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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 that foreclosure or bankruptcy
- Talk about the implications for the seller
- Talk about the implications for the buyer
- Address investor related questions on capitalizing on short sales (which
you will soon find based on the definition is not really what you investors
are looking for)
- If your question is not answered in the article, see the Short Sale FAQ.
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 or even as a judgment which will show on your credit for 10 years
(not 7 years, 10 years).
- 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?"
If it seems like I know a lot about "this example" it would be because I was
the mortgage broker for the people making the offer and seller of the property
happened to be my wife.
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 do a promissory note for the deficiency.
Some banks are stupid enough to require that the deficiency be paid at closing.
Think about it. This does no good because it's the same thing as the seller
selling their house without doing a short sale and simply bringing cash to the
table. If a bank tells as seller they need to bring cash to the table in a short
sale, they are either idiotic, or more likely LYING.
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. All this really means is that the seller has
to pay taxes on that income. Depending on one's situation,
it could mean that people that are dependent on some form of aid because of
"low income" will have some explaining to do come tax time.
Another way that the deficiency can be written off is in the form of a judgment.
This will often occur in conjunction with the 1099 reporting. It might say something
on the seller's credit report such as "judgment filed against John Doe in the
amount of $xx,xxx by ABC lender." This will appear in the "public record" section
of the seller's credit report for 10 years (7 years is only for late payments,
10 years for public record info, don't argue, trust me). It can either show
up as satisfied or unsatisfied. Satisfied is obviously better because it means
that the worst thing that can happen is that the lender will report 1099 income.
Unsatisfied could be a problem, because it means that a court has found in
favor of the lender to collect the deficiency from you. Now they still might
simply do the 1099 thing, or they might try to collect it from you. They can
keep trying to collect it from you until they get it. They can garnish
your wages. Your only hope then is that you qualify for a chapter 7
bankruptcy.
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.
How did we get to this place in the first point?
A short sale can come about for many different reasons. In my wife's
case, she was the owner of the house and had been making payments. We bought
an investment property and put it solely in her name to protect our family in
the event that the market took a turn for the worse. It did. We owed 590k, but
the best offer we had after 6 months was 550k.
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.
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 only slightly better than the alternatives. You will still lose your house,
and your credit is still destroyed just because you've made 4-5 late payments
on your mortgage.
Despite popular belief, A BANKTUPCY, FORECLOSURE, OR REPOSSESSION DO NOT HURT
YOUR CREDIT AS MUCH AS THE MULTITUDE OF LATE PAYMENTS THAT OFTEN LEAD UP TO
THEM!!!!! I just cannot stress this enough. People think that a bankruptcy damages
their credit beyond repair in and of its own accord. I've had many clients file
bankruptcy with 750 scores and no late payments only to have their score drop
to 680. It's the clients with 20+ late payments that are having their credit
hurt.
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 1-4 weeks on the TERMS of their "approval."
Be warned their approval will most likely be thinly disguised attempt to collect
their debt and will almost never be the "write off" you were hoping
for.
Investors
If you're an investor, by now, I hope I've scared you off. Short
sales are not some magic way for you to find properties under market value.
They are a tool for sellers that owe too much on their homes to sell them at
market value.
What you are looking for (or should be if you're not) are sellers that
owe far far less on their homes than what they're worth. Sellers who don't
care how much they earn because they're either desperate or have so many
houses they don't care.
Still if you see a house you want, there is one way that a short sale could
come into play. Say there's a distressed property that you'd pay
100k for that you know would be worth 180k if it was fixed up a bit. The seller
doesn't have the money to do it and the house is either vacant or they
want out of their situation. In this case, if the seller happens to owe 130k
(around there), and you will only pay 100k, AND the seller hasn't had
any viable offers because of the level of distress on the property, then a short
might be just what the doctor ordered.
Don't be unethical and take advantage of people. You're only going
for short sales if the person WANTS to sell their house and no one else but
you will buy it because you're not afraid to rehab a house that's
smells bad and is falling apart.
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 your lender and get information
in writing. It's usually not easy, and hardly ever will truly "win." But in
some cases, it can leave you much better off than the alternative of foreclosure
and bankruptcy. If you're an investor, there are much better ways to obtain
undervalued homes.
Remember that this is a complex process and you should always seek the help
of a professional when considering a short sale.
For any questions left unanswered, again, please consult the "Short Sale FAQ."
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