Short Sales – The Nitty Gritty

house short sale

What is a short sale?

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 agent’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.

How do I know it’s short?

A real estate agent can run a  CMA (a comparable report) for you as  your first indicator.  You also need to know what the outstanding debt is and calculate the cost associated with a sale — from transfer taxes to commissions. This will give you an estimate of the net proceeds that will be realized. 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 a 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, you should also consider getting a home inspection to determine what repairs are needed on a home and how this might affect its value.

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

The short sale department of your bank will outline the items they need from you for the short sale package. The  package usually includes W-2 forms from employers (or a letter explaining you are unemployed), bank statements, two years of tax returns, and other financial documents outlining income and debt obligations. The bank will also request a hardship letter from you explaining the reason why you need to short the sale. The bank will also need comps and will conduct an appraisal or broker’s price opinion (BPO) which will show an estimate of value.

What are the options besides a short sale?

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, says Loni Parmelly, a real estate practitioner and consultant who specializes in short sales. Parmelly also is author of Success in Short Sales (2004), a book she sells on her Web site. 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.

How long does it take to complete a short sale?

Although response times vary from lender to lender, it can take as long as 90 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.

What can my real estate agent 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 buyer that is willing to close in 30 days and who can make a substantial down payment may make the deal more attractive than a buyer who wants 95 percent financing.  All buyers should be preapproved for a mortgage before submitting the offer.

What are my 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,” says Pierce. You also need to prepare your seller in advance for the possibility of foreclosure if a short sale fails, says Parmelly.

A short sale might be rejected if the loan is less than a year old. In such cases, the servicer that’s bought the loan can often require the original lender to buy it back.

What financial or credit liabilities will I 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.

It’s particularly important to understand this distinction if you work in states such as California that have a nonrecourse mortgage, says Churchill. In such states, the lender cannot pursue a deficiency judgment against a seller for any deficiencies after a property is foreclosed. Because of this distinction, sellers who are already in default on a mortgage and do not have the resources to pay off a separate promissory note after a short sale might be better off letting the lender foreclose, he says. If you are working in a state in which mortgage loans are nonrecourse, be sure and alert your seller-clients to this distinction.

Having a portion of a loan forgiven may have an adverse affect on the seller’s credit. Encourage your client to try and sign a lease on an apartment before credit is further damaged, suggests Roberta Murphy, an associate broker with Windermere Exclusive Properties, San Diego.

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

One often overlooked aspect of short sales is that a seller must count any amount forgiven by the lender as income and pay taxes on that income, even if no actual money was received. The IRS requires lenders to submit a Form 1099 stating the forgiven amount. Sellers who meet the Internal Revenue Service definition of insolvency (either in bankruptcy or with debts exceeding assets) will not have to pay taxes on the forgiven amount.

The U.S. House of Representatives has introduced the Mortgage Cancellation Tax Relief Act (H.R. 1876), which would eliminate taxes on any debt forgiven on a principal residence through either short sale or foreclosure. The NATIONAL ASSOCIATION OF REALTORS® has been working to support this bill.

Original article by Mariwyn Evans.

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2 responses to this post.

  1. Posted by Oliver on September 26, 2009 at 10:03 pm

    Its all about the BPO. That number will drive how easy you can get an approval. When you meet the BPO agent make sure to bring the lowest active, pending, and sold comps.

    Follow me on Twitter, lets connect:
    http://twitter.com/OliverGraf360

    Reply

  2. Very informative. Thank you so much.

    Reply

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