WHAT’S A SHORT SALE August 25, 2008

Housing Counsel: What’s a Short Sale

by Benny L. Kass

Question: We are in financial trouble. Our house will not sell for enough money to even pay off the mortgage, let alone a real estate commission. Our real estate agent suggested that we do a “short sale”.

 

What exactly is this?

Answer: This is a method of disposing of your home without having the lender foreclose on you.

You are unfortunately what lender’s call “upside down.”

Let’s take this example: you bought the house last year for $500,000, and foolishly took advantage of the mortgage broker’s sales pitch and obtained a 100 percent loan. Now, the house will probably only sell for $475,000, and you lost your job and cannot afford to continue with the monthly mortgage payments.

A short sale is an arrangement with your lender whereby they will allow you to sell the property for less than the amount of the current mortgage.

Why would a lender permit this? First, you should understand that not all lenders will allow a short sale. Their decision depends on a number of factors: where is your house? how much loss will the lender suffer? What is the possibility that a speculator/investor will buy at a foreclosure sale?

Lenders have their own requirements, so I can only provide general information; you will have to consult your specific lender to determine what they need in order to move forward with the short sale process.

The first step is to contact your financial and legal advisors. Do not contact the lender until you fully understand the potential risks involved. Under Federal law, when a debt is forgiven, it can be treated as ordinary income on which tax must be paid. Thus, if your lender allows you to sell the property to $475, less a 2 percent commission, you will pay off your $500,000 mortgage and have a deficit of almost $35,000. According to many tax professionals, you will have to pay income tax on this amount even though you did not actually receive the money.

Furthermore, you want to make absolutely sure that even should the lender approve the short sale, you will not be obligated to make up this difference, which is called a deficiency. Unfortunately, most lenders will not put their agreement in writing, so your legal advisors will have to satisfy themselves — and you — on this matter.

In fact, many lenders have been known to use this “forgiveness of debt” issue as a way of dissuading their borrowers from pursuing the short sale approach.

After you are satisfied that you understand the concept and are prepared to move forward, you should contact your lender. Go up the corporate ladder as high as you can and talk with the manager of the short sale department. Typically, the lender has a “loss remediation” department that handles these matters.

If you have authorized your attorney or your real estate agent to act on your behalf, the lender will need a letter of authorization from you. The Privacy Laws enacted after 9-11 prohibit lenders from discussing personal and financial information with a stranger without such written authorization. This letter will include your name, property address and loan number.

You (or your agent) should then prepare a comprehensive letter explaining why you are requesting the short sale. Emphasize — but not as a “sob story” — your hardship. It would also help if you include a market analysis which will show what houses in your area are currently selling for. And finally, spell out your request in detail: what price are you asking the lender to approve, what percent commission will the real estate agent be allowed to accept, and what closing costs will be associated with the settlement. Keep in mind that in many jurisdictions, there is a recordation and transfer tax which is typically split between buyer and seller.

Your proposal should be as specific as possible. You don’t want to learn at settlement that you still have to come up with a lot of cash, because your lender did not authorize certain out-of-pocket expenses.

You should also request from your lender the amount of your outstanding balance. The lender has a legal obligation to provide this to you on request, and the burden is on the lender to provide an accurate accounting. Review this carefully to make sure that there are no charges which have been erroneously added. If you have missed some payments, you will be assessed late fees. When you present your proposal to the lender, try to get these charges deleted from the amount of the outstanding mortgage balance.

Your proposal should also include your financial situation. Keep in mind that many loans in the past few years were what are called “no-doc” — in other words, the lender made the decision to fund your loan based on the value of the property and not on your financial status. In your case, since you lost your job, include proof with your letter.

The more documentation you can provide the lender, the faster the decision will be. However, currently lenders are swamped with these requests, since you are not the only one facing a possible foreclosure.

Thus, the earlier you can start the process, the better chance you have of getting it approved.

But the lender’s approval to proceed with a short sale does not end the process. When you or your real estate agent find a prospective purchaser, the contract must state that it is contingent on lender’s approval. You have to send the contract to the lender, and it would help if you would include an accounting of all expenses which you will have to pay at settlement, and a final number that the lender will receive when settlement takes place.

In fact, if you can have a HUD-1 settlement statement prepared, this would be helpful and would expedite the process. Your lender will then review the documentation, and may reject certain expenses. For example, if the contract provides that you will give your buyer XX dollars for “closing costs” — or that you will pay some items which are traditionally the buyer’s obligation (such as title search and survey) — the lender may not allow such payments.

You want to go into the settlement knowing exactly all of the terms and conditions on which your lender will accept the short sale, including whether or not you will have to come up with money at the settlement table.

You are in financial trouble. If you have already missed some payments, your lender may already have reported this information to the credit reporting companies. You should try to convince the lender not to report any more delinquencies, but unfortunately, that’s in your lender’s sole discretion.

The short sale process works, but is complicated, time-consuming and uncertain. If you can start now — before you are actually in default — you will be ahead of the game.

Published: September 17, 2007

SHORT SALE & FORCLOSURE YOUR CHOICE August 25, 2008

 

Two Alternatives to Foreclosure

By EMILY GREEN
July 27, 2008

The housing legislation that is close to becoming law may help as many as 500,000 cash-strapped homeowners avoid foreclosure, by assisting them in refinancing into more-affordable government-backed mortgages.

COUNSELING RESOURCES FOR STRUGGLING HOMEOWNERS

 

• Neighborhood Assistance Corp. of America
naca.com
1-888-302-6222

• ACORN
acorn.org
1-866-672-2676

• Homeownership Preservation Foundation
995hope.org
1-888-995-4673

• HomeFree-USA
homefreeusa.org
1-866-696-2329

But since many struggling borrowers may not qualify, people facing foreclosure should also familiarize themselves with two other options: “short sales” and “deed in lieu of foreclosure” transactions.

Neither option will keep you from losing your house or avoid severe damage to your credit score. Still, they may be less painful in some ways than foreclosure, the legal process in which the bank repossesses a homeowner’s property because of failure to meet the terms of the mortgage.

In a short sale, the borrower sells the house at a fair market value that is less than the amount owed on the mortgage, and the lender usually agrees to forgive the remainder of the debt.

In the other option, the borrower hands over the property to the lender with the lender’s consent “in lieu of” waiting for foreclosure. The obligation falls on the lender to sell the house; as in a short sale, the lender typically agrees to forgive the amount by which the mortgage balance exceeds the house’s current value.

Put Debt Behind You

A key advantage of both strategies is that most individuals walk away from their house freed of their mortgage debt, a psychological and legal relief, says Vicki Vidal, an associate vice president at the Mortgage Bankers Association.

In contrast, in foreclosure proceedings, lenders can theoretically pursue the differential owed to them, depending on state law. The great majority of lenders don’t pursue this debt, but it has occurred, particularly in cases where the borrower vandalized the property upon departure.

A second benefit of short sales and deeds in lieu of foreclosure is that borrowers will generally face a shorter waiting period before they can obtain another mortgage.

Many lenders primarily make loans that they can sell to big mortgage players Fannie Mae and Freddie Mac. Starting Aug. 1, Fannie Mae generally will not buy loans made to borrowers involved in a short sale in the past two years. That’s shorter than the four-year wait time if you have a deed in lieu of foreclosure on your record, and the five-year wait time if you have a foreclosure on record. (The current wait time is four years for a foreclosure or a deed in lieu of foreclosure; there is no existing policy for borrowers with a short sale.)

Freddie Mac generally won’t guarantee loans made to borrowers who have had a foreclosure in the past four years, says Freddie Mac spokesman Brad German. (If the foreclosure was due to circumstances beyond the borrower’s control, such as a medical emergency, then Freddie Mac will guarantee the loan in two years’ time). The company considers short sales and deeds in lieu of foreclosure a significant negative but not an “automatic no,” says Mr. German.

A Blow to Credit Scores

What short sales and deeds in lieu of foreclosure don’t do is minimize the impact on a borrower’s credit score. All three proceedings have roughly the same negative impact on an individual’s credit score, says Craig Watts, spokesman for Fair Isaac Corp., which created the widely used FICO score.

Mr. Watts says that to date little analysis has been done distinguishing, for instance, the credit risk of individuals who completed a short sale versus those involved in a foreclosure. For that reason, “the model ends up treating them [a short sale, a deed in lieu of foreclosure, and a foreclosure] all the same.”

If homeowners are interested in pursuing a short sale, they should open discussions with their lender or loan servicer before attempting to sell their house.

For both short sales and deeds in lieu of foreclosure, borrowers will have to present a “hardship letter” to the lender or servicer detailing why they are unable to make their mortgage payments.

Lenders have shown increasing willingness to negotiate short sales and deeds in lieu of foreclosure because of the losses they frequently incur in foreclosures.

Short sales are considered preferable because they save lenders the hassle of selling the house. But a deed in lieu of foreclosure also has its advantages to lenders versus foreclosure: “The earlier they get the home, the better the condition the property is in,” says Ms. Vidal of the Mortgage Bankers Association.

Still, for both short sales and deeds in lieu of foreclosure, the process of negotiating with lenders can quickly become complicated. If a borrower took out second and third mortgages, he or she may need to negotiate with multiple firms.

Whether attempting a short sale or a deed in lieu of foreclosure, borrowers should take a “proactive approach,” says John Snyder, homeowner specialist with the nonprofit NeighborWorks America.

He recommends that borrowers who foresee problems making their mortgage payments contact a nonprofit organization to help them negotiate with their lending institution.

Write to Emily Green at emily.green@wsj.com