What is a Short Sale?
A short sale is a sale of mortgaged property where the proceeds from the sale are insufficient to pay in full the seller’s outstanding mortgage and any other liens against the property and the seller lacks sufficient other assets to pay the remaining amounts due on the secured debts. Because the seller lacks the financial ability to remove these encumbrances in order to convey marketable and insurable title, the seller’s lender and any other lien holders, must consent to the sale and voluntarily release their liens. If someone owes more on their house than what it is worth and they have a compelling reason to sell, then that person will need a short sale.
Benefits of a Short Sale
It is important to understand the benefits of a short sale to each of the parties involved. Why would a seller want to cooperate? Why would a lender accept less than what is owed? Why would a buyer want to wait for a short sale to be approved? Why would an agent take on the potential headache of a short sale?
How Sellers Benefit
Dignity. Imagine the shame of having sheriff’s deputies forcibly move you out of what was once your home. Imagine the awkward looks of the neighbors as you hurriedly throw a handful of possessions into a waiting car or truck. Imagine seeing the lender’s locksmith changing the locks as you leave the property for the final time. A short sale allows the seller to have a normal closing and a move on their own schedule. In most cases, the neighbors won’t know that a seller sold their property via a short sale.
Credit. A short sale, while damaging to a person’s credit, is lessdamaging than allowing the property to go to foreclosure.1 Settling the debt and ending the delinquent payments allows a person to stop the damage and start rebuilding their credit sooner. It is important to note that a short sale may affect a borrower’s credit for at least seven years because lenders might report that a loan was settled for less than its balance. A seller may be able to convince the lender to include a letter of explanation in the credit file that outlines the extenuating circumstances that caused the short sale. This can soften the blow to one’s credit.
Prevent a Deficiency Judgment. If the seller opts for a deed-in-lieu of foreclosure, they might surrender the property without an agreement on the lender’s loss. If state law permits it, the lender may elect to pursue the seller for the remaining balance after the deed is transferred. If the seller allows the property to go to foreclosure, in some states the lender may have the right to pursue the seller for the remaining balance after the foreclosure sale. A short sale involves a negotiated settlement, whereby the seller and lender reach an agreement on the loss. In most short sales, the lender will forgive the remaining debt.
Avoid Bankruptcy. A mortgage loan is typically the largest debt instrument a person must service. By selling the property via a short sale, a person might avoid bankruptcy altogether. A bankruptcy would affect all of the seller’s creditors and be more damaging to the seller’s credit rating.
How Lenders Benefit
Avoid Excess Inventory. Banks are in the business of lending money, not owning houses.
Many banks are already saddled with far more Real Estate Owned (REO) than they can handle. In many cases, lenders prefer to allow properties to be sold via a short sale.
Purge Toxic Loans. Nonperforming assets hurt a lender’s balance sheet. Bank executives face pressure from shareholders to keep the books free from toxic assets. While forgiving some of a defaulted mortgage loan is financially difficult for a bank, the lender then receives a tax write-off that can offset profits.
High Costs of Foreclosure. A June 2007 report from the Joint Economic Committee of Congress stated that the average foreclosure results in $77,935 of costs to the lender, borrower, government, and neighbors. The Joint Economic Committee calculated that the lender would spend $50,000 of that amount on legal fees, court costs, appraisals, maintenance, rehabilitating, insuring, and reselling the property to a third party. Lenders know that taking back properties via foreclosure often results in more losses, so they are willing to permit short sales as a cost- cutting measure. The Joint Economic Committee calculated that the borrower has a typical loss of $7,200 in a foreclosure, to include legal costs, moving expenses, and loss of equity.
Neighbors typically suffer a loss of $1,508 due to a decline in area property values. On average, the local government loses $19,227 from a foreclosure
How Buyers Benefit
Bargains. A patient, opportunistic buyer may be able to purchase a property below fair market value.
Equity Creation. A buyer of a short sale may have purchased a property worth inherently more, thus creating equity that may benefit the buyer now or in the future. Many short sale properties fall into disrepair, and equity can be created by renovating those properties.
How Real Estate Agents Benefit
More Sales. Agents who refuse to list distressed properties for sale may cost themselves thousands of dollars in lost commissions. Agents who become short sale experts, or who outsource the processing of a short sale to a competent third party, will generate many more listings. In today’s market, any sale is a good one.
More Homebuyers. It is a buyer’s market, and many buyers specifically are looking for the bargains that may be created by distressed property. Those buyers may bypass certain agents and go to those real estate salespersons who have short sale listings. Also, if an agent helps a grateful borrower sell their property via a short sale, it may only be a matter of time before that person (or their family or friends) calls upon the agent to help them with a new real estate need.
More Investor Clients. Real estate investors and landlords are enjoying the bonanza of distressed properties. Investors typically buy (and sell) multiple properties, so an agent with numerous short sale listings may generate many sales with just one client. Some agents prefer to deal with investors and landlords because of their repeat business and quick, unemotional decision-making. Even if an agent refuses to handle short sale listings, that agent will likely represent buyers interested in acquiring properties facing a short sale.
Elements of a Successful Short Sale
1. The property is worth less than what is owed.
2. The seller has a hardship that makes it impractical for the seller to keep the property.
3. The seller is cooperative and willing to work with a real estate salesperson.
4. The lender is contacted and expresses willingness to consider a short sale.
5. A ready, willing, and able buyer can purchase the property in a timely manner.
The Players in a Short Sale Transaction
It is important to understand who is involved in a typical short sale. As an agent or investor, you will be dealing with each of these players.
Seller(s). They are also referred to as the Borrower or Homeowner.
Lender(s). These are the banks or investors with liens against the property. In many cases, the loan may have been sold from one lender to another. In other cases, a loan servicer may be handling the collection of payments for the lender.
Loss Mitigation Officers. The loss mitigation specialists of a lender or servicer help determine an acceptable payoff.
Real Estate Agent(s). Typically, the property will be listed with a real estate licensee. Another agent may represent the prospective buyer.
Short Sale Consultant or Negotiator. There are many legitimate and experienced short sale consultants who act as a third-party liaison or negotiator to help sellers and agents. There are also many illegitimate or inexperienced people claiming to be short sale consultants. Having a professional consultant work the short sale is what can make or break a deal.
Contractor(s) and Inspector(s). Many distressed properties face deferred maintenance or neglect. An estimate from a licensed contractor and a report from a certified inspector may be powerful negotiating tools in convincing a lender to accept less money.
Appraiser or BPO Agent. In the latter stages of a short sale, the lender or servicer will likely pay for an appraisal or a Broker’s Price Opinion (BPO) from an agent. The lender will determine a payoff based upon the valuation established by the appraiser or BPO agent. It is imperative that the listing agent and/or short sale consultant meet the appraiser or BPO agent when they visit the property.
Attorney(s). The lender or servicer will hire a law firm to represent them in the foreclosure action. The seller is strongly encouraged to have legal representation too.
Accountant(s). The seller is strongly encouraged to consult with their accountant in any short sale or potential short sale transaction.
Credit Restoration Specialist or Counselor. The seller is strongly encouraged to speak with a credit counselor prior to a short sale transaction. After a short sale, it may be a good idea for the seller to hire a credit restoration service to help clean up their damaged credit record.
Alternatives to a Short Sale
1. Make Payments to Reinstate the Loan and Keep the Property
Lenders often will permit a borrower to making a payment that covers all the late payments. A homeowner facing default should consider borrowing money from a family member or other
lender.
2. Sell the Property and Bring Cash to Close Escrow
This is known as a make-whole pre-foreclosure sale. The lender does not sustain a loss. The shortfall is paid by the borrower at closing. For example, if a borrower owes $100,000, and the proceeds of the sale generate only $95,000 for the lender, then the borrower can contribute $5,000 at settlement.
Alternately, the private mortgage insurer (PMI) may pay the shortfall. In some cases, the hazard insurance company may pay the shortfall if there was damage to the premises covered by the policy.
3. Attempt a Workout with the Lender
Homeowners are encouraged to work with the lender to forbear the loan, develop a repayment plan, or modify the loan. A forbearance plan is one in which the lender permits a partial payment or a skipped payment if the borrower has an acceptable plan to catch up on the payments. A repayment plan is one in which the lender allows the borrower to pay an additional amount each month until they catch up. A loan modification is a permanent change to the terms of the note.
4. Assumption of the Mortgage by a Buyer
The lender may allow a buyer to assume the mortgage. The lender will determine if the buyer is qualified to handle the monthly debt obligations. Lenders often charge a processing fee to evaluate whether to permit an assumption, and in many cases a new appraisal must be paid for by the buyer and/or original borrower. The lender may require that the original borrower remain personally liable for the loan should the buyer default on the payments.
5. Offer the Lender a Deed in Lieu of Foreclosure
This is known as a “friendly foreclosure.” The homeowner voluntarily conveys clear property title to the lender in exchange for the discharge of the debt.
6. Allow the Property to Go into Foreclosure
In this situation, the homeowner either gives up or fails in all other attempts to resolve the situation. The property is sold at a publicly advertised foreclosure sale or transferred to the mortgage lender if there are no sufficient bids. This situation is the most damaging to a borrower’s credit.4 Some attorneys may advise their homeowner clients to stop paying the mortgage and live for free in the house until the foreclosure sale. This course of action is often the last resort, given that the homeowner has exhausted all other measures to prevent the foreclosure action.
By living in the house until the very end, the borrower does not have to pay rent elsewhere. In such cases, the borrower saves the money that they would have paid the lender so they can have enough to rent a home when the time comes. Remember: only an attorney or accountant familiar with bankruptcy and foreclosure situations should advise a client to stop paying their mortgage. There are serious consequences to this course of action for borrowers.
7. Declare Bankruptcy
A bankruptcy typically does not prevent a foreclosure action, but it will delay it. Only a bankruptcy attorney or accountant familiar with bankruptcy should advise a client to pursue this course of action. Some bankruptcy actions will eliminate the debt, but the lien will remain until the owner attempts to sell the property. At that time, it is possible the lender may expect some money to release the lien.
What is an Arm’s Length Transaction?
Most banks these days insist upon an arm’s length transaction. That is a transaction in which the buyer and seller act independently and have no relationship to each other. They are not related, nor are they business associates. The concept of an arm’s length transaction is to ensure that the parties are acting in their own self-interest and are not subject to any pressure from the other party.
If a woman sells a house to her brother, she may sell the house at a discount. If the owner of a business sells his commercial property to an employee, he may sell at a discount or perhaps provide favorable financing.
If two strangers are involved in the sale of a house, it is more likely that the sale price and terms will be close to fair market value. The assumption is that both parties are well informed, well represented, and not under any major duress. The notion is that the seller seeks the highest possible price and the buyer seeks the lowest possible price, and they meet near fair market value.
In a short sale, the mortgage lender insists upon an arm’s length transaction to prevent collusion or fraud. There are instances where someone facing foreclosure will ask a family member with a different last name to purchase the house. The lender would forgive the remaining debt, which could be tens of thousands of dollars. The family members who buy the house might then rent or sell it back to the previous owner. That person would have the benefit of continuing to live in the house, but for less money. Furthermore, the lender would bear the brunt of the loss. In addition, the lender assumes that the offer price from the family member might be far below fair market value, further deepening the lender’s loss and unjustly enriching the owner.
Most lenders today require that the buyer, seller, and real estate agents sign an affidavit in which they swear that it is an arm’s length transaction. Some banks have short sale fraud departments, and they investigate suspicious transactions a few months after they are consummated. If a bank discovers evidence of a non-arm’s length transaction when the parties all signed an affidavit to the contrary, the lender can press criminal charges and sue for civil damages. The buyer, seller, real estate agents, and even the title agent or attorney can be sued for committing fraud. Lenders are losing tens of millions of dollars in fraudulent short sales, and they are serious about finding evidence of illicit activity.
Disclosure: We at Significa are not attorneys, accountants, or certified credit counselors. Your attorney and accountant can advise you regarding your situation and how it is affected by your state’s laws. Our National Short Sale Guide is merely for informational purposes only.
