Coming Up Short - A Brief Intro to the Short Sale

Say you didn’t heed my advice over the past few years about avoiding exotic mortgages and you got wired into a 100% mortgage consisting of an 80% 1st mortgage and a 20% 2nd with an adjustable interest rate. Now the rate has adjusted once or twice and your income hasn’t quite kept up, leaving you a tad shy of the monthly nut your (formerly) friendly lender wants. Or maybe you’ve lost your job or lost the person who had a job – whatever, the funds just aren’t there for the mortgage. You’ve looked into selling the house but there’s no equity built up. You owe $525,000 and at best you might sell it for $400,000 but more likely you’d get closer to $375,000, leaving a shortfall on your side of the ledger sheet. What do you do?

Essentially you’ve got three options:

• ·        Figure out a way to get the extra money
•     Walk away and let the property go to foreclosure
•     Sort Sale
  

If you coulda figured out a way to get the extra money, you wouldn’t be in the situation to begin with so that option is probably limited.

Most sellers have worked long and hard to build up their credit rating and would like to avoid having it all trashed by a foreclosure. There are all kinds of negative consequences to a foreclosure that will cost you for years to come. That limits your second option.

A short sale, or short pay-off, is a transaction in which your lender agrees to accept less than is owed to allow the sale of your property. You’ll also find short sales referred to as ‘pre-foreclosure sales’ by some since it is usually your last, best hope of avoiding that eventuality.

In a typical short sale, the lender agrees to accept the net proceeds from the sale in return for releasing the lien and allowing you to transfer title. The net proceeds are the sales price minus customary closing and selling costs. In the above scenario where the mortgage amount is $525,000 and the sale price is $400000, the net to the lender is about $372,000. The 1st and 2nd mortgage holders have to agree to accept some percentage of that net amount applied toward your debt. If you just have a 1st mortgage, it's usually somewhat easier to negotiate.  If the shortfall is not to a 1^st mortgage holder but to a 2^nd, it will be more difficult and they will almost invariably require a promissory note since a 2^nd mortgage may not be considered a ‘purchase money’ loan.

Why would a lender agree to lose money on you? Well, most lenders will evaluate the transaction on a number of considerations, including:

1.        What are the circumstances leading to the need? Was there a divorce, death of a wage earner or birth taking one wage earner out of the picture? How about a job loss or transfer? Just because you bit off more than you could chew and the market changed may not be enough reason.

2.        They’ll want to make sure they net more through a short sale than they would if they go ahead with a foreclosure process. They’re going to want to make sure it’s competitively priced and not a fire-sale and that the estimated closing costs and commissions are equal to, or less than, they will have to pay through foreclosure.

3.        Assurance that the seller doesn’t have the money to make up the shortfall. They’ll want a financial statement showing all assets, liabilities, income and expenses, bank statements and tax records. Even if your income comes up short, if you’ve got an IRA or other portfolio, they’re going to want you to use it. (See coming up with extra money above).

It’s unlikely the seller will receive any proceeds from the closing on a compromise sale since there’s no equity to work with, and they may still end up owing money for a home they no longer live in. While short sales rarely create any capital gains problems for a seller, there may be detrimental tax consequences from ‘forgiveness of debt’ and sellers would be wise to consult a tax advisor.

Buyers and sellers should also be prepared to be patient since the process can take 2 to 3 times as long as a normal transaction as you will likely be working with your loan servicer, the underlying investor and a mortgage insurance company at the very least. Once your short sale is approved based on your paperwork, make sure all their conditions and terms are likewise in writing. Too many he-said/she-said’s between the different entities can easily derail the process and you don’t want to end up getting sued by a buyer on top of everything else.

Finally, ignoring the problem will not make it go away and delay can be detrimental. This also isn’t the time to cut corners or look for the cheapest agent. There are scams galore out there that will do no more than add insult to your injury and leave you in far worse shape than necessary. While it’s true your lender does not want your home back, they will not agree to a short sale just to be nice guys either. They must be convinced of the validity of your need and that their interests are best served by a short sale instead of just foreclosing and kicking your debt-ridden butt out on the street. If you find yourself in these circumstances, please contact a professional and experienced Realtor for assistance. Not all agents are Realtors, not all Realtors are experienced in short sales.  It's your future - be smart about it.

Gene Wunderlich - Selling Southwest California Homes including Temecula, Murrieta & The Southern California Wine Country

Remember, Don't wait to buy real estate - Buy real estate and wait.