The Definitive Short Sale Article by
This article will attempt to address the following:
Define a short sale
Talk about the different ways it can come about and be structured
Talk about how it's different than foreclosure or bankruptcy
Talk about the implications for the seller
Talk about the implications for the buyer
Address investor related questions
Definition:
A short sale is an "arrangement" between the current owner of a home and the bank that lent them the money to buy their home to accept an offer for less than the total amount owed to pay off the home. The "deficiency" is the difference between the amount owed and what the bank collects at the short sale.
Although, the "arrangement" can take many different forms, there is no other definition of a short sale. I say this because many realtors and some investors simply throw the term around as if it meant "a sale under market value." No. A bank owned (foreclosed) house is not a short sale. A seller deciding to lower their price and take less profit is not a short sale. An old lady that owns her home free and clear, selling a $150k home for $75k, IS NOT A SHORT SALE. For it to be a Short Sale, someone must be getting "shorted." Either the seller, or the bank. I will explain how both of those happen in more detail presently.
Another important definition of a short sale is how it differs from foreclosure. In foreclosure, the homeowner falls way behind on their payments and the bank repossesses the house and sells it. In almost all cases, THE BANK PURSUES THE HOMEOWNER FOR THE DEFICIENCY!!! No one seems to know or believe this, but just ask someone who has gone through foreclosure, they will tell you the only way out of this was to file bankruptcy.
How It Can Happen - The Arrangement
Most short sales arise when a seller owes more on their house than they can sell it for (upside down). The owner of the home then attempts to make an arrangement with their lender to sell the house for less than is owed.
The term "arrangement" was used in the definition and is intentionally broad because the arrangement depends on the bank that holds the loan. Though there are general practices, every bank does it differently. This article will give you the most common arrangements, but if you take part in a short sale, it's crucial you assume nothing until you have the bank's policies in writing.
There are some overriding principles:
There is no such thing as a free lunch. This is not some dream come true alternative to foreclosure where the money you owe magically disappears. The deficiency will be accounted for. The deficiency can be 100% loaned to the seller in the form of a promissory note, which they then must repay. If any portion of the deficiency is "written off" meaning that the bank eats it, you can be sure that they will report it as 1099 income to the seller, although the recently passed (10/04/2007) House Bill 3648 The Mortgage Forgiveness Debt Relief Act of 2007 will remedy the archaic I.R.S. tax code that causes this problem.
It is a cumbersome process. If you are entering into a short sale as a buyer or seller, don't expect it to go as quickly as any other sale. There's a lot of "back and forth". The employees of the lender that are negotiating the sale ARE NOT there for the benefit of the seller. Their only goal is to collect as much money possible for the lender and they will use whatever means necessary. You can be sure they will misrepresent their own policies and flat out LIE to the seller in order to intimidate and scare them into paying more money. If you think I'm exaggerating, the joke will be on you.
For instance, I was once told by a lender negotiating a short sale that, as a policy, they don't "write off" any of the deficiency and that the seller would have to have a promissory note for $40,000. This lender also told the seller that their hands were tied and this decision came directly from the investor who provides the money for the lender. The lender also said there is absolutely no negotiation on the amount owed, either pay the deficiency, or they will foreclose. The lender made the promissory note very manageable (20 years 0%) so that the seller would be more enticed to just roll over.
But the seller called the lenders bluff. The seller then provided a letter from an attorney stating they would qualify for a bankruptcy, thus rendering the lender incapable of collecting anything. That same day, the lender called the seller saying they would reduce the promissory note and write off $30,000 of the debt! It would have to be reported as 1099 income, but it would not have to be paid. Amazing change of policy! Then the seller saw what was happening and just said, "no thanks, we don't want to owe you anything, we'll just go ahead with the bankruptcy." Two days later the seller received a written offer that the lender would completely forgive the debt and simply report it as 1099 income! Wow!
The moral of the story is that the lenders will LIE to obtain their money. Many of the managers of the collections departments are paid on COMMISSION on how much they collect. Just imagine if that seller had rolled over on the first offer! That employee would have been responsible for keeping $40,000 of his company's money with one five minute phone call!
One other important thing to remember is that if the lender gets the property back (i.e. short sale doesn't go through), they have to put it up for auction. This creates the risk that additional money will be lost if the house doesn't sell for what it's worth. In the case of the example, the short sale offer was for $550,000, and the amount owed was $590,000. The seller faxed in evidence to the lender that most similar houses in the area were now selling for $480,000. So this enabled the seller to make the argument that it was a much more prudent risk to write off $40,000 instead of running the risk of losing $110,000. This enabled the seller's representative to intimidate the employee of the lender asking him "did he really want to be responsible for losing his company $110k, when he had the option, right now, to settle for 40k?"
The Details of the Arrangement
Different banks have different policies. The best case scenario is to get a bank that actually "writes off" the deficiency. All that happens here is that the seller has some minor derogatory credit reporting, but doesn't actually owe the bank any more money. This credit reporting can consist of anything from "creditor settled for less than the amount due" all the way to "foreclosed."
As the example noted, many banks will want to do a promissory note for the deficiency.
Some banks may suspect that the homeseller(s) have enough liquid assets to bring in the entire deficiency at closing. Think about it. This line of thinking does no good because if the seller(s) selling their house had the amount of cash in the bank account necessary to close, then the seller would either a.) Not need to do a short sale in the first place b.) Not be in default on their current loan(s) or c.) Could have possibly refinanced earlier on to avoid the problem entirely. Most banks however will first have to be satisfied of the seller(s) inability to bring cash to the closing table before a shortsale approval will be rendered. If a bank tells a seller(s) that they need to bring cash to the table in a short sale, they are either idiotic, or more likely LYING. Banks will push sellers to the limit on this issue until they are satisfied. Most seller(s) will have to produce all pages of their most 2 or 3 recent bank statements to satisfy the bank's requirement.
In cases where the money is "written off" it's important to understand that the lenders will never actually "write something off." In most states (I don't know the law in every state), the lender has the ability to show any deficiency as 1099 income for the seller(s). The recently passed (10/04/2007) House Bill 3648 The Mortgage Forgiveness Debt Relief Act of 2007 has remedied the archaic I.R.S. tax code that causes this problem. Until the new law sunsets in 2010, no homeowner receiving a 1099 statement for the shortsale of their primary residence will be taxed on that phantom income. Some exclusions apply, so it is prudent to consult with a qualified C.P.A. or tax attorney before embarking on your individual short sale. Despite the new tax law, some homeowners will still owe income tax on phantom 1099 income. Depending on one's situation, it could mean that these unlucky homeowners who don't qualify under H.R 3648 may have to work with the I.R.S. under the "Offer and Compromise" program to eliminate or substantially reduce and tax debt created by a short sale.
This brings up an important note. NEVER EVER ASSUME THAT A DEBT THAT YOU OWE A LENDER IS GONE UNLESS YOU HAVE THE DETAILS OF THE RELEASE OF THAT DEBT IN WRITING. For instance, someone who had done a short sale had a first and a second loan. The bank agreed to the short sale, which ended up being enough to pay off the first loan, but not the second. The seller had assumed that because the bank agreed to the short sale that they wouldn't have to worry about the deficiency from the second mortgage. Now they are surprised that they are being pursued for the deficiency. REMEMBER, the lender(s) will always want ALL their money accounted for somehow. NEVER assume something is written off unless you have a formal, signed, written, unconditional release of lien and/or judgment from the lender specifically stating that no further action to collect this debt will be taken. This point is critical so it is important to make sure that the individual or entity negotiating your short sale is competent, experienced, and has successfully closed short sale transactions. You do not want to be surprised by a collection call after the sale has closed because your short sale negotiator failed to press the bank for a release of your liability.
Despite popular belief, YOU DO NOT HAVE TO BE BEHIND ON YOUR MORTGAGE TO REQUEST A SHORT SALE. You just have to demonstrate that your house can't be sold for what you owe. Although banks are more motivated to negotiate a short sale with a delinquent homeowner. They are even more motivated if the forclosure sale is just around the corner.
In other cases, short sales happen when a seller can't afford to make their payments and is nearing foreclosure or bankruptcy. It makes life much more complicated if you are living in the house in question. The bank's ability to scare you is much greater in that case. In this case, a short sale is better than the alternatives. However, you will still lose your house. But avoiding the stain of foreclosure on your credit history, being able to manage the timeline of when and how to vacate the property, and maintaining control over your individual circumstances far outweighs the notion of allowing the property to become a foreclosure.
A final note on how the short sale can come about... Most banks will not agree to a short sale in writing until you have a formal offer. You can simply call your bank and ask them if you could do a short sale at a certain price and they might say "sure, no problem, we'd be happy to facilitate that offer." BEWARE. That doesn't mean a thing. Before your short sale is APPROVED, you'll have to submit an application, hardship letter, financial statements, tax returns, pay stubs, the purchase agreement from the buyer, a HUD statement from the pending transaction, payoff letters from all lenders involved, and several other things depending on the lender.
Once this huge packet of information is submitted to the lender, you will most likely hear back in 2-6 weeks on the TERMS of their "approval." Be warned their approval will most likely be thinly disguised attempt to collect their debt. Often the initial "approval" will just be the starting point from where the final "approval" will be negotiated.
If you're an investor... short sales can be a great way for you to find properties under market value and avoid having to compete with multiple buyers at the foreclosure auction. If working with the right broker a short sale can be a win-win-win situation for the investor, the seller, and the bank.
Don't be unethical and try to take advantage of people. You're only going for short sales if the person WANTS to sell their house, the property value has fallen below what is owed, and the seller wants to avoid a foreclosure. The bank also has to believe that the prospect of approving a short sale has more upside then does an eventual foreclosure. So terrifically "lowball" offers often will not fly. It has to be a win-win-win... NOT win-win-lose
Conclusion
Again, a short sale is not a magic cure. It's also not some mystical solution that only an elite few know about. If you're curious about selling your house as a short sale, you should contact an experienced broker versed in short sales who can then contact your lender and begin a "process". It's usually not easy, but in some cases, it can leave you much better off than the alternative of foreclosure and bankruptcy.
Remember that this is a complex process and you should always seek the help of a licensed professional when considering a short sale. Beware of those who claim to be short sale or foreclosure experts but have NO real estate license. Beware of anyone asking for upfront money!!! Beware of someone who has been in the real estate business for only a short time. Short sales are no place for a neophyte to learn the business. Ask for references. Ask to see letters of short sale approval issued on past negotiations. This is all very easy information to produce if the company is licensed, legitimate, and experienced.
