Real Estate Articles
Short Sales And The Short Sale Process
Copyright © 2008 - 2013 Lex Levinrad, The Distressed Real Estate Institute ™
If you are a homeowner in foreclosure or considering a short sale and you are thinking about selling your house then it is important for you to understand the short sale process and how you can successfully complete a short sale. Below is an explanation of why banks allow short sales and how the process works.
When a bank loans money by giving a mortgage to a homeowner, the bank expects to be paid back in full when the homeowner sells or refinances the property. A typical bank mortgage is a loan at a loan to value (LTV) ratio of 80%. The standard conventional loan requires a 20% down payment and an 80% mortgage.
As long as the property does not decline in value, the bank has the house as collateral and can be assured of getting their money back by selling the house via the foreclosure process in the event that the homeowner does not pay.
However, sometimes prices decline so rapidly that the equity in the home is diminished to the point that there is no equity left in the property for the homeowner. In extreme cases, such as over the past few years, homeowner’smay be “upside down” meaning that they owe the bank more money than what their house is worth. This is not a great situation to be in, especially if the house is worth a lot less than what the homeowner owes the bank.
Upside down situations usually result from either a sharp decline in prices, high LTV loans or mortgages that do not have fixed rates like negative amortization mortgages and adjustable mortgages.The foreclosure crisis that we have all experienced over the last few years is a direct result of poor lending standards and sharply deteriorating property values.
When a homeowner is “upside down” and cannot afford to stay in their home then the best option is for them to try and sell their house. However, if prices have dropped dramatically and they cannot sell the house for anything close to the loan value then when they do receive an offer from a buyer, the purchase price will be substantially lower than the amount that is owed to the bank. In this situation they will have to receive prior approval from the bank to accept an amount less than the full amount owed on the mortgage. This is called a “short sale”.
In this situation, the bank will have to decide if they want to accept the “short sale” offer which is an amount less than the full value of the mortgage balance. The bank has to carefully weight many factors including the condition of the house, the time it will take to foreclose on the property and the legal costs and holding costs of lost mortgage payments. Typically banks will easily accept a 5% to 10% discount off the face value of a mortgage when faced with a homeowner in foreclosure. However, many banksare not willing to negotiate with a homeowner that is current on their payments.They are only willing to negotiate with home owners that are behind on payments or are facing foreclosure. From the banks perspective as long as the homeowner is still paying they can afford to pay and there is no reason for the bank to negotiate. This creates a dilemma for the homeowner who has a good credit record and would like to maintain their good credit.
In order to proceed with a short sale, the bank has to feel that the homeowner is willing to walk away from the property and is going to allow the bank to foreclose on the property and take the property back. Usually a homeowner needs to be at least 90 days late in order for the mortgage bank to file a foreclosure notice called a “LisPendens”. Once the property is “in foreclosure” the bank will be more willing to entertain offers that are less than the full value of the mortgage balance since the bank now has an incentive to negotiate.
The bank has to carefully analyze what they believe the house is worth, and what they think it would sell for at a foreclosure auction or as a bank owned REO property. Then they need to consider the time it would take to get the house back and how many months of monthly payments they would lose and how much that would total. They also have to consider the legal costs of the foreclosure lawsuit as well as the holding costs and disposition costs to sell the property. The bank also looks at the current condition of the property and if any repairs are needed.
Sometimes the bank will consider selling a property for as little as 50% of the face value of the mortgage. Usually this occurs when there is substantial damage and rehab required to bring the property to a marketable condition. A more typical short sale is probably at around 80% of current fair market value although each property is different and there is no set guideline. I have seen banks decline high offers and I have seen banks accept very low offers. Each case depends on the property in question, the comparable sales, the condition of the property and many other factors. The ability to have a good short sale negotiator and a good working relationship and understanding of loss mitigation is also a key factor in the negotiations.
Houses that are in pristine move in condition do not sell for a lot less than fair market value. Some lender guidelines allow for an offer of no less than 88% of current fair market value. However if the property is substantially damaged from fire, flood or any other damage that makes the property uninhabitable then the bank will be willing to accept substantially less than the amount owed. If the house is abandoned, or is in a high crime area with visible signs of graffiti, squatters or illegal activity then the bank will be very willing to negotiate a quick sale since the bank does not like the liability of these types of properties.
Negotiating a short sale is a time consuming and cumbersome procedure. It can typically take a few months of back and forth negotiations between the buyer, the seller and the banks loss mitigation department. This is best handled by an experienced short sale negotiator who negotiates short sales full time.
The short sale negotiator will request supporting documentation from the seller that the bank will request in order to approve the short sale.
The bank will request the following:
- Documentation and pictures of any damages to the property (the more the better). If there is mold or severe damages to the property then the bank will be much more willing to negotiate.
- Comparable sales supporting the offer from the buyer
- Broker price opinion (BPO) as to the value of the property according to a local real estate agent (damaged properties will have much lower BPO’s)
- Financial hardship letter indicating why the homeowner can no longer afford to pay their mortgage.
- 2 years of tax returns
- 3 to 6 months of bank statements
- Any other relevant information as to the financial situation of the homeowner for example job loss, disability or whaterver reason resulted in the homeowner wanting to sell their house.
- Proof that the seller is prepared to file bankruptcy can help the case of the seller since this can significantly delay the foreclosure process). Many sellers facing foreclosure are behind on all of their bills and so bankruptcy is an option for them to consider. This scares the banks since it means more time until they get to recover the property
- Estimate of damages and repairs needed and the cost of these repairs for the property to be in marketable condition.
- A solid case for why the buyer is not prepared to offer more for the property with supporting evidence. Good examples are current REO sales prices and estimates of repairs at the same price, or previous low purchases by the same buyer. A solid cash buyer that buys many properties will be taken much more seriously by the bank than a buyer putting together their first short sale package.
After all of this information is gathered by the short sale negotiator, it needs to be put together in a “short sale package” and then submitted to the bank. The loss mitigation department then reviews this package and takes it to their superiors for review. The process is extremely time consuming and cumbersome and there is no guarantee that loss mitigation will even be interested in negotiating at all. They can also ask for additional bank statements, more documents repeatedly so it is important that the seller is willing to cooperate with the negotiator in a timely manner.
Any buyer will have to be a cash buyer so a proof of funds is an absolute necessity in order for the bank to take the buyer seriously. The buyer needs to show that they have the ability to close quickly for cash and they must be willing to show the bank a HUD of exactly how much the bank will net on the sale of the house. The homeowner can also not derive any economic benefit and must be prepared to walk away from the house without receiving any compensation at all (violating this is mortgage fraud which is a felony).
It is preferable that the negotiator submit an offer with the condition that there will be a “non-deficiency judgment” meaning that the bank will not go after the homeowner for the difference between the amount owed on the mortgage and the amount that the bank is accepting in the short sale. The previous owner will be required to report the difference as income (although currently this requirement has been waived for primary residences for another 12 months by the Obama administration). The bank will issue a 1099 since they will be deducting the loss for income tax purposes and their loss will be your gain which by definition means income. Filing bankruptcy will not absolve the previous owner from any taxes that are due in the following year as a result of this 1099 so the negotiator should make sure that the seller is aware of this fact.
There is no guarantee that the bank will accept, review or even communicate with the negotiator once they have submitted a short sale offer. However over the past few years banks are much more receptive to short sale offers than in the past and some banks are expediting the process with some short sales being completed in as little as six weeks.
It can be quite disheartening for a seller to spend a lot of time on a short sale with a negotiatorand then to get adenial from the bank. Remember that as the seller there is no guarantee that the bank will accept the buyers offer. Many cash buyers that purchase these properties are buying the property with the intention of having the property as an investment property. These buyers will not over pay for the property and the buyer needs to offer high enough for the bank to accept the offer. There is no guarantee that the buyer will offer high enough and there is no guarantee that the bank will accept the buyers offer. For this reason it is very important if you are considereing a short sale to act immediately in order for the negotiator to have sufficient time to negotiate the offer and in order for the real estate agent to have sufficient time to market for buyers for the property. If you are behind on your payments and considering a short sale please contact us to get started at 800-617-2884.