The Short Sale 2.0
The media has been filled with stories in recent years about foreclosures. The pre-foreclosure alternative is a *short sale*. Hopefully, none of you are facing one, but you may be considering purchasing one. There are a number of pitfalls of which to be mindful. I*ll discuss short sales from the perspective of the four principal parties in such a transaction: the lender, the seller, the buyer and the realtor.
WHAT IS A SHORT SALE?
A short sale is one wherein the lender agrees to the sale of a property for a discounted payoff that is *short* or less than that which is owed on it. The usual reasons that a lender agrees to take a loss on a property are because the mortgage is in arrears and if the property were to be foreclosed upon, the lender would sustain an even greater loss. There are other reasons that a lender will agree to a short sale, though they are somewhat rarer, like the homeowner has hardships (e.g., death, disease, disability, loss of job, etc.) and cannot afford the mortgage payments, the area or neighborhood has depreciated in value, the lender is required to keep its REO (real estate owned) inventory below a certain percentage of their assets, or the lender*s shareholders are concerned that there are too many defaulting loans on the books. A lender will not consider a short sale if the loan balance is low enough that the homeowner can sell the property and pay off the loan, fees, taxes, etc..
TIME IS MONEY
For anyone who has braved the housing market in the past four years, short sales have become synonymous with high risk and high reward. But with so many discounted properties on the market today, are they really worth a buyer's trouble? Maybe*if you have a lot of time and a strong stomach. You can get a below-market price, but it's going to take patience because these deals are slow and difficult.
Unlike foreclosures, in which the owner has walked away and the bank is looking to unload a vacant and sometimes, vandalized property, a short sale isn't a distressed home that will sell at a rock bottom price. The homeowner is underwater (meaning he owes more on his mortgage than the property is worth), and he has a financial hardship such as a job loss. But to limit the damage to his credit rating, he has agreed to stay in the house (often continuing to pay his mortgage bills) and to help sell it, at which point the bank has agreed to eat the loss. According to RealtyTrac, short sales typically went for nearly 10 percent less than the market price in the first quarter of 2011. (Foreclosures sold at a 35 percent discount.) What makes the transaction tricky for the buyer is that you're negotiating not only with the homeowner but the bank and that creates three big headaches:
1. It takes a long time.
Normally, when you make an offer on a house, you'll hear back within days, or even hours. But banks move very slowly these days because their representatives are overloaded with cases. You might wait 30 to 60 days for a response, perhaps longer if there's a second mortgage on the property and therefore a second bank. The total process can easily take as long as six months from start to finish.
2. Your offer can't be contingent on selling your current home.
Banks generally won't accept offers on short sales if they're contingent on selling your current house to get the funds you need. So unless you're a first-time homebuyer, you don't need the equity from your current home, or you're a real estate investor, it's unlikely that you can make a short sale work.
3. It's an "as-is" sale.
Banks also typically won't consider short-sale offers that have inspection contingencies in them. So you can either do your inspection before you make your offer*which would mean spending $500 to $1,000 on the outside chance that you can make a deal (and less than a quarter of short-sale offers lead to a purchase) or do what most people do, and go without an inspection.
As long as you're prepared for these hurdles, you may just land yourself a bargain. But make sure to work with a veteran Realtor because you want someone who knows the ins and outs of the process and can protect your interests throughout the negotiations. And since short sales aren't necessarily identified on Realtor.com or the part of the MLS data sheet that buyers see, always ask your agent whether any house is a short sale before bothering to look at it.
Then, if you fall in love with a house that's a short sale, get yourself a mortgage pre-approval -- another short- sale requirement and make a lowball offer. Sometimes you can do that without putting down any money, but if the bank requires a deposit, have your Realtor put language in the offer letter stating that if you don't have a response by a certain date (perhaps 60 or 90 days out) however long you feel like you can wait), you have the option of retracting the offer and getting your deposit back. That gives you an out, just in case. When the bank finally replies, it will more than likely counter with whatever value its appraiser gives the house. Offer them 15 percent less than that and see what happens.
To the lender, a short sale is by far preferable to a foreclosure which has costs and risk for the Lender in terms of lost payments, eviction, property maintenance, insurance, taxes, fees and the like*or a loan modification with the associated lack of certainty. So, anything that could lessen the cost and shorten the foreclosure process should be welcome in the eyes of the lender. Lenders are in the business of lending out money, not acquiring real property. Also, the now vacant property may have fallen into a state of disrepair. An REO (Real Estate Owned) is a liability, not an asset. Too many liabilities will cause any business to go under if not dealt with quickly.
Now, let's take a look at the motivation of the seller/owner. A short sale benefits the owner that is in default in that it mitigates the negative impact on his or her credit. When a borrower fails to pay his loan as agreed and falls 30-60-90 days behind he is considered in default. When the lender files a "Notice of Default", which is recorded with the county recorder, this begins the foreclosure process. By this point, much of the damage to one's credit has been done. A foreclosure, like a bankruptcy, will show up on one's credit report for the next 10 years. (Obviously, if one is able to effect a short sale in lieu of foreclosure, the borrower is much better off because the adverse impact of 30, 60 or even 90 day "lates" will diminish after 2 years).
As for the buyer, he or she would seem to be in an enviable position from the standpoint of having a grateful seller and a lender who is willing to take less than is owed on the property, and one who in all likelihood should be willing to entertain offers that are 10-20% below market price to get this non-performing asset off its books, not to mention avoiding the expense of foreclosure and repairs that may be required to be made before it's saleable.
SHORT SALES: A WIN-WIN-WIN SITUATION?
It should seem to be a win-win-win situation all the way around and yet it rarely is. This is one of those classic cases of "it's fine in theory, but a different matter in practice." One would think that the party that had the most to lose and the most experience in these matters, namely, the lender, would be the savviest and ready to make a deal, but ironically, it's rarely the case.
EIU, ALM, & PFC = MISSING IN ACTION
Lenders' Loss Mitigation Departments go by a variety of names: Early Intervention Unit (EIU), Accelerated Loss Mitigation (ALM) department or Pre-ForeClosure (PFC) group, etc. and they rarely live up to their appellations.
The personnel are usually too overburdened and/or under-trained to be effective. The "specialists" in these departments are responsible for between 125-175 files per month which perhaps serves to explain why so often "the buck gets passed on" from one person to another with seemingly little or no understanding of the process or what is in the company's best interests they just want to get the file off their desk or the phone call on to someone else.
Since loss mitigation departments will never be profit centers for a lender, one would think they would be more predisposed to arrive at a solution space that benefited the bottom line rather than pushing things through the system and tallying up another foreclosure. Yet, it's been my experience and that of many others, that this is the norm.
LIEN HOLDER APPROVALS = REALTOR ROADBLOCKS
With a normal real estate transaction it can close at will once the contract is *four cornered* or that all signatures are affixed and there has been a meeting of the minds. In the short sale, all agreements are subject to lien holder approval. Since the seller is requesting a discounted payoff from the lender, all parties must allow the lien holder to complete an evaluation to determine the value of the home and determine if the loss is justifiable. The lender wants to mitigate his losses so the process of evaluation must be completed before the approval is granted. This process can delay closing for several months.
The lender won't work directly with the homeowner because when a borrower signed the original note, he agreed to pay the money back as outlined in the mortgage note. Regardless of the circumstances, he is still obligated to pay the full amount. The lender cannot negotiate with the homeowner; hence, the need for a realtor's services. When faced with the decision to liquidate the property, a lender must hire a professional to evaluate all of the marketing costs and value of the property. This is often called a BPO (for Broker*s Professional Opinion) or CMA (Comparative Market Analysis). Both of these are little more than a cursory appraisal reflecting market conditions.
Sometimes, sellers ask if it's possible to sell a property that has multiple liens. The answer is an unequivocal yes. Liens against a property are prioritized according to date and time of recording. When a property is sold *short* the loan in first position is paid the majority of the proceeds. All others are pretty much happy to get what they can. All lien holders can be negotiated with. Here again, the requisite need for a realtor's service are vital.
SOME REALTORS ARE.... "NOT READY FOR PRIME-TIME" WHEN IT COMES TO SHORT SALES
Despite having a signed purchase and sales agreement, one-third of these transactions fail to complete because, on average it takes lenders 4.5 weeks to provide an answer on a potential short sale, resulting in many potential buyers walking away. The lender (because they*re taking less than what is owed on the property) has to approve the short sale, not the seller and lender*s Loss Mitigation Departments are notoriously slow because they are geared for foreclosures, not short sales. Other common reasons for failed transactions are tied to problems with home inspections or damage to the property, seller refusal to sign a deficiency note, and the seller*s inability to pay a real estate commission or closing costs.
As frustrating as lender*s Loss Mitigation Departments may be to deal with and at the risk of alienating many of my readers who are realtors, THE #1 PROBLEM WHEN DOING SHORT SALES IS THAT MOST REALTORS DON*T KNOW HOW TO SUCCESSFULLY NEGOTIATE THE SALE WITH THE LENDER OR LIEN-HOLDER. Most realtors do not fully understand the process and what should be included in a short sale package. It is crucial that the realtor spells out the obvious to the lender (in terms of dollars and cents) just how much more beneficial to the lender a short sale is as compared to a foreclosure. Realtors, also, often leave out critical components (usually of a financial nature), which if they*re not there, the lender*s Loss Mitigation Department isn't likely to aid them in their cause given that those personnel are, as previously mentioned, over-burdened and under-trained. A realtor's package should include:
1) a Borrower*s Statement of Authorization which allows them to talk to the lender
2) a Hardship Letter telling the real story of why the property needs to be sold
3) Supporting Documents: e.g., divorce papers, tax returns, etc.
4) Listing Agreement
5) a BPO with Market Trend Analysis, Time on Market, Months Inventory & Rising/Falling Trend
6) Copy of Purchase Agreement and Addendums
7) Repair Estimates, if any
8) Copy of Estimate of Seller's Charges (a.k.a. Net Sheet or HUD-1) with Lender, Escrow, Broker Commission/Fees, etc.
9) Seller's current financial profile e.g., pay stubs, recent bank statements, disability benefits, unemployment benefits (Freddie Mac form #1126 Borrower's Financial Information is useful)
10) Explanation of your Request for a Short Sale.
If all these items are included, the lender should approve the short sale as opposed to waiting months for a response and having the buyer tire of waiting and look elsewhere "for a deal".
SELLER POINTS TO PONDER
Salvaging the seller's credit is important because it affects their ability to purchase a new home. Credit is only one consideration though. Where there has been minimal credit damage as a result of a short sale clients have been able to purchase a new home within six months with little down and with an excellent rate. A lender is most interested in the borrower*s ability to repay the loan. If the problems that led to the Short Sale are behind him or her and there are at least 12 months of good credit with three or more credit accounts one should be able to purchase with minimal down payment at a competitive interest rate.
There are some points that sellers should be aware of when considering a short sale: they usually can receive NO MONEY, the seller may still owe the difference between the mortgage balance and the amount of the short sale via a "deficiency judgment." If granted, this judgment will affect the seller*s credit as any other judgment would. It is important to get the lender to accept the short sale amount as "payment in full without pursuit of any deficiency judgment" such that the seller's credit report shows "Paid as Agreed" or "Satisfied". Obviously, this agreement should be written on the contract. Also, the I.R.S. deems this Forgiveness of Indebtedness, as it's termed, miscellaneous taxable income (form 1099) i.e., the difference between the mortgage balance and the short sale is considered earned income. Very often a letter from one's CPA to the I.R.S. showing Proof of Insolvency will remove the seller's tax liability of miscellaneous income.
ADDITIONAL SELLER CONSIDERATIONS
If a seller files bankruptcy, it is still possible to have the home released from the assets included in the bankruptcy, thereby allowing the agent to complete the sale. One of the main goals in the completion of the short sale is to minimize the damage to the credit of the individual. While a bankruptcy is disastrous to one*s credit, adding a foreclosure is financial suicide. Such a seller should be spared the latter.
Buyers sometimes think that short sales abound in every price range, but that's simply not true. Bad things happen to good people in all walks of life and price ranges for a variety of reasons. The rich, however, are more insulated from the financial depredations that face lower income borrowers. Consequently, it's certainly possible to buy a very nice home as a short sale because of the many reasons already alluded to but there are far fewer in the million-dollar plus range.
If a lender*s Loss Mitigation department is unresponsive, I am not above "Fed-Ex"ing the realtor package to the CEO or President of the lending institution and have enjoyed considerable success with this approach.
If one wishes to deal with the lender in a less dramatic fashion I would, at the very least contact, the V.P. of their Loss Mitigation Department.
From the above, one can see there are a variety of problem areas that need to be avoided and/or negotiated. My recommendation: only entertain short sales when dealing with experienced pros. (The title of the January issue of my newsletter was "The Annual Forecast for 2011 or We're Turning Japanese." Now CNN/Money seems to have picked up on the same notion. The parallels between what happened in Japan in the 90's and our current economic situation are eerily similar. What follows is a reprint of its interview with Richard Koo).
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