In some markets home prices are stabilizing and even declining rapidly in combination with adjustable mortgage rates increasing. Many homeowners and banks are considering a short sale as a solution to what seems to be unsolvable financial problems—Is a short sale a good solution?
What is a short sale?
Simply put, when a lender agrees to accept less than what is owed as payment in full and releases the homeowner from the mortgage.
Why would a lender accept a short sale?
Banks and Mortgage Companies are not in the business of selling real estate. They are in the business of loaning money. When a bank takes back a property through the foreclosure process, what once was considered a performing asset, the mortgage, is now bad debt and a liability.
A lender’s ability to access new fund is directly tied to the health of their financial portfolio. Debt and bad loans directly affect their ability to borrow and in turn to lend to customers in the form of new mortgages. This is not good for business. In addition, lending institutions are required to set aside liquid assets, cash, against the defaulted mortgages. Sometimes the ratio can be as high as 7:1. A $100,000 defaulted mortgage can result in $700,000 of cash reserve that is unavailable to the lender. This further reduces their borrowing power to make new loans.
Why would a homeowner want to do a short sale?
The homeowner is released from the mortgage and their credit is spared the damaging effects of having a foreclosure on their record. In most instances, a foreclosure is an automatic deduction of 300 points from a homeowner’s FICA score.
My credit is already ruined, why not let just let the house go to foreclosure?
Delinquencies such as late pays of 30, 60 and 90 days or more are not as damaging as having a foreclosure on your record. Over time, reputable credit repair companies can work to ‘cleanse’ a credit report from some delinquencies and increase credit scores. A status of ‘paid as agreed’ or ‘paid satisfactory’ allow much more flexibility in creditor’s assessment of an individual’s financial health.
Can bankruptcy proceedings save a homeowner from foreclosure?
Typically not. Bankruptcy may prolong the time a homeowner may live in the house during the court analysis of the owner’s finances, but a bankruptcy will not remove a mortgage from a homeowner’s name. Once the court has decided, either through Chapter 7 or 13 rulings, the mortgage will still be in the homeowner’s name and eventually, be removed from bankruptcy protection for the lender to pursue the foreclosure.
Are there other options for the homeowner?
Yes. Because banks do not want to foreclose on a property, they have options designed to help the homeowner. The majority of these options are designed to help homeowners that are experiencing a temporary financial hardship. If the homeowner cannot afford to ‘make-up’ back payments in a short period of time, or afford the mortgage payment with consistency in the future, these options usually are only temporary solutions. The mortgage for the homeowner is still a burden and unaffordable. These options include: a refinance, a financial work-out plan with the lender, and a loan modification. If the short sale is unsuccessful, the homeowner may want to consider a deed in Lieu of foreclosure as a last resort.
When should a homeowner consider a short sale?
When they can no longer afford the mortgage, have experienced some personal and/or financial hardship and have considered all other options. Additionally, it is very helpful to go through financial counseling with a unbiased, 3rd party financial advisor.
What are the major reasons a homeowner may find themselves in a position to no longer afford the mortgage and therefore consider a short sale?
The number one cause of foreclosure in our nation is the medical expenses associated with illness or sickness and a person’s inability to pay. Job loss or layoff, relocation, divorce, death of a loved one and a rapidly increasing number of adjustable rate mortgages rising so fast that a homeowner cannot afford the increased monthly payments are other significant reasons.
What are the financial consequences to a homeowner when doing a short sale?
After being released from the mortgage, the homeowner may be responsible to the lender for what is called a deficiency judgment. A deficiency judgment is the gap between the entire amount owed on the mortgage and the amount the lender agrees to accept as payment in full. Most lenders, when considering a short sale, are willing to waive their right to the deficiency judgment. The lender also has the right to file a 1099 on the homeowner. In this case, the homeowner may be responsible for the deficiency amount as taxable, ordinary income. In some instances, the lenders are agreeing not to file the 1099. The government is currently establishing new guidelines in favor of the homeowner.
Can a Homeowner negotiate with their lender for their own short sale?
Typically not. A short sale requires that there be a buyer to purchase the property from the bank at the negotiated reduced amount. If the homeowner has such a buyer, that is considered an ‘arm’s length’ relationship, it is possible.
If a homeowner wants to perform a short sale, how do they do it?
It is important the homeowner work with an investor or real estate agent that is experienced in short sale negotiations. The negotiations are time consuming and complicated. Many agents are not trained and have not navigated such negotiations. It is important to work with a reputable individual or organization that demonstrates a track record of successful bank and client references. An investor may be the buyer and negotiator. This is good because the investor will write a purchase offer and begin negotiations immediately. A real estate agent will typically try and find a buyer, which may never materialize at the right price, and then begin the negotiations delaying the outcome in a very time sensitive process. Investors and agents can work very well together in this process.
When a bank forecloses on a property, I have heard that they actually auction the property outside on the court house steps. Is this true?
Yes. The lender must follow the guidelines established by the state and give appropriate notices to both the public and to the homeowner. Once the law has been carried out, and if the homeowner has not cured the defaulting financial issues, the lender establishes an opening bid and conducts a sale, typically on the court house steps. This is commonly known as the ‘Sheriff’s Sale’.
What if the lender does not sell my property at the Sheriff’s Sale?
Depending on the state, and if there are any ‘redemption’ time allowances for the homeowner to cure the default, the lender now has legal title to the property and is the owner. This is known as REO, or Real Estate Owned property.
May the homeowner live in the property after the short sale or in the instance of a Sheriff Sale if the lender owns the property as REO?
No, in the majority of cases, the homeowner must vacate the property. The state determines the rights of the lender and homeowner to possess the property after the lender has taken the property into it’s REO inventory. If a short sale was performed, typically, the new owner purchasing the property will require that the homeowner vacate the property at time of closing.
What if there is equity in the property, may the homeowner receive profit from the short sale?
No. If the lender agrees to accept less than what is owed on the property, they will not allow the homeowner to benefit from the short sale. In some instances, when the homeowner works with an investor, the investor may assist the homeowner financially in exchange for the owner’s equity. Such financial arrangements must be ethical and legal and accomplished between homeowner and investor apart from the lender negotiations.
Do all lenders accept short sales?
No, but the majority of them do. There are whole departments dedicated just so a lender may analyze short sale packages and determine if it is better to accept a short sale or to proceed with the foreclosure proceedings. This department is typically called the loss mitigation department. The more defaulted properties a lender acquires through foreclosure proceedings, the more liability accumulates and the more likely the lender is to negotiate a short sale for the homeowner.
