Credit Counselors and Short Sales May Bail Out Mortgagors

Several weeks ago we wrote two-parts of a three-part series on foreclosure fraud, i.e. scams perpetrated against troubled homeowners ostensibly to help them save their house or at least avoid legal action but are actually intended to strip off the home's equity or take legal title to the property. (See Mortgage Fraudsters Finding Ways to Exploit Bubble Burst, September 17; and Foreclosure Scams Can be Complex Enough to Fool Most, Sept. 24.)

While it is pretty depressing to see the lengths to which some people will go to profit from another's misfortune, there are people who do legitimately seek to rescue homeowners who are delinquent on their payments.

For a list of legitimate credit counselors visit the following websites:

• Neighborhood Works America
• Department of Housing and Urban Development
• Department of Justice

The second group is a subset of the group we have been warning about; persons or companies that seek to purchase your property to get a deal. The trick is that some of these buyers are actually legitimate. They try to purchase distressed properties through what is called a short sale; i.e., to convince the mortgage company to settle the debt and release the mortgage for less than is owed on the loan.

This is tricky is several ways. First of all, it may be hard to tell the honest foreclosure investor from the scam artist, second, mortgage companies are not often eager to participate in a short sale, and even if they are so inclined the process can be cumbersome and, particularly now, time consuming as loss mitigation specialists are buried in short sale requests.

Some of these short sale investors are very skilled at working through the process with mortgage companies, others may not know the ropes any better than the homeowner who is being foreclosed, and some will utilize a third-party service that, for a hefty fee, negotiates with the mortgage lender. In the latter case the investor may request a good-faith payment from the homeowner to test his sincerity and insure his cooperation before paying the third party. This should not be a large amount, perhaps $200 or $300.

Every mortgage lender has its own process for handling requests for short-sales, but in general it works like this.

The homeowner receives an offer to purchase, usually below both market value and the mortgage balance. The homeowner should check the would-be purchasers references (other homeowners who have sold to the investor or perhaps references from the Better Business Bureau or the purchaser's bank.) The first document in the process is a signed purchase agreement clearly stating the offer. The homeowner is generally not permitted to pull any money out of a short sale and lenders will often refuse to pay a real estate commission but some experienced investors will sign a side deal to purchase personal property such as appliances or window treatments or will pay moving expenses to help the homeowner get started again.

Once the lender is approached with the offer it is going to require most if not all of the following from the homeowner.

• A "hardship" letter which details why the homeowner is unable to continue making his mortgage payments or pay the loan in full.
• An authorization to release information so that the purchaser can negotiate directly with the lender to purchase the house;
• A financial statement detailing assets, income, and liabilities;
• The last two years federal tax returns;
• The last two pay stubs for each signer of the mortgage;
• The last two bank statements
• A copy of the listing agreement and/or sales flyers and ads if the house has been for sale. Some lenders will insist that the house be on the market for a period of time before they will consider a short sale.
• If there is a second mortgage involved, a letter from the junior mortgagee agreeing to the short sale (the junior lender will typically not receive any proceeds from the sale.)

The lender will commission a BPO or broker's price opinion which is cheaper and less thorough than an appraisal in order to determine the fairness of the offering price.

Most lenders will not deal with a partial short sale package and will refuse to even look at a package that is not complete. Most will, once they receive a complete package, put the actual foreclosure on a temporary hold however some (notably HSBC) refuse to stop the process so the homeowner would be wise to move as quickly as possible to assemble the relevant information and get a hearing from the lender.

We have anecdotal information that some loss mitigation specialists are coping with up to ten times the normal number of short sale requests so the process may take a while. And there are some other caveats.

A completed foreclosure will wipe out all liens that are secondary to the first mortgage - i.e. home equity lines, second mortgages, condo fees in those state that do not grant condo loans super-lien status. A short sale does not do this. We are hearing stories of second mortgage lien holders insisting on receiving payments on those mortgages even after the sale is complete. Also, unless pending federal relief legislation is enacted, the homeowner will receive a 1099 form from the lender for the amount of the debt that is forgiven in the short sale. Federal taxes will be due on this amount which is considered "other income."

So why even bother going through the aggravation of a short sale? First of all, while having a delinquent loan will definitely impact your credit report and score it will not do so as much damage as a completed foreclosure. Second, the short-sale usually prevents the lender from proceeding against the homeowner in court to obtain a judgment for any deficiency after the property is sold at foreclosure auction (something to look for in the agreement.) Last, if the short sale package is submitted before the foreclosure is initiated it may keep the borrowers name out of the paper which can be humiliating.