Short Sales 101 – How the Process Works

Posted by Matthew Lahti on Monday, March 4th, 2013 at 12:18pm

A short sale occurs when the net proceeds from the sale of a home are not enough to cover the sellers’ mortgage obligations

A short sale occurs when the net proceeds from the sale of a home are not enough to cover the sellers’ mortgage obligations and closing costs, such as property taxes, transfer taxes, and the real estate practitioner’s commission. The seller is unwilling or unable to cover the difference.

Some — although by no means all — short sellers may also be in default on their mortgage loans and be headed for foreclosure. However, home owners who bought at the top of the market or who took out large amounts of equity with a refinance and who now need to sell because of divorce or job transfer may also find themselves upside down, owing more than the home is currently worth when closing costs are factored in.

Other sellers simply don’t understand that if they have assets, such as stocks or a high-salaried job, a lender is not going to let them just walk away from a short sale without signing a note to repay what they owe.

How do I know it’s short?

A Comparative Market Analysis (CMA) will be your first indicator, but you also need to ask the seller what their outstanding debt is and calculate the cost associated with a sale — from transfer taxes to your commission. This will give you an estimate of the net proceeds that will be realized, often called the net sheet. This information can then be entered into a HUD-1 Settlement Statement to calculate out the final, negative result at closing. Some lenders also have their own forms.

Check with the title company and the lender to get exact figures on closing costs and loan balances and to find out what procedures they have in place. If they can afford it, sellers should also consider getting a home inspection to determine what repairs are needed on a home and how this might affect its value.

Who do I and the seller need to talk to about the problem?

If there are a first and second mortgage or a home equity line of credit, you may have to talk to more than one lender to get approval for a short sale. In addition, you may also need approval from the entity that holds the pool of loans if the mortgage has been securitized.

The presence of two lenders makes a short sale more complicated since it’s often the lender holding the second, or junior, mortgage that has to absorb most of the loss.

The first thing you should do is contact your lender or lenders.  Many lenders have established a loss mitigation department to handle the increasing amount of default and short sales.  Some of the major lenders like Bank of America and Wells Fargo have streamlined the process and are even beginning to provide bank approved list prices which is expediting the process.

Tip: Be sure you contact the bank’s loss mitigation department, which will be the group to decide whether to accept a short sale, rather than the collection or customer service department, which is only interested in recouping past due loan payments. Finding the decision maker is often one of the biggest initial challenges in a short sales.

What information will the bank need to decide whether to accept a short sale?

The sellers’ submission package should include W-2 forms from employers (or a letter explaining the seller is unemployed), bank statements, two years of tax returns, and other financial documents outlining income and debt obligations. The bank will also need comps or a broker’s price opinion showing your estimate of value.

In addition, the sellers should submit a “hardship letter,” explaining the circumstances that make it impossible for them to pay the full amount of the loan. The seller needs to be able to show true financial hardship. Someone with the assets or the income to pay is unlikely to be considered, say most interviewees.

Thanks to programs such as those proposed by Fannie Mae and Freddie Mac to assist subprime borrowers, many lenders are more willing to offer loan modification options. This option can extend the term of the loan, add on delinquent payments to the loan principal, and/or reduce the interest rate to make the loan more manageable for the home owner.

Another option is a repayment plan that requires home owners to increase their monthly payments until the loan is current. It may be possible to refinance an adjustable rate loan with a Federal Housing Authority or conventional fixed loan. Note that lenders will not postpone a foreclosure just because a property is listed, although they may postpone if you have a reasonable offer in the works.

How should I price a short sale property?

In general, most short sale experts say to price the property at or near fair market value, although a few will begin with the total payoff amount owned by the seller. How frequently prices are dropped will depend in part on whether the property is in preforeclosure. Most banks have a formula for what percentage under market value they will accept, say interviewees. Figures cited vary from 8 percent under to almost 20 percent under.Most lenders will want to get a broker’s price opinion or even an appraisal to see what the property is worth before you and seller set a list price. One way to help ensure that the bank’s estimate of value is realistic is to offer comps of recent sales — both traditional and REO.  REO or Bank Owned or properties that have gone through the full foreclosure process and have later been resold in the market.

What and how should I disclose about the short-sale property to prospective buyers?

Seller’s must fully disclose their current situation to REALTORS and Buyers.  REALTORS are required to note the Multiple Listing Service (MLS) with the appropriate property status in order to insure the buyer is aware of any potential delays in the buying process.  Failing to disclose will only open the seller to additional liability and problems.  The most important thing you can do during the short sale process is to disclose, disclose and disclose some more.

How long does it take to complete a short sale?

Although response times vary from lender to lender, it can take two weeks or as long as 60 days to receive an approval of a short sale from a lender. That’s why it’s critical that buyers and their representative understand and accept that time frame before they make an offer.  Short sales are not for everyone, patience is key.

An addendum to the purchase and sale agreement includes a provision allowing either party to cancel a short-sale contract within a set period if the seller hasn’t received bank approval.  Properties with securitized loans (which are the majority these days) may require a longer time to get an approval of a short sale because of the possible need for approval from the entity holding the pool of securities.

What can the seller and I do to make a short sale more attractive to a lender?

Getting a lender to approve a short sale is primarily a question of economics. You have to provide hard numbers to show that the amount of money a bank will realize on the short sale is better than the amount it may recoup from foreclosing on the property and selling the property as an REO.

A 2002 study by Craig Focardi of the Tower Group estimated that the entire cost of a foreclosure was $58,759 and took 18 months. Other factors that can influence a bank’s decision include the liability risk it assumes by owning the property after foreclosures, the money tied up during the holding period for a foreclosure and REO resale, additional costs associated with an REO such as attorneys’ fees, and the additional reserves it will need if REOs rise in the bank’s portfolio.

However, to avoid unnecessary costs, buyers should wait on having a home inspection and an appraisal for the loan until after the bank has accepted the short sale proposition, such as a lost job or high medical bills from an illness may also have an influence.  Provisions as to when timelines begin are included in the short sale addendum which is attached to the purchase and sale agreement.

What are the seller’s options if a short sale is rejected by the lender?

There are a variety of reasons a bank will reject a short sale — from too low a price to too many files on the loss mitigator’s desk. You can look for another buyer or even try resubmitting the same contract. Banks don’t want to take properties back in foreclosure, so they are going to do everything they can to make it work provided the numbers make sense based your financial documents and appraisals.

What financial or credit liabilities will a seller have as a result of a short sale?

Many lenders ask sellers to sign a promissory note for all or part of the difference between the proceeds of the short sale and the debt obligation as a condition to a short sale. In such cases, the note gives lenders the right to sue a seller and attach other assets if the note is not paid when due.

Generally, a deficiency judgment may be not obtained using the non-judicial foreclosure process when a property in foreclosure is sold at a public sale for less than the loan amount that the underlying mortgage or deed of trust secures. A deficiency judgment can be obtained in judicial foreclosure sale, unless the property had been abandoned for the preceding six (6) months prior to the foreclosure judgment or decree that would preclude any deficiency.

Currently the State of Washington is attempting to pass H.B. 2718 which would protect seller’s from lenders pursuing any legal action after the sale for the difference between the sold price and the original note.

Until the passage of H.B. 2718 the only way to insure your protected is to consultant an attorney.

What tax liabilities will a seller have as a result of a short sale?

In 2007 the government passed The Mortgage Forgiveness Debt Relief Actwhich currently covers the period form 2007 – 2012.  The Mortgage Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for the relief.  Please visit the IRS website for more information and as always check with your attorney or accountant for the latest laws.

What’s the first step?

The first step in determining whether you need to short sale your home is to contact a Real Estate Agent.  Your agent will do a Comparative Market Analysis on your home in order to determine fair market value.  Once it has been determined that you’re underwater the next step is to contact your lender and explain your situation. Your lender will begin working with you and your agent in order to gather the necessary documents required to process a short sale.  In addition to your agent and lender we always encourage you to consult with an attorney and/or account during the process.  Your agent will work with all parties involved during the process to ensure all necessary documents are in place.  Your agent will list and market your property, present all offers to you and your lender and assist in successful closing.    Call us today for a confidential appointment.

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