Everything You Need to Know About Short Sales
A short sale occurs when a lender authorizes the sale of a borrower's real estate property at a lower value than what’s due on the mortgage. This typically takes place when the borrower is in financial distress and cannot pay their mortgage.
The property is sold to a third party, and the lender takes all the proceeds from the sale. In some cases, the lender can forgive the difference between the original mortgage amount and the amount received from the property sale. In other instances, a court passes a deficiency judgment that forces the borrower to meet all or part of the difference.
For instance, a first-time homeowner can approach a mortgage lender for a $300,000 mortgage. The borrower makes a 20% down payment and agrees to pay the rest over a set period. Due to unavoidable circ*mstances, the borrower fails to honor the lender’s agreement. With $200,000 due on the mortgage and no means to pay, the homeowner sells the property at a lower sale price, $170,000, to repay the lender. In this case, the difference between the mortgage and the sale is $30,000.
Here’s a breakdown of the short sale process:
Help Your Client Get Approval from the Lender
The lender doesn't have any legal obligation to approve a short sale; it does so independently. The process begins once the homeowner officially decides to sell by signing a pre-foreclosure sale.
A short sale approval can take anywhere from a few weeks to a few months depending on the lender's timeline. On the brighter side, a short sale has fewer impacts on the homeowner's credit score compared to a foreclosure. Sometimes, the lender may not include the mortgage default in the homeowner's credit report.
To get the lender's approval, the homeowner must:
- Provide proof of new financial difficulties (such as alimony, health issues, a sudden job relocation, etc.). Note that only new financial difficulties qualify for short sale approval. If the homeowner failed to disclose financial difficulties in the original mortgage registration, they will not be approved for a short sale.
- Deliver a short sale package containing a hardship letter, bank statements, wage information (including pay stubs, tax returns, and W-2s), and a letter authorizing a real estate agent to transact on the borrower's behalf.
However, a lender can disapprove a short sale at this stage due to:
- The homeowner's unlimited spending, especially on non-essential products.
- The presence of a property co-signer who can contribute toward settling the mortgage.
- A foreclosure giving the lender more proceeds than a short sale.
We recommend talking to an authoritative figure at the lender's office, such as a loss mitigation executive, to convince them to approve the short sale.
Determine a Short Sale Price
The purpose of short sale transactions is to offset what’s due on the mortgage loan, hence the need for a property value close to the amount due. The borrower should set a realistic value but include all sales costs such as taxes, penalties on the mortgage, commissions, and closing costs.
The real estate agent considers the current property and housing market values and creates a Comparative Market Value (CMV) or Broker Price Opinion (BPO). Whatever the property value, chances are there'll be a difference, or worse, a deficiency which can either be recourse or non-recourse. Each state has varied statutes regarding the difference, but a real estate attorney can advise you accordingly.
Finding Potential Buyers
After the lender approves the set property value, the attorney and real estate agent will develop a short sale proposal to present to the lender. Like an ordinary property, the agent will list and aggressively market the short sale home to find a buyer.
Submit a Short Sale Offer to the Bank
Once a buyer comes forward, the attorney will draw a property sales contract and present it to the buyer, who can either approve or table a counteroffer. Upon reaching a consensus, the sales contract and the buyer's short sale offer are presented to the lender. The lender can either reject the agreement entirely, reject it but with terms and conditions, or accept it as is. After all the documentation is approved, the real estate transaction is complete, and the lender takes the proceeds.
Short Sales vs. Foreclosures
Unfortunate financial circ*mstances, such as medical bills, can force a borrower to fall short in their mortgage payments, eventually resulting in property loss. That property loss can come in the form of a short sale or a foreclosure, and it’s important to know which would be better for your client. Both processes take different amounts of time to complete and have various repercussions to the borrower. Let’s break it down:
Short Sales
A short sale is initiated by the buyer who's under financial hardship, and the only way out is selling their property at a lower value than what’s due on their mortgage loan. Alternatively, a bear market can cause the home value to decline until it’s worth less than the home loan, prompting the borrower to seek a short sale. A short sale requires the lender's approval, which can drag on for months.
Foreclosures
A foreclosure occurs when the lender repossesses a borrower's property after they’ve fallen behind in settling their mortgage for a set amount of time, usually between three to six months. Unlike a short sale, the lender initiates a foreclosure to force the property sale and raise an amount close to the original loan total.
A foreclosure takes a shorter time since the lender is working to recover what’s due on the mortgage. Unfortunately, a foreclosure has tougher consequences than a short sale, such as negatively impacting the borrower’s credit score, and they may not be eligible to own or buy property for the next seven years.
The lender typically initiates the foreclosure when the borrower has vacated the property. Otherwise, the lender begins the foreclosure process through the following steps:
1. Loan Payment Default
If a borrower misses at least one mortgage payment, the lender sends a notice of missed payment but is still willing to accommodate the borrower. If the borrower still fails to pay the missed amount after the grace period – usually 15 days – the lender sends a missed payment notice and a late payment penalty.
2. Notice of Default
If the borrower misses three to six consecutive payments, the lender records a notice of default payment at the borrower's home county records office and notifies the borrower through a certified letter. At this stage, the borrower has 90 days – also known as the reinstatement period – to offset the payments and reinstate the loan.
3. Property Sale's Notice
Upon the borrower’s failure to reinstate the loan payments, the lender records a notice of trustee's sale at the county's records office. Also, the lender publishes a notice of the borrower's property public auction for three consecutive weeks in the local dailies indicating the borrower's details, location, and date of the auction.
At this stage, the borrower has five days to reinstate and offset the loan before the public auction.
4. Public Auction
After five days, the property is publicly auctioned and sold to the highest bidder, who is gifted the deed to the property. By default, the borrower has three days to vacate the property unless the buyer states otherwise.
5. Real Estate Owned (REO) Property
If the public auction is unsuccessful, then the property becomes the lender's property. After removing any liens and costs, the lender employs a listing agent to market the property.
6. Eviction
If the borrower still occupies the property after the public auction, they’ll receive an eviction notice with efficient time to pack and vacate. If the borrower doesn't leave voluntarily, the authorities will evict the borrower forcefully and lock their belongings in storage to be retrieved at a cost. Luckily, the lender can consider directives from Fannie Mae regarding evictions.
Given the significant impacts that a foreclosure has on the borrower, it should be avoided whenever possible. Instead, borrowers should try to secure approval for a short sale or otherwise find a way to change their circ*mstances without hurting their financial future.
Pro-Tip:
Short sales and foreclosure skills can come in handy when a real estate professional is looking to start their agency. Furthermore, helping distressed borrowers who are about to lose their properties find the least harmful solution is important, as is guiding buyers who are looking to capitalize on these opportunities. If you are interested in honing your short sales and foreclosure skills, check out NAR’s SFT Short Sales and Foreclosure Resources certification.
Working With Short Sale Sellers
It's unfortunate when a borrower loses property, a dream they've nurtured for long, due to financial hardships. When your clients are longer able to finance their mortgage, they might think a short sale is the only way out, but it's not! Have them sit down with their lender and attorney to discuss alternative methods, such as:
Loan modification: The lender can change the terms of the loan to affordable regular payments.
Refinancing: The client may be able to secure funds from another lender and refinance their mortgage debt.
Deed-in-lieu of foreclosure: They can hand over the deed to their property to the lender, but only if there are no other liens against the property, according to HUD.
Private mortgage insurance: The insurance your client purchased while applying for their mortgage can advance funds to finance the mortgage.
Loan workout: Your client’s lender could offer a different repayment plan, claim advance, forbearance, or reinstatement.
Before your client decides to buy short sale property, they should:
- Keep records of all their correspondence with the seller
- Seek professional services from an attorney and a real estate agent
- Be patient - short sales are time-consuming
- Be prepared to buy the house as-is
- Be ready to pay any costs incurred before the short sale approval (i.e., property taxes, utilities, insurance, etc.)
Finding Short Sale Listings for Home Buyers and Real Estate Investors
Purchasing a short sale home is an excellent opportunity to own a property at a reduced price. Short sale listings are usually shared on real estate websites and Multiple Listing Services (MLS) sites.
An MLS provides a vast pool of short sales listed by fellow real estate agents. As the homebuyer's agent, increase your chances of finding short sale homes by joining an MLS and utilizing their network. Each MLS is unique to a particular region, but all conform to the National Association of REALTORS®.
While a short sale is a good investment, particularly for those who can buy the property as is, revamp it, then flip it for profit, your clients should consider the closing costs before deciding to buy the property. A short sale might have a limited open window, so ensure your homebuyer's preapproval letter and other paperwork is ready while you find their ideal property.
