The first client I represented in a short sale had a mortgage that adjusted and they couldn’t meet the payment. In order to prevent imminent foreclosure by the bank, it was critical that they sell the home as soon as possible, even if it meant selling below the amount the initially borrowed. This was in March of 2007 and it was the beginning of my becoming an expert on short sales. The buyer wanted to close by the beginning of the summer because they wanted to do some rehabbing during the warm months. But the bank was hesitant to take our offer. It was truly a sign of things to come – the ominous direction of the mortgage market, why sellers were seeking short sales, how long lenders would take to make a decision, and how long buyers would hang in to get the benefit of a good bargain.
Maybe because I do so many of them, I am surprised when someone asks me what a short sale is. The simple answer is that it is the sale of real estate for less than the amount owed to the lender to prevent foreclosure. The idea is to make the best of a less-than-great situation. Sellers preserve their credit (to some extent) and their dignity, buyers get a bargain, and lenders get a better value, since the financial worth will go down an additional 20 to 30 percent if the bank has to sell the property after a foreclosure. A short sale can be an advantage to all the parties and, since the property will generally sell for more than in a foreclosure, it is better for the neighborhood and the overall economy. For people who can no longer afford their homes – because of job loss, because of adjustable rate mortgages that have adjusted beyond the homeowners’ ability to pay them, or due to illness or divorce – a short sale is one solution.
Of course, while the idea is simple, the process can be emotionally draining, frustrating, and downright confusing. In the hopes of shedding some light onto this often misunderstood practice, I’ve broken down the process into a few basic steps. The requirements for conducting a short sale vary by lender (bank), but the strategy is generally the same.
Step 1: Notifying The Lender
The first step is notifying the lender of the sellers’s urgent need to sell, essentially offering proof that it will be impossible for them to pay their current mortgage off. If a homeowner is requesting that a lender release without full payoff, the lender is entitled to know that the homeowner has no other alternative. The customary requirements to open a dialog with the lender are:
1. The Listing Agreement
2. The listing history
3. The signed contract
4. Two years tax returns
5. Two month’s bank statements
6. The last two paycheck stubs, or other proof of income if not a w-2 employee
7. A hardship letter explaining why the homeowner can no longer pay for the property
8. Authorization for an attorney, real estate agent or negotiator to talk to the lender about the short sale.
9. Financial documents required by specific lenders.
10. A preliminary HUD (RESPA Statement or Net Statement which says how much the lender will be paid at closing.
After all of this is received by the lender, there is usually a 30 to 60 day wait. Depending on whom the lender is and how backed up their processing is, it may take longer. It can be a frustrating time for everyone involved.
Step 2: Getting the Lender’s Approval
Before giving their approval, the lenders of course want to make sure they are, in fact, getting as much as is owed to them as is remotely possible. When the lender finally does review the package for a decision, they may make certain requests in order to give an approval. These requests may vary from demanding a certain payoff – and the parties can figure out how to get to that figure (i.e. by the brokers and lawyer taking a reduction in fees) – or denying or reducing payment of certain amounts (I’ve seen surveys disallowed, attorneys fees reduced or disallowed, broker’s fees cut). Sometimes it takes time to educate the lender on how transactions work in Illinois, since the negotiator is based out of California or Alabama or North Carolina and doesn’t understand the way real estate taxes are prorated because we pay the taxes a year in arrears here.
If there is a second mortgage, the challenges can be enormous. Some second lenders will not release their position without a certain amount being paid to them, despite the fact that if the property went through a foreclosure they would get nothing. Some lenders insist that you negotiate with the first lender, the brokers, the buyer, the seller, and assure them there is not one more penny that can be shaken out to pay them. Sometimes the first lender and the second lender are from the same institution, but because they are in different divisions, they won’t talk to each other. Other times, it is only one conversation for both loans.
Step 3: Finalizing the Sale
Once the lender does approve, the parties to the transaction have to jump through hoops to get the sale closed before the expiration of the approval. The buyer has to get their lending finalized, a survey has to be ordered, transfer stamps must be ordered for the city or village where the property is being sold, and a condo association right of first refusal may need to be obtained. In Chicago, a zoning certification (that the property being sold has the same number of units as in the records of the city) takes 8 days to obtain. There can be numerous other challenges to getting the closing done before the approval expires.
Avoiding The Alternative
And so while it is often a long, tedious, and frustrating process, short sales can be a good defense against foreclosure and work to avoid a much worse scenario. If there is a foreclosure pending, the case is dismissed, which can mean some improvement to a credit score. Putting the property on the open market as a homeowner will usually fetch more money than a sale by the lender. If the lender goes through the foreclosure process, they can bid in any amount they choose at Sheriff’s sale, leaving the homeowner with substantially more owed on the balance of the mortgage – if they are going to pursue the homeowner for the balance.
For people who short sell investment properties, the amount obtained by selling the property themselves as opposed to letting the lender foreclose, can mean a significant difference in the tax implications of debt-forgiveness.
Debunking Short Sale Myths
A short sale is NOT a defense against a weak housing market. I recently heard of a man in Arizona who was going to try to obtain an agreement of his property at short sale because it had lost so much in value. He was able to pay his mortgage and he wasn’t planning on moving, but someone had convinced him that the only way to deal with the downturn in the market was with a short sale. This makes no sense to me. While a short sale is certainly preferable to a foreclosure, it still deals a significant blow to the seller’s credit. If one can afford to make their payments, it is always advantageous to ride out the market and wait for prices to improve. A short sale is an alternative to a foreclosure, not an alternative to a bad market.
Back to my first short sale, we notified the lender of our desire for the sale in March of 2007 and didn’t close until September 5th. As the housing market continued to deteriorate, the bank realized that recouping most of their money was going to be preferable than a foreclosure. Needless to say, after surviving the long and drawn out process, we were relieved. The buyer got a good deal that allowed him to invest more money into rehabbing the property. It wasn’t exactly the best-case-scenario for my client as the seller – he clearly would’ve preferred to have been able to pay his mortgage on time and keep his home – but he certainly was content to be able to avoid foreclosure.
Next: Is there a defense to a foreclosure?