What is a Short Sale?
With the recent boom in foreclosures hitting the nation, itâ€™s almost certain that if you watch the news or read the news paper, you have probably heard the term â€œshort saleâ€â€¦Â But do you really understand or know what a short sale is?Â For many, they are still unclear.
Put simply, a short sale is when a lender or lenders, accept less that the full amount due on a loan when the property is sold.Â The lender will usually accept the short sale to avoid the time and expense of a foreclosure, but do require that the owner of the property show some type of a â€œhardshipâ€, or reason that they can no longer afford the home and need to sell. In a short sale, the lender will pay all of the fees that are involved with the sale, including the Realtorâ€™s commissions.
With home prices down over 29% across the nation, many homeowners are finding themselves in a position where they no longer have any equity in their property.Â And even if they have a small amount, when a borrower is in default on a mortgage they not only owe the back payments but also may owe late fees, back taxes, attorney fees, etc. This can add up quickly to eat up all the equity the borrower had in the property. If the borrower is unable to bring the account current the lender will then foreclose on the property. With a foreclosure, the lender can lose up to 40% of the mortgage amount because of the extra costs involved with foreclosing on a property: attorney fees, court costs, lost interest, eviction costs, property maintenance costs, and selling costs. Foreclosing on a property can take anywhere from a few months, up to 2 years in some states. Therefore, it is sometimes in the best interest of the lender to accept the short sale.
It also can be in the best interest of the borrower. They will not have to endure the time and stress of a foreclosure and their credit may not be as adversely affected as it would with a foreclosure. It is quicker and easier and does not subject the borrower to the embarrassment of a foreclosure.
How does it work?
The first thing the borrower should do when they can no longer afford a property is to contact the lender immediately. The last thing a lender wants to do is foreclose on the property. When contacting the lender, they have departments that work with people who are behind on their payments to resolve the situation and will be able to direct you to their departments.Â
Unfortunately though, these departments are typically understaffed, overworked, and have very poor systems in place.Â Getting through to someone and getting them to actually work on your file can be a very frustrating battle.Â This is why it is important to hire a Realtor, or Realtors that are experienced in short sales and dealing with the lender that hold your mortgage.Â If they are experienced, they will have the numbers and the contacts to get the deal done.
Once you have notified the bank, the first step will be hiring a Realtor and placing your property on the market. With most lenders, they will not review any paperwork or consider you for a short sale until your property has been listed on the market and a buyer has submitted an offer.Â Once that has taken place, there is a lot of paperwork the lender will require along with the offer in order to consider the short sale.Â The information required may include:
Â· Income documentation such as 2 years of tax returns and W-2s, along with one month of pay check stubs to verify the borrowersâ€™ income.
Â· Bank statements to verify the borrowersâ€™ assets.
Â· Hardship letter â€“ this letter will describe for the lender the reasons the borrowers are in the financial position they are in and will ask the lender to accept the short sale. Borrowers should make this letter sound as sad as possible and back up the story with any documentation you may have such as medical bills, etc.
Â· Financial Worksheet â€“ this worksheet will show the borrowers net montly income vs. all of the monthly expense, and will be used to show that the borrower is unable to afford the property.
Â· Fair market value for the property â€“depending on the lender they may require aComparative Market Analysis (CMA) from the Realtor justifying the price of the property.
Â· Purchase agreement signed by all parties.
Â· Preliminary HUD1 - This will show the proceeds of the sale of the property after the mortgage is paid off and all other closing costs and fees are paid. This will show the lender what they will be receiving as the short payoff.
Â· Listing agreement.
Â· (And many lenders have their own specific forms that are required in addition to everything above.)
Once the lender receives all of the above information, they will hire an outside third party to complete either an appraisal on the property or a BPO (brokerâ€™s price opinion) to determine the fair market value of the property.Â Â They will use the information provided above to make sure there is a hardship and they will compare the offer that is presented against this value to determine if the short sale makes sense, or if they can obtain more by going through foreclosure.
Once the lender has reviewed all of the information, they may or may not approve the short sale. If they do not approve the short sale they will proceed with the foreclosure. If they do agree to the short sale, the transaction will move forward the same as a normal sale, you will close on the sale of your property and the lender will take the loss.
So, is the borrower off the hook?
Not necessarily. The lender still has options to try to collect this shortage. As a condition of the short sale the lender may require the borrower to sign a note to repay the shortage or bring in cash at closing.Â The lender may also require that the borrower agrees to the lender retaining their rights to pursue a deficiency at a later time. This is why it is important to work with a team that is experienced in Short Sale and to consult a real estate attorney to fully understand all of your options.
There may also be tax implications in a short sale or foreclosure. When the lender forgives the amount of the shortage, they will report that amount to the IRS and the IRS will send out a 1099 showing the shortage as income.Â Each personâ€™s situation is different and they may be protected from having to pay taxes on that amount through the â€œMortgage Debt Relief Actâ€ or through showing insolvency. I cannot offer advice on that and highly recommend that any person considering a short sale or foreclosure consult a tax professional to fully understand the implications of a short sale or foreclosure.