Many homeowners and homebuyers alike begin considering short sale transactions without fully understanding what a shortsale is and how it works. Before deciding on this transaction as a method to avoid foreclosure or before choosing to purchase short sales, understanding these transactions thoroughly is important.
Defined by Wikipedia, “A short sale is a sale of real estate in which the proceeds from selling the property will fall short of the balance of debts secured by liens against the property, and the property owner cannot afford to repay the liens’ full amounts, and whereby the lien holders agree to release their lien on the real estate and accept less than the amount owed on the debt.”
For example, if the homeowner still owes $100,000 on their home and they are able to sell the property through a short sale for $90,000, the lender may accept that $90,000 as full payment, even though it is less than the unpaid balance of the home loan.
Explained more simply, shortsales are options that certain homeowners may try to use to avoid foreclosure. This option is used when the lender allows the borrower to sell the home to a third party at a lower price than the amount that is owed on the home loan. While borrowers can initiate this option, it is important to note that a short sale cannot proceed without the final approval of the lender.
All creditors that hold liens on a piece of property must approve applications individually for short sales if they are being requested to accept less than the amount they are owed. This includes both primary mortgages and junior lien holders, which can include HOA liens, home equity lines of credit (HELOC) lenders and second mortgages. In most cases, lenders will require proof from the lender that they are dealing with some type of hardship and the loss mitigation department of the creditor will evaluate the application of the borrower.
Both the lender and the borrower must agree to the short sale. In many cases, both can benefit from these transactions. Borrowers can benefit from avoiding a foreclosure, which can be devastating to their credit report. While a short sale does have an impact on borrower credit, its impact is not as drastic. Lenders can benefit from the high cost of going through foreclosure proceedings, especially since foreclosures are currently taking more than 300 days to settle.
How Short Sales Work
The short sale process can vary from lender to lender, but it usually follows several general steps. The following are the steps commonly used in a short sale.
- First, homeowners usually consult with their lender to discuss the available options regarding a short sale. At this point, the borrower is provided with the transaction information needed from the lender about the specific process that must be followed by a short sale property.
- Next, homeowners must send a letter to the property buyer and the escrow agency that lists the short sale information in detail, also authorizing this information to be released.
- The lender will then need to review the short sale information included in the settlement statement. This statement includes shortsale information such as the sale price of the property, any expenses involved in the sale, loan balances and other fees that may be required to close the deal.
- A “letter of hardship” must be written to the lender by the homeowner. This letter must include relevant details about the financial or economic hardships being faced by the owner. Lenders also look for information that validates the owners need to go through with a short sale, such as pay stubs, investment account information, savings and checking accounts and other relevant financial records.
- The broker supplies the lender with information that includes the property’s overall condition and the real estate prices of comparable homes in the area. This information is used to help determine the fair market value of the home.
- The mortgage lender carefully scrutinizes all the information provided in the short sales agreement. Lenders do this to ensure that the conditions and amounts are reasonable and to make sure that the commission charged on the property is acceptable as well. Once this agreement is finally approved by the lender, the sale can be closed.
Two Short Sale Options
Banks, credit unions and other lenders can offer two different shortsale options. Homeowners considering short sales should find out which option is being offered by the lender before deciding to go this route.
Option #1 – Deficiency Judgment
With this short sale option, homeowners are still liable for the amount of money still owed after the short sale transaction takes place. For example, if the amount still owed on the mortgage was $150,000 and the short sale purchase takes place for only $120,000, then the borrower will still be liable to pay the lender the $30,000 difference between the purchase price and the amount owed on the loan.
Until this amount is paid to the lender, the deficiency judgment will be noted on the borrower’s credit report. Since the balance still owed usually is thousands of dollars, it can take years to pay off this amount of money and the negative effects of the deficiency judgment on the borrower’s credit report can be long lasting with devastating financial consequences.
Option #2 – Payment in Full without Pursuit of Deficiency Judgment
This option is the more popular choice and the obvious hope of most homeowners interested in a shortsale. Borrowers are not required to pay the difference between the amount paid for the sale and the total amount still owed. Once the property is sold with the approval of the lender, the borrower is free and clear of any financial obligations once the process has been completed.
When considering short sales, it is essential for borrowers to contact their lender as quickly as possible to receive information on the options available from the lender. Once this information is provided, homeowners should look it over carefully, weighing their options to choose an option that will best suit their unique financial situation.
What is an Approved Short Sale?
For buyers considering a short sale purchase, it is important to understand what an approved short sale is when looking for real estate for sale. Although many homes are listed as a short sale property on the market, in many cases, the seller has listed them in this manner and the home has not been approved for a short sale by the loss mitigation department of the lender.
An approved short sale is a property that has already been approved by the lender for short sale. When buyers are considering different real estate homes, they should ask the seller if the home has actually been approved for this transaction by the lender. If so, the homeowner should be able to provide paperwork and details of the approval that the lender granted.
What happens if a home is not an approved short sale? This usually means that buyers will spend a lot more time trying to get the sale approved, since the homeowner has not already approached the lender about the possibility of a short sale transaction. If the home is not already approved, the seller will have to prove that they are dealing with a financial hardship that will not allow them to pay off their home.
Financial hardship has to be proven, the details of the potential transaction have to be provided to the lender and the lender has to actually decide if they are willing to allow a shortsale to occur. If so, then negotiation on the terms and the price of the sale will take place. This can take quite a bit of time and in some cases, while the seller may have agreed on a deal with the buyer, the lender will not agree.
While there are still negotiations that take place when a home is considered an approved short sale, it is much less time consuming for buyers. Approved homeowners already have their paperwork filed and financial hardship has already been proven. The lender has decided that they will allow a shortsale to take place. All that must be negotiated is the real estate prices on the home and the specific terms of the sale.
However, there is less of a chance that the sale will fall apart if the home has already been approved for this type of a sale.
Choosing a home that is an approved short sale offers buyers a faster way to enjoy all the benefits these transactions have to offer. Buyers can more quickly buy the home of their dreams and the lender is more motivated to go through with the sale at this point, making it easier for both parties to come to a good compromise after negotiations.
Homeowner Qualifications for Short Sales
Lending institutions have specific stipulations on borrowers that are able to qualify for a shortsale. Homeowners considering this process must meet certain criteria with their lender before the process can move forward.
The following are some of the common criteria that must be met by homeowners to show they are dealing with financial or economic hardship. Of course, keep in mind, the specifics can vary slightly depending on the specific lender.
The market value on the piece of property has dropped significantly.
The homeowner experiences a change in their financial situation, which results in bringing home less income than they were initially bringing home when they first took out the mortgage loan.
Mortgage payments on the home are a month or more in arrears.
Homeowners have no funds within their savings account.
A debt service cannot take care of existing liabilities.
Payments may still be current on the mortgage, but the homeowner can show the lender proof that they cannot make their payments on the home in the future.
The borrower is in an upside down mortgage, which means they owe more on the home than the home is actually worth.
These are only a few of the qualifications that homeowners may have to meet to qualify for a short sale transaction.
When considering this option, homeowners should contact their lender to find out the specific qualifications that the lender requires to be met before granting permission for a shortsale to take place.
Common Short Sale Myths
Many misconceptions and myths are spread around about shortsales, which is why some homeowners are afraid to consider this option and some buyers are afraid to consider purchasing them. Both sellers and buyers need to be aware of some of the common myths and the real truth behind them when considering this transaction. Here is a look at some of the top misconceptions about these transactions.
Short Sale Myth #1 – Buyers Overpay for Shortsales
In many cases, listing agents have been known to price a short sale property below market value, working to bring in more offers on the home. However, listing real estate prices may not be a good guide to follow, since buyers never know what the bank will accept until an offer is accepted in most cases. Keep in mind that banks will usually consider a price that is 90% of the current market value of the home. Unreasonable offers will be rejected. In most cases, the truth is that buyers usually end up getting the home at or below market value, which provides homebuyers with an excellent deal on the home.
Short Sale Myth #2 – Short Sales Can Take a Year or More to Close
In many cases, short sale transactions can take longer to close than other real estate transactions. However, the idea that it takes more than a year to close is a big myth, especially now that banks are becoming more motivated to go through with short sales. The amount of time it actually takes to close on these properties depends on whether the lender has approved the home for a short sale or not. Homes that are already approved for this type of a sale can close in less than 30 days. If the homes are not currently approved can take quite a bit longer.
Short Sale Myth #3 – Sellers Must Be in Default Before They Can Be Approved for Shortsales
This is not the case. Lenders approve these transactions based upon the home’s value and the hardship of the seller. In some cases, sellers may be having difficulty paying their loans without having fallen behind on those mortgage payments at the time. Sellers in default often are given immediate attention, but sellers that are still paying on time may be able to qualify for a short sale. For homeowners that feel they cannot keep up with mortgage payments in the future, this may be a better option than going into default and harming one’s credit even further.
Short Sale Myth #4 – A Severely Discounted Payoff Will not Be Accepted By the Lender
Some sellers are afraid that their lender won’t accept a severely discounted payoff. However, home values have fallen so significantly that homes may only be worth half of what they were when the home was purchased. Lenders do understand the decline of the real estate market and keep this in mind when considering shortsales. Banks take the time to research the value of the property, basing the home’s value on comparable sales instead of on the mortgage amount.
Short Sale Myth #5 – Banks Would Rather Go with a Foreclosure
Another common misconception about short sale properties is that banks would rather go through with a foreclosure on the property instead of approving the shortsale. In reality, banks are realizing that foreclosures can make them lose even more money, since these proceedings are quite costly. Lenders usually find that they receive more of their money back when going through with a short sale.
Of course, lenders will require that certain qualifications be met before approving these transactions. However, these transactions are becoming even more popular and trends show that shortsales will probably begin outnumbering foreclosures in 2013 as banks realize that short sales make a better loss mitigation technique.
Important Short Sale Terms – Glossary
A letter from the homeowner/seller that is dated and signed, authorizing a lender to discuss personal information with a real estate agent. The letter should include the name of the agent, their contact information, the seller’s contact information, loan reference number and the address of the property.
Broker’s Opinion of Value
A valuation of a property that is done by a realtor. In most cases, banks usually request and pay for these appraisals if a property is in default, a short sale is occurring or the mortgage is being refinanced.
Deed in Lieu of Foreclosure
This is a term describing the voluntary surrender of a piece of property by the borrower to the lender. When this occurs, it eliminates the need of the lender to continue with foreclosure action. It is possible for lenders to refuse to accept this option, then filing a Notice of Non Acceptance with a County Recorder.
Indicates that the borrower has failed to make one or more mortgage payments.
Once a debt is partially settled after a short sale takes place, this is the amount that is stilled owed on that home loan. The borrower is still responsible for paying this amount.
A distressed property is advertised for sale either by the lienholder or under foreclosure order. These properties usually are purchased for a price far below the property’s market value.
A property is called Equity Deficient if the proceeds of a sale will not pay off the entire amount owed on the mortgage.
A letter that the borrower must submit to the lender indicating all relevant reasons that they are unable to continue making payments on the home loan.
A junior lien refers to a lien that is subordinate to the first mortgage, often referred to as the senior lien. Order of recordation usually establishes the lien priority. Junior liens often include second mortgages, home equity loans of credit and other loans taken out along with the primary lien.
Loss mitigation refers to a division within a bank or other lending institutions that works to mitigate the loss of the institution. This department within a lending institution works with borrowers that are not currently meeting their obligations to repay the loan. The goal of this department is to minimize the amount that the lender loses on these loans.
A second lien, also referred to as a second mortgage, is a lien for which property is used to secure a loan where there is already a mortgage on the piece of property. If the borrower does not make payments, the first lien holder would get all the money from a short sale up to the full mortgage amount. The second lienholder gets any other money left up to the value of the second lien.
An underwater mortgage takes place when the balance of the mortgage loan is larger than the value of the home. This often referred to as an upside down mortgage as well.