Decoding the Short Sale Mystery: Part 2

In part 2 of this series, we take a look at the answer to the question, "WHAT ARE MY OPTIONS IF I AM FACING A SHORT SALE?"

We already established in Decoding the Short Sale Mystery: Part 1, that selling short, while not the only option, might be one of the best ones.

When facing the type of financial crisis that leads to a short sale, homeowners might want to curl up and ignore the problem. That's probably the WORST option. Why? Because acting as early as possible, there may be a way reduce the negative impact on credit scores, avoid foreclosure and avoid bankruptcy.

First, let's look at the options for dealing with the debt.

Option 1 - Renegotiate the Loan: The best case scenario is to work early and diligently to convince the bank to help negotiate a way for the homeowner to stay in the home. There are a lot of options here - interest rate can be lowered, loan term can be extended to create lower monthly payments, an equity line can be established to make payments until a negative situation is turned around (job loss, pay cut, etc.). In some cases, if the lending bank is not willing to help, maybe another bank will.

Option 2 - Short Sale:  Work with the bank, buyer and seller to agree on a sales price that is less than the amount owed on the home. This is the option we will look at in more detail in this blog.

Option 3 - Foreclosure: The bank takes back ownership of the home (in Deed of Trust states like TN , there are some technical differences, but, for the sake of simplicity...) and tries to sell it as a bank owned property (REO). Banks are not interested in incurring marketing expenses to get that home sold. They just want to get it sold and recover some of the lapsed mortgage. They may post the property on REO websites. Often, these properties are not even in MLS. They are rarely marketed in very aggressive ways (agreesive ways require $$$ and the bank is trying to mitigate their own loss.) More frequently that not, the homes may end up for sale on the courthouse steps. Banks often report that these foreclosed homes sell for anywhere from $.50 to $.25 on the dollar.

When the house does sell, the bank will likely 'go after' the foreclosed homeowner for the difference between the loan and the sales price. (As you may have guessed from above; that can be a pretty big difference!) They will also add any legal and marketing expenses to the total.

Option 4 - Bankruptcy: Bankruptcy may be an option for some homeowners. There are requirements to meet to qualify for this option. Most recommend bankruptcy as a last resort and you should consult an attorney to get the specifics.

Now, let's look at points to negotiate in a short sale.

Let's use some numbers in an example. Let's say the mortgage is $300,000 and the offer is $250,000. Let's also assume that the bank has not yet incurred any legal expenses from a foreclosure. There could, however, be real estate agents involved in the transaction with either the buyer or seller. Sometimes, there is even a negotiator, who works with all parties in the interest ONLY of working out a short sale acceptible to all parties. This person does not serve any one party's interests. Rather, they get paid to close the deal and get the property sold.

It's important to remember that all of the fees associated with closing the sale (the negotiator expense, the real estate agent commissions, the title search, taxes, etc...) are negotiable. The closing fees can average around 3-8% of the purchase price.

There are also several ways things could work out regarding the debt:

Option 1 - Bank writes off difference:  The short amount in the example above would be $50,000 + any closing costs associated with the transaction which are not paid by the Buyer. In some cases, the bank may agree to write off those expenses.

WHY? Foreclosure requires significant legal fees - sometimes as much as $30,000 to $50,000. If the homeowner declares bankruptcy, the bank may never recover the debt at all. They may actually net more money than with other options. And they would certainly put the matter to rest faster than with other options. 

Option 2 - Bank requires Seller to pay some of the difference:  In this scenario, the bank may write off a portion of the shortage. Let's say, for example, they agree to write off all the closing fees, but will not forgive the mortgage shortage. They may require the Seller to pay the remaining short amount. The bank will often negotiate a loan (secured or unsecured) with the Seller for that difference. While this seems shocking at first; remember, loans are what the bank does. They have a lot of flexibility about how they can negotiate this loan (interest rate, payback terms, etc.). And for the Seller, negotiating a workable monthly payment is definitely preferrable to being 'on the hook' for the whole foreclosure amount.

Option 3 - Bank requires Seller to pay all of the difference: This is the same scenario as above except the bank does not write off any expenses. The Seller would be responsible for all the shortage. Again, may be preferable to the Seller being 'on the hook' for the entire mortgage.

It's important to speak with experts to learn all the nuances of the process and figure out what works best for the specific situation. There is no Short Sale formula. Every one is a little different. But with the right team helping to negotiate the transaction and preparing you for all the steps in the process, short sales can be less painful than the alternatives.

In the next blog we will review the impact of short sales on credit ratings. Interestingly, there are some ways to negotiate a better outcome here, as well.