What Is a “Short Sale”?
When a homeowner owes their lender more than the home is worth and is therefore unable to get enough from the sale of their home to pay off their mortgage, that’s a “short sale”. When a home such as this is on the market, the homeowners will have to ask their lender to accept an offer on the property that is less than they owe.
THE LENDERS LOGIC
However, most lenders will not simply accept a short sale from a homeowner just because they request it. If the homeowner is current on their payments the lenders logic is; “Well, they’re making their payments now, why should we take a short sale? Just let them continue making the payments.”
THE "HARDSHIP" ISSUE
As a result, lenders will require the homeowner to demonstrate “hardship”. In some cases, the homeowner must have missed a certain number of payments on the home (depends on the lender) and the house must be listed on the MLS. Every lender has different “missed payment” criteria. Some require the homeowner to be at least 30 days late, others require 60 or even 90. Some will accept what is called a “rolling 30”, meaning the homeowner misses one payment and then begins to make payments on time, but as a result of the missed payment, is always 30 days late. Some will allow the homeowner to remain current on payments. Every lender is different.
The homeowners must also write a “hardship letter” explaining why they need to sell, and the reasons for the hardship. But a hardship letter alone is not enough to qualify. If they have a good job, good income, and enough assets to cover the short sale by bringing cash to the closing table to cover the loss and pay off the mortgage, it’s unlikely that the bank will agree to accept a short sale request. The homeowner will have to provide W-2's or 1099's, pay stubs, tax returns, bank statements, a statement of assets and debts and a monthly expense statement. Moving 50 miles or more from their current home to take a job can also qualify as a hardship.
THE PROBLEM WITH "PMI"
If the homeowners feel they qualify by meeting the criteria for the lender to consider a short sale, there’s still more. If the note was insured by a third party against default by the borrower, meaning the homeowner carries PMI (Private Mortgage Insurance) or if it’s FHA, Fannie Mae, Freddie Mac or VA, there was no incentive for the lender to take a short sale. All the lender had to do was wait for the home to go into foreclosure, pass through the 6 or 12 month redemption period and then they will be paid off in full by the insurer for the entire balance due, regardless of the market value of the home. Then the home became the property of the insuring party to sell. UPDATE: Lenders with insured loans will now consider short sales since the TARP money arrived.
THE NEGOTIATIONS - THE PAPERWORK
The next step is the negotiations. The homeowners must sign a form authorizing their Realtor to speak with the lender on their behalf. It usually takes 72 hours for the bank to respond to the request. However, depending on the lender, it can take even longer, sometimes weeks or even months. At that point, the Realtor orders a “loss mitigation” package which will outline the requirements for the lender to consider a short sale. Both the Realtor and the homeowner must complete the package. The homeowner will be required to provide much the same documents that were necessary to get the loan in the first place, w-2’s, pay stubs, tax returns, bank accounts, credit report, assets and debts. Only this time it’s to prove they don’t have the money to make the payments or bring cash to the closing table. The Realtor will be required to prove to the lender that the list price for the home, while less than is owed on the note, is fair market value. This is done by preparing a market analysis, including comparable homes and providing a BPO (Broker Price Opinion) which is similar to an appraisal. However, when an offer comes in, before accepting it, the lender will order their own BPO. Keep in mind, what the homeowner owes the bank has no bearing on what sort of offer they will accept. All that matters is the BPO. The bank will accept that as fair market value, even it's only a small fraction of what's owed. Then the lender will require the listing agent to prepare a preliminary settlement statement (referred to as a preliminary HUD) so they can see exactly what their net will be after all closing costs are paid.
THE CURSE OF THE HELOC
If the homeowner has more than one loan on the house, usually a HELOC, (home equity line of credit) it complicates things. When the lender who holds the primary loan gets an offer, their negotiator must go to the secondary investor (HELOC) and convince them to go away so they can sell the home. Remember, while it's at this stage, all secondary liens are still in place. Once it goes to Sheriff's Sale and the 6 month redemption period runs out, it becomes an REO (Real Estate Owned, the term the banks use for foreclosures). Then all secondary liens automatically go away (except taxes). That means the HELOC gets zip. So there's some incentive for them to take a little now to go away, vs. get nothing later. However, the fly in the ointment of most short sales is the HELOC demanding more than the primary lender is willing to give them to go away. If that happens, the secondary note holder may turn to the homeowner or the buyer to cough up the difference. This complication is the main reason many short sales fail.
WHY BOTHER?
At this point you may be asking yourself…what’s the point of all this work? Just tell them to hand the deed back to the bank and walk away.” After all, isn't that what the "experts" on the morning talk shows are advising? (Who are these people?). That’s referred to as “Deed in Lieu of Foreclosure” and it appears on the homeowners credit history as “Deed in Lieu” which is even worse than a foreclosure. Because it says to creditors…”They didn’t even try. They just gave it back and walked away”. By selling the home short, it appears on their credit report in a manner similar to a “Paid Charge Off” or "Settled". That says to creditors “They did their best to get as much as they could to pay off the note”. Much better. Even if the home goes to Sheriff’s Sale, a short sale during the redemption period shows up in a manner that is similar to a “Paid Charge Off” which is much better than a full foreclosure and light years ahead of a “Deed in Lieu”. There's an added benefit to a short sale when the homeowner has a HELOC (Home Equity Line of Credit) on the home. The Homeowner Debt Relief Act that passed a couple of years ago prevented the primary mortgage holder from coming after the homeowner for the difference between what they owed and what it sold for as a foreclosure. It also prevented the bank from sending a 1099 to the homeowner for the deficiency. But what most homeowners don't realize is that a HELOC is not a mortgage. It's a promissory note, like a car loan. So it doesn't fall under that law and the bank can come after the homeowner for the entire amount due if the home sells as a foreclosure (remember the HELOC gets nothing if it goes to foreclosure). It's important that the homeowner makes sure that the negotiations with the bank on their short sale includes the secondary lender (HELOC) accepting their share of the short sale proceeds as payment in full. Then they cannot come after the homeowner for the balance owed.
BUYER BEWARE
The caveat to buyers considering the purchase of a short sale home is the time factor. It takes much longer to buy a home in this stage than after it has passed into foreclosure, gone through the 6-12 month redemption period and is now what is refereed to as an REO. That stands for Real Estate Owned, the term banks use for the properties that have gone back to them completely or have been paid off by a third party insurer such as HUD and turned over to them to sell.
When considering making an offer on a short sale, it’s critical that the Buyers Agent get as much information regarding what has been done thus far. If the homeowner has not even completed the hardship package and been approved for the short sale, or if the agent has not yet submitted the BPO, it could take many months. So....my advice is this; unless this is the home of your dreams and you have all the time in the world….move on to something else.
For more information on the process of buying a foreclosure click here.
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