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The Short Sale - Part I*

What is a Short Sale?

The definition is simple. A short sale occurs when a lender adjusts a loan pay-off down to accommodate the sale of a property. For example, a seller might have a loan balance of $300,000 and a buyer willing to pay only $240,000. If the lender accepts the offer, he has agreed to "short sell" the pay-off down $60,000.

There are many other terms describing the short sale which you may have heard. The most common terms in the industy include:

Short Pay Sale
Compromise Sale
Write Down Sale
Negotiable Sale
Pre-foreclosure Sale
Pre-Sale
Loss-prevention Sale

Don't be confused. All of these terms describe the same principle for the same transaction. The term varies from lender to lender, however the most common name is the Short Sale.

Why would a lender accept a pay-off for less than the loan balance?

Lenders must manage and mitigate their losses. The short sale option is usually a prelude and/or alternative to foreclosure. Because banks are required to maintain reserves on all properties in foreclosure, it can be advantageous to accept a pay-off for less than the loan amount. Remember, there must be a willingness for the lender to negotiate this type of arrangement.

Who and what situation qualifies for a short sale?

There is mainly one requirement for qualification and that is proof of hardship. Hardships are not necessarily financial. The most common hardship situations are:

Impending divorse -A situation where both spouses may be able to meet the payment before the divorse, neither party alone can afford the payment afterwards.

Illness - Illnesses where the person is unable to work and continue the loan payments.

Unemployment - A situation where an individual has inadequate income to meet his/her loan obligation.

"Hardball" - For lack of any other term, hardball refers to anyone who no longer wants the property for whatever reason and will accept the consequences whatever they may be.

What are the consequences of implementing a short sale?

1. Expect derogatory credit. In the vast majority of short sale situations the seller maintains a satisfactory credit rating however, derogatory credit is a possibility.

2. Expect tax liability. A new IRS law is currently pending which will require the issuance of a 1099C for the difference between the loan amount and the pay-off amount. For example, a property with a loan amount of $300,000 short sells for $240,000. Theoretically, the lender can issue the seller a 1099C for $60,000 with applicable taxes due to the iRS.

In reality only about one half of the banks issue a 1099C because there are usually several parties involved. None of the parties involved (lender/bank. Fannie Mae/Freddy Mac or mortgage insurance) are willing to accept the responsibility to issue the 1099.

There are several davantages to the short sale. The seller can reduce his/her debt, avoid foreclosure, maintain credit worthiness and most importantly, get out from under a mortage.

However, there are also some disadvantages. Bad credit and tax liabilities can occur. In addition, any short sale from a VA loan requires payment in full (for the full amount) or the seller loses all veteran benefits including death, educational and medical until the balance is paid.

The key decision makers in the short sale process include the lender, investor and the mortgage insurer (MI/PMI). The lender (sometimes also the "investor") typically gathers all the information required to consider a short sale package. The lender will then calculate what the actual loss is and then either approve or disapprove the package. The final decision maker is the mortgage insurer. MI/PMI will only approve a package that has been signed off by the investor and require the most comprehensive support information. The process takes some time and can make a short sale transaction a very slow process.

*It should be noted that lending and foreclosure practices and laws vary from state to state. This posting is based on the laws and practices of the State of California. Although they are similiar throughout the United States, there are differences. There are also differences between Trust Deeds and Mortgages, although we collectively all refer to them as mortgages. In California we use Trust Deeds and do not use Mortgages. Most of the western states use Trust Deeds, however the eastern states generally use Mortgages. The redemption period during a forclosure is different with Mortgages. Also the lenders ability to collect delinquencies varies with the type of loan and the choice of the foreclosure process. To collect delinquencies the lender must use a judicial foreclose. Few lenders do as this takes more time and involves additional legal expenses. Most use the non-judicial forclosure method. Also with purchase loans taken out at the time of purchase, delinquencies cannot be collected. They can be collected on refinance loans. On a short sale the delinquency is waived by the lender. Thus there are differences even in California. Please consult with a real estate attorney and CPA in your state for specific details.

Mike Stankewich, Realtor, Huntington Beach, Orange County, California

ZipRealty, Inc.

Huntington Beach Real Estate

Your Huntington Harbour, SeaCliff, and Seabridge Real Estate Expert in Huntington Beach

Surf City USA

Posted by <i>Mike Stankewich, MBA, e-PRO - ZipRealty, Inc.</i> on 05/19/2007 11:49 AM

Comments (19)

short sale, mortages, real estate

This post has been included in California Information

19 Comments on The Short Sale - Part I*

MAY

2007

I read part 2 before I got to part 1. Excellent job explaing for both agents and consumers the details.

Mike, this is so helpful. I am dealing with an offer we made on a home yesterday and just found out the selller needs to get a short sale. He is not if foreclosure, has good credit.

But, he is upside down, due to a appraisal of 1.5 mil and a divorce. His home has been on the market 2 years and we have a contract on it for 830,000. It had been reduced to 899,900. I am nervouse for my buyers who just returnd out of the country. Any help would be appreciated.

This is a timely post for me. Thank you.

Missy,

I hope this listing agent is experienced with this. You as a buyer's agent are at the mercy of the listing agent, as she or he is the only one authorized to deal with the lender on the seller's behalf.

The lender needs to approve the purchase price. In some cases if he has insurance, the insurance adjustor needs to approve the price. As these are loss mitigation people, they will sometimes try to negotiate the price upwards. As part of their strategy they will drag their feet on approval. The listing agent needs to be all over them to push the process along.

I assume the listing agent got the lenders approval to reduce the listing to $899,900 and did not just do it him or herself. If you list these types of sales you need to work things out with the lender before it goes into escrow and you should establish the listing price with the lender.

Good luck with your $70,000 reduction. Your buyer may have to compromise and come up somewhat is the lender tries to negotiate the price. Expect a long process.

I had one where my buyer held out on the price and the lender was dragging his feet trying to get a higher price. My buyers got fed up so we cancelled escrow and found them another place. As soon as we cancelled the lender came back and said he would accept our price. Sometimes you need to play hardball with the listing agent and the seller's lender.

Since this one has been on the market 2 years, you may have an easier time. Good luck!

Thank you Mike very good information - I'm going to read part two now.

MAY

2007

Mike,

Great comment on the pricing of short sales. Too often buyer's agents see short sales and think they can come in with an extremely low-ball offer. This can really complicate the process as it makes the lender begin negotiating on the price. Going back and forth with a lender on a short sale can be an arduous process. It is important for the listing agent to be able to effectively communicate this reality to the buyer agent. If the buyer agent is not experienced in short sales it can make for a long process as they advise their client to hold out for a lower price while the lender is not willing to budge.

This can be exceedingly detrimental if the house is on track for auction. Trying to get a short sale done on a property headed for auction requires maximizing the remaining time before the property is auctioned. That time can be saved by the buyer understanding the price point where the lender is comfortable short-selling the property. It is very difficult (near impossible) to keep a property from going to auction - an extension of even one day may not be approved. (Dependent on the lender of course.)

Great article - especially during these times.

Question: If the property goes to county steps, and say the second is the one that did the foreclosure not the first. When the bids are open and closed and someone's won does that winner assume the first in this case or did he just purchase the house for the amount of the bid (which was only for the second loan amount).

example.

1st loan amt due is $403, 000.

Second loan due is $44,000

Bid starts at $44,000 and stops with a winning bid of 46,000. Is the 46,000 all the bidder will have to pay on the house or do they assume the first loan too?

Rosemary

MAY

2007

Typically, the IRS views forgiven debt as taxable income. It is immaterial whether or not the lender issues a 1099 to reflect the forgiven debt. It is the responsibility of the taxpayer to report and treat all sources of income. I understand you are writing about California foreclosure customs, and there are issues regarding recourse and nonrecourse loans and debt forgivenness, and resultant tax implications.

When taking a listing, it is very important to know if you will be in a short sale position or not. Sometime, when working on a net sheet with your customer, they will forget about the HELOC that they took out to buy that new RV, the boat, and do renovations with. So do not forget that 2nds go against their bottom line, and do not forget to ask about them.

Joe nice reminder.

I have ran up on seller forgetting to tell you that they just refinanced a few months ago -- which is not good usually because the lender sometimes view this is a getting the money and run Forest run! And if that is thought to be the case, your bargaining for short sale just feel in the can in some cases.

Happy Monday!

helpful article...what do you know about the irs insolvency clause? I heard a cpa say that if the borrower is proven insolvent (bankrupt) at the time of the short sale, he or she is not liable...any thoughts or comments

Jacob,

The results of backruptcy are determined by judicial process as determined by the backruptcy court. The court determines which liabilities are removed.

The filing for bankruptcy during the foreclosure process extends the foreclosure process by the amount of time it takes to get a bankruptcy judgement. Thus a lender cannot forclose during this period and a short sale may be the lenders best option to mitigate losses.

Bankruptcy is drastic as it will severely affect ones credit for many years.

MAY

2007

Insolvency (a financial condition) can be proven without formal bankruptcy (a legal position). If a borrower who receives debt forgiveness is insolvent at the instant the debt is forgiven, the income arising from forgiven debt may be totally or substantially exempt from tax to the extent of the insolvency.

Lenders asked to consider short sale approval are stymied by bankruptcy. Why? In theory, the automatic stay of relief suspends all collection activities. Negotiation of a short sale is a collection activity.

David

In real simple terms. Are you saying that at the time of bankruptcy, if insolvency is present at that given time of forgiveness then the IRS will not tax you on that because you were in hardship and proved it?

And are you saying that Lenders cannot collect anything once the BK is filed and that they can still do a short sale but it is in the collection status and the forgiven part is not something that they can come back and ask for later on and that this is not something that can be tax by the IRS?

Well, I hope you understand my question. I am confused at this point.

I have a situation where the lender turned down the short sale, seller filed bk-13 and still wants to attempt to short sale because she was told it ain't over til its sold or withstand the bk-13 until its paid up and bk-13 is released. HELP!

Unfortunately, there aren't simple terms, and if I attempt to simplify I run the risk of providing an incomplete response....

Bankruptcy and insolvency are two, separate issues. If the short seller is insolvent at the time the debt is forgiven, and while the 'income' arising from the forgiven debt still must be reported as income, it is likely exempt from tax.

In your scenario, if the lender is following the law, the lender won't be able to consider a short sale unless/until the bankruptcy is dismissed, and/or the bankruptcy trustee abandons its interest in the property and lifts the automatic stay of relief.

Well in this case if the bk is dismissed the lender will probably foreclose instead of trying to work out an agreement for short sale, because they are not being nice!

Lenders simultaneously pursue foreclosure, and consider non foreclosure alternatives including, but not limited to a preforeclosure short sale.

MAY

2007

A question regarding a short sale.

Is the seller still responsible for their late property tax bill or does the bank pay if they accept the short sale or is it wiped out if bank accepts short sale?

JUN

2007

Is a broker who represents the lender in a short sale situation obligated to present all written offers to the bank or can they pick and choose?

JUN

2007

Bill - my experience is that the taxes should be listed on the HUD and they are included in the short sale. If they are left out that is up to the agent to review, review the offer and counter offers and MISS NOTHING to protect your seller. The lender will let some things go unmentioned to save money. Now I am not sure if there is a rule that states that they HAVE TO pay the property taxes, but I would think so. Let me know if you find something definite.

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