Homeowners who purchased their residence within the last several years and are now in a position where they need to sell their home for financial reasons, relocation, or any number of other life events may find themselves in a "Short Sale." A "Short Sale" is when the market will not support a price that is equal to or higher than the current owners debt on the property plus any Realtor fees, taxes, and closing costs. In other words, the seller will have to bring money to closing in order to sell the home. Many homeowners who find themselves in this position feel they have no way out of this property and will be forced to allow the mortgagor or trustee to foreclose. Fortunately, there are ways to avoid foreclosure and reduce the damage to their credit ratings.
First, lets expand on the "Short Sale" concept with an example:
Mr. and Mrs. Smith purchased their home in November of 2005 for $400,000. They obtained 100% financing with an interest only payment for 5 years. One year later, November 2006, they are notified that Mr. Smith has lost his job and they can no longer afford the payments. Mr. and Mrs. Smith decide that selling is the best option for them, so they meet with a Realtor and discover the identical homes in their neighborhood are selling for only $369,000. If they were to sell the home for that amount, they would have to make up the difference between the sales price and their mortgage, or $31,000. In addition, they would also be responsible for paying taxes, closing costs, and Realtors commissions; approximately $23,000* more for a total of approximately $54,000. The Smiths do not have the money to pay for this shortage; they are in a "Short Sale" situation.
In this example, this couple is experiencing a financial hardship that will create an inability to maintain their monthly mortgage payments. There are steps they should take in order to make an informed and financially correct decision.
Get Qualified Financial and Legal Advice
The first step the Smiths should take is to contact an accountant or Enrolled Agent (EA); a professional accountant or EA will assist them in evaluating their financial situation and creating a true picture of their financial health. Without this true picture, they are not basing their decisions on accurate information and can not truly incorporate any tax consequences into their decision making process.
The accountant will include all liabilities such as short and long term debt as well as assets such as retirement funds, other properties, and personal property in the evaluation of their financial condition. They should then evaluate the tax and overall financial consequences of a short sale with the Smiths and make recommendations on an appropriate course of action. This information will also be necessary for the lien holders to evaluate the potential for a short sale.
Next, the Smiths should speak to a credit professional. There are lawyers and non-profit agencies that specialize in credit issues. The Smiths need to understand the ramifications of a short sale with regard to their credit file and rating.
If, after analyzing the risks, consequences, and benefits, the Smiths decide they should still investigate the potential of a short sale, they should continue by contacting additional professionals to assist them.
Speak to a Realtor who is familiar with Short Sale Situations
There are many options when choosing a Realtor, from fee structures and advertising methods to levels of experience and specialties. In this case, their decision must be based on several factors. First, they need to find a Realtor who is willing to accept less than the traditional 6% commission, because in a short sale situation the mortgage holder will most likely require that as part of their terms for accepting less than agreed to in the terms of the note. Choosing a company that employs a set fee model, such as Help-U-Sell, will allow them to have the benefit of a full service real estate firm, while reducing the amount of potential financial liabilities.
In order to get the best service available, they should also choose a Realtor with experience in dealing with short sales. As the real estate market has seen record growth over the last several years, it may be difficult to find a Realtor who has experience in this area. As we progress further into deteriorating market conditions, many more will be faced with the opportunity to assist in the coordination of such a sale. The Smiths should ensure the agent they choose has done so or has access to a team leader, supervisor, or broker who has.
Coordinate with Lien holders
The Smiths lien holders must be contacted prior to placing the home on the market. A thorough analysis of whether or not the Smiths are candidates for a short sale approval will be done and that decision must be made before the home is offered for sale. If the lien holders refuse to entertain accepting a short sale, the owners could be placed in a situation where they would be held liable for the difference between the sales price and amount owed at closing. In this example, the Smiths would not be able to do that and could possibly be in default of the sales agreement. Confirming the lien holder will entertain a short sale does not guarantee they will accept the offer to purchase; they are not obligated to do so.
Many Lenders have established "Short Sale Departments" to assist sellers with the process. All offers will have to be submitted to the lender for approval before the contract is fully ratified. In order to protect the Smiths, their Realtor should ensure that all offers include a "Third Party Approval" contingency for the sellers. In doing so, if the lender ultimately rejects the terms of the offer or denies the short sale entirely, the Smiths are protected from defaulting on the sales agreement.
Attract the Right Buyers
The contract process for a short sale can be time consuming; not all buyers have the liberty to endure the elongated time line associated with it. In most cases, the sellers lien holders will have to approve the contract, as they will be "taking a loss." This can sometimes take 30 days or more. The lien holders will evaluate the sellers overall financial situation in their decision process. Until they approve or reject the contract, the buyers will be waiting to move forward on locating another property, unless other wise specified in their offer. Most buyers have defined time periods for locating and closing on a home. This may preclude them from meeting those deadlines and therefore from purchasing the property.
Often one of the first ideas a seller in this position has is to locate an investor. The myth is investors like to purchase properties where the owners are "desperate." Although that may be true, in a short sale the offer price still has to be satisfactory to the lien holders. An investor certainly would have the tolerance for the time involved, but the margin of profit would most likely not be adequate. If we return to the Smiths example, a desirable sales price for the investor would be well below market value, in this case $369,000. Lets assume the investor wants a 20% return, his offer price would be around $295,000. After fees and commissions, the bank would net approximately $277,000 or $123,000 less than the Smiths owe; the lien holders will most likely not accept an offer with those, or similar, terms.
Although it can be difficult to attract buyers of this nature, the sellers and their Realtor should clearly state the fact this is a short sale and requires third party approval to all interested parties. Doing so will avoid that surprise for otherwise qualified buyers as the negotiations progress. Explaining how the process will transpire to any prospective buyers allows them to plan ahead and evaluate whether or not their timeline allows their participation. In addition, the buyers Realtor may also have to accept less than traditional commission for the lien holder to accept the offer.
Closing an Offer
Throughout the ratification and closing process, all parties will need to stay well informed and up to date on all aspects of the transaction. This includes the lien holders, closing company, sellers, buyers, and agents. After ratification and lien holder acceptance, the seller should once again meet with their professional financial advisor to recalculate potential tax consequences with the actual amounts in the transaction. It is likely there will be tax issues that need to be addressed and it is beneficial to begin that process early.
*Assumes a real estate commission of 6%. Commissions are negotiable and not set by law. Costs are approximate based on average expenses. Does not include buyers closing costs.
**Nothing is this article should be construed as legal or financial advice. For legal/financial questions, seek a the advice of a professional advisor.