issues to consider: 1) what approvals to get at what stage of the negotiations; 2) what evidence do you need to make your approval reasonable; 3) how much time do you need to get this all done so the deal doesn’t fall apart once a contract is produced; and 4) what priority lien does the Lender have on the property; 5) is this a good business decision.
4. Short Sale Process
- A short sale is a negotiation, it is very fluid and the person negotiating it should be a step or two ahead of the other party at all times.
- Because it is a negotiation there are usually no hard and fast rules by which to handle a short sale.
- It depends on the Lender, the Seller’s payment/credit record and the Seller’s financial situation, the current real estate market, an appraisal and/or, BPO, CMA, and timing. Notice that none of these factors are under your control at this point.
- Lender - some Lenders are more receptive than others. You will likely deal with the Loss Mitigation Department and need to speak with a supervisor there to get any real information on how their particular office would like to proceed. Consider what the Lender needs from you and what forms you need from them. What are the time frames? What is the internal process of that Lender?
- Seller’s Payment / Credit - Obviously, the Seller must have some type of financial difficulty; otherwise why consider a short sale. It is not necessary that you have missed any mortgage payments as much as it being likely that you will in the near future! Some will require substantial financial records from the Seller over the last 3 - 6 months to demonstrate their financial losses.
- Real Estate Market - Does the current market demonstrate that the property could not be sold for the amount due on the mortgage? The Lender will likely test your theory by having an appraisal (BPO) done on the property before they approve a short sale. You may want to beat them to the punch with evidence of market value.
- Appraisal / CMA - The Lender will want one, so maybe you should have one ready. A tool the realtor will use to list your property on the MLS.
- Timing - The Lender, Seller, and Buyer all have to be ready for process to begin. The Realtor or other real estate professional involved should prepare them.
How has your financial condition changed since to obtain the loan?
- The objective is to convince the Lender that a short sale now is better than all of the trouble and expense of a foreclosure or bankruptcy later. A Lender will usually spend $50,000.00 or more in a foreclosure proceeding.
- Lender Requirements -
- Loss Mitigation Application for Short Sale
- Seller’s letter of hardship
- Seller’s financial records (3 -6 months)
- - Federal Tax returns
- - Income verifications
- - Bank statements
- - Asset / Debt statement or affidavit (with proof)
- - Evidence of listings at higher price w/o offers
- - Evidence of market value being lower than listing price
- - Preliminary title work
- - Preliminary HUD-1 statement
- - Monthly budget (income / expenses)
- - Other evidence of financial hardship
- Lender review committee
- Depending on the Lender, it may empanel a review committee or the supervisor you are talking to may simply make a decision once they have all of the paperwork. Typically the Lender will wait for an offer to make a final decision.
- The Lender will also require some approval of the investor in the mortgage note which may be a mortgage insurer, investment firm or some combination thereof.
- The Lender will either agree to permit you to attempt to sell the property at a specific listing price or not permit you to do so, or counteroffer.
- Listing the property - you should identify the property as subject to a pending short sale with “name of lender”
- Contract For Sale - is always subject to the Lender approval and MUST state that clearly in the contract. You might also want an appraisal contingency in the contract as well in case the appraisal comes in higher or lower than anticipated. May also consider an inspection contingency, and may have subject to Sellers’ approval of any additional terms by any other Party. Consider the issue of debt forgiveness.
- Submit contract for final approval
- Lender may revisit their earlier findings
- Lender may request additional or updated financials from Seller
- Lender may order an appraisal of the property
- Lender will likely require review of closing documents as part of their approval
- Lender approval & closing (everything must be disclosed in the settlement statement and Seller may not receive any compensation from the transaction).
Closing the transaction
- You should always use a real estate attorney in any real estate transaction, but particularly in a short sale transaction because of all of the above requirements.
- The closing attorney must insure title for the Buyer and new Lender and make sure that all of the debt of the Seller has been released or revised and all other liens satisfied/released.
- Closing attorney must make sure that he has all of the necessary documents from the prior Lender and that all parties including the new Lender are aware of all of the parties and that this was a short sale transaction.
- The property must have zero equity or negative equity for the Seller.
- The final settlement statement must reflect the net proceeds to the Seller of zero or less than zero.
- The sales price to the Buyer less the gross payoff of the loan must be equal to or less than zero.
- No monetary proceeds of the sale may be paid to the Seller.
- Transaction must be at arms-length (no related parties)
- A name search for the Seller and Buyer is generally required (check prior dealings).
- Must issue a special or general warranty deed to Buyer.
- Can be a part of a “flip” transaction but, only if all parties to the transaction are aware of the terms of the transaction. (Special rules on title insurance).
- Seller must have present authority to sell the property.
Preparing the Seller for the Transaction
- Is this the best solution for the Seller of the property?
- Does the Seller want to or have to sell the property?
- What other assets does the Seller have available to them? Is this a consideration for the short sale Lender?
- What is the loan to value of the property?
- Is there another option which would protect them better or make more sense for the Seller?
- What other assets does the Seller have?
- In a short sale the Seller must reveal their assets to the Lender and if there are valuable assets that are available to pay down some of the mortgage debt then the Lender may attach or choose to seek attachment of some or all of the assets.
- Are the Seller’s other assets protected from attachment
- If the Seller has assets then Lender may require the Seller to pay back some or all of the remaining debt remaining after the short sale transaction.
- Taxable implications
- The Seller should consult with a competent tax advisor before entering into a short sale transaction.
- If the property is investment property and there is any debt forgiveness then the Lender may report the debt forgiveness to the IRS as taxable income of the Seller.
- If the Seller owned and occupied the property prior to the short sale transaction, and the funds forgiven were used for the purchase or improvement of the property there will likely not be any tax implications (with some qualifications).
- Insolvency is an affirmative defense to any tax implications created by debt forgiveness in a short sale transaction.
- Ride out the Storm - If you don’t have to sell in this current real estate market then do not sell or be prepared to wait for the right buyer.
- Lender Loan Modification - You should consult with your lender to see if any sort of loan modification is available so that your debt service becomes manageable and you do not enter into any financial difficulty. The earlier you contact your lender to discuss these possibilities the better off you will be. There are programs available through HUD (FHA) which will permit you to qualify for a refinance of your current mortgage at a fixed rate if you can negotiate with your current lender a 105% LTV for the new FHA loan. Have your considered the Homeowners Affordability and Stability Program (HASP) or (HARP) as options? Of course your present lender will likely have to work with you on this negotiation and still forgive some remaining debt. This is generally only possible for homeowners, (owner occupied property), and not investors. You should consider what percentage of your gross monthly income is taken by your principal, interest, taxes and insurance. This will help you identify if you may qualify for a mortgage modification.
- Deed In Lieu Of Foreclosure - This is considered a foreclosure although you are voluntarily giving your property back to the Lender.
- Your Lender has to accept the Deed In Lieu of Foreclosure.
- Typically, you must have had your property listed or at least tried to sell your property for some extended period before requesting a Deed in Lieu of foreclosure from your Lender.
- Your Lender will usually require that the property is free and clear of any other debts or claims (i.e. HOA, property taxes).
- Typically considered by credit bureaus and lenders as a foreclosure.
- Consider the effect upon any remaining debt to the lender if you give the property back.
- Foreclosure - An involuntary action at law whereby the Lender sues the Borrower for repossession of the property and may also include full repayment of any remaining debt due the Lender (deficiency judgment). The Lender may have up to five years after the foreclosure action to seek a deficiency judgment against the borrower for any deficiency in the loan. That is why a bankruptcy is generally filed by the borrower to escape the deficiency judgment and costs charged by the lender in the foreclosure. One should investigate all of the possibilities before choosing any particular plan of action. If you are going to end up in a bankruptcy anyway, then it may not make sense to go through all of the trouble of a short sale. You must seek out and consult expert advice in each of these areas before you make any decisions.
- Deficiency Judgment – Keep in mind that a real estate loan has two separate and independent repayment obligations from you the borrower to your lender. There is the mortgage, which is a specific security interest in your property for repayment of the loan and there is the promissory note which is your personal obligation to repay the loan. If you default on the loan repayment, then your lender may proceed against you in a foreclosure of your mortgage and take back the property; and, the lender may also file a deficiency action against you for repayment of the loan in full and any costs and expenses incurred in obtaining repayment of the loan. A deficiency action may be taken against any deficiency unless it is settled or forgiven appropriately. Your lender may proceed in a deficiency action at anytime within five years of a foreclosure action.
- Bankruptcy – A voluntary action in Federal court which is intended to help a borrower start fresh by escaping debt that they can not possibly repay. An individual or a company can file a bankruptcy and you may either eliminate debt completely based upon your current financial situation or you may reorganize your debt to repay a portion of what you may owe back to the creditors. You have to qualify with the court to file a bankruptcy and not every one can qualify. It is evidence of insolvency and will devastate your creditworthlyness for the next seven – ten years. However, it will give you the opportunity to escape full repayment of your debt. It pertains to all debt both personal and realty and includes a means to eliminate a deficiency judgment by your lender. If you are considering a short sale you should also consult with a bankruptcy attorney to examine all of your options.
A short sale is a great solution to resolving this type of problem but should only be negotiated with a real estate attorney involved who has experience in these types of transactions. The Parties must be patient and willing to negotiate to achieve a great real estate deal. A short sale will not likely have the same title or rehabilitation issues as an REO property and since it is typically occupied it has been generally better maintained by the sellers. A short sale will permit the seller to sell, a buyer to buy, a Realtor to move property and take inventory off of the market while spreading the least possible loss over to the most responsible parties!!!