Short Sale Basics: What is a Short Sale?
For homeowners who can no longer afford to keep mortgage payments current, there are alternatives to bankruptcy or foreclosure proceedings. One of those options is called a short sale. When lenders agree to a short sale in real estate, it means they are willing to release their lien against the home for less than the outstanding mortgage balance (including default interest and penalties, etc.). Not all lenders will accept short sales or discounted payoffs, especially if it would make more financial sense to foreclose.
Lender's Incentive
The incentive for the lender is to avoid foreclosing on the premises as this process is both time-consuming and expensive. On average the foreclosure process takes a year to complete. Over this period the lender will have to retain an attorney to repossess the property. As you can imagine there are many legal hurdles to overcome which can cost the lender tens of thousands of dollars depending how on vigorously the homeowner defends themselves in court. If the bank agrees to a short sale, this expense can be avoided in its entirety.
Further, if the homeowner is not making their mortgage payment, nothing is being contributed into their escrow account. The escrow account is used to pay the homeowner's real estate taxes as well as their homeowner's insurance. Taxes and insurance must be kept current in order for the lender to protect its collateral. Therefore the bank is forced to carry the cost of the home from the time of default through the date of repossession or resale. The lender can save a substantial amount of money by agreeing to a short sale as opposed to foreclosing and carrying the expense of the home.
Frequently I am asked what the average percentage a lender will reduce the outstanding principal when considering a short sale offer. The answer is it does not matter whatsoever! It may initially seem counterintuitive; however, it is a reality.
When deciding whether to accept a short sale the lender will compare the current offer to the alternative: simply letting the home go to foreclosure. At a foreclosure auction potential bidders will take the "fair market value" into consideration; not the outstanding principal balance owed by the homeowner.
The short sale lender is aware of this fact and will apply the same principle to the offer that is presented. As long as the offer reflects the current appraised value the lender will ignore how much of a cut the deficiency is because that is what will happen at a foreclosure sale!
The Positives & Negatives
It is important to understand that most short sale candidates have not done anything wrong. Typically a short sale homeowner purchased the property within the last three years and financed a high percentage of the purchase price and perhaps closing costs, if not all (i.e., 100% financing with a seller's concession). Since that time prices have dropped significantly in value which means that if the homeowner wanted to sell or refinance they would have make up the difference between the mortgage balance and the current decreased value, plus closing costs.
There is also the possibility that the homeowner may not have understood the terms of the mortgage, or was fraudulently induced into predatory subprime loans.
Whatever the reason the homeowner is in the situation they are in, it is crucial to appreciate that foreclosure should be avoided at all costs and there is always an opportunity to rebuild both your finances and overall quality of life.
Privacy
A short sale is the lesser of two evils. Inevitably, if the homeowner cannot afford to remain in premises, the lender will repossess the property through foreclosure proceedings. A short sale can save the homeowner many months of stress, embarrassment, aggravation and uncertainty.
When considering whether to undertake a New York short sale, it is very important to make sure that the seller understands the benefits when compared to foreclosure.
One advantage to a short sale is that it is a private proceeding; unlike a foreclosure which is public in nature.
A financially distressed homeowner will receive literally 4 inches of mail on a daily basis from investors who are attempting to convince the homeowner that it is in their best interest to sell to them. Some of these solicitations are skillfully crafted to look like actual legal documents which may confuse and frustrate the homeowner. With a short sale this aggravation can all be avoided as the parties who are aware of the transaction are limited to those intimately involved.
This is not to mention the daily phone calls from the bank inquiring as to why the homeowner is missing their payments. Often the bank will attempt to reach the homeowner at work where they will initiate conversation with anyone who answers the phone, including the homeowner's coworkers or boss! Remember, they are attempting to collect hundreds of thousands of dollars and will use anything within their power to reach that goal.
In a short sale transaction this nuisance can all be avoided as the homeowner should instruct the lender to contact the attorney they have retained who is intimately involved in the transaction and familiar with all relevant facts. The lawyer in this scenario acts as a shelter or buffer between the persistent lender and distraught client.
Credit Implications/Bankruptcy
Obviously late payments can be devastating to your credit score. By the time the foreclosure process ends a homeowner may have missed a year's worth of payments, if not more.
By successfully negotiating a short sale, homeowners can salvage as much of their credit score as possible. Yes it is true that the lender will reserve the right to report this transaction to the appropriate credit bureaus which may negatively affect the homeowner's credit. However, as previously stated, the blemish caused by a short sale pales in comparison to the destruction of a completed foreclosure.
Commonly clients are concerned about the timeframe necessary to rehabilitate their credit so as to qualify for a conventional mortgage in the future. The only reliable data we can gather has been based upon the information provided by our prior clients; credit may be restored in as little as eighteen months. The only guarantee is that however long the timeframe may be, it is certainly less than it would have been had the foreclosure action concluded. Contrary to what the lenders will tell you, the homeowner does not need to be in default in order to be considered for a short sale! The reason the bank will tell you this is because they want you to try to make as many payments as possible. We have closed many transactions where the homeowner never missed one payment. This is the best way to preserve as much of your credit score as possible.
Post-Closing Financial Obligation
Generally clients are concerned about the potential liability to repay the difference between the amount owed and the amount received by the lender as part of the short sale. This amount is known as a deficiency.
The most common result of a short sale for the homeowner is that the lender can file a 1099-C ("Cancellation of Debt Form") which may subject the homeowner to tax liability. The I.R.S. in turn will consider the debt forgiveness as income. However, recent legislation, known as the Mortgage Forgiveness Debt Relief Act of 2007, allows the homeowner to exclude the "income" if they qualify by filing Form 982 ("Reduction of Tax Attributes Due to Discharge of Indebtedness") (see referenced websites for more information).
Very rarely will the lender consider the Promissory Note to be in full force and effect after the closing. Because the outcome of the short sale is unknown when entering into a Contract with the purchaser, we reserve the right for the seller to cancel the transaction at any time. Therefore, in the unlikely event that the lender does pursue the deficiency, or "go after" other assets, the homeowner has the absolute right not to consent and rescind the Contract.
Timeframe
From the time a Contract is entered into to sell the home, the process should take no longer than 3 months. However, great attorneys have been known to negotiate short sales in as little as 2 to 3 weeks. All transactions are reviewed on a case-by-case basis so as to better advise the homeowner what can be expected.
It is very important to understand that the only time a lender will stop foreclosure proceedings is after a successful short sale negotiation. In other words, the lender will continue their efforts to repossess the home despite the fact that a homeowner has listed the home for sale or entered into a contract to negotiate a short sale. Again, it is only after the transaction has closed that the lender will abandon the foreclosure action.
Proceeds
Homeowner's are forbidden from receiving any proceeds from the sale of their home. Keep in mind that as an incentive for the lender to accept less than what they are owed, they will mandate the defaulting homeowner not receive any money whatsoever, without exception.
When reviewing a short sale, the lender will consider the year of purchase or refinance, as well as the type of loan (fixed, ARM, etc.).
Contrary to what most lenders will advise, you do not need to be in default of your mortgage to qualify for a short sale. Banks will notify homeowners that they need to default on their mortgage for 2 or 3 months before they will be eligible for a short sale. This simply is not true. In fact, the best way to preserve your credit rating is to negotiate a short sale having never defaulted on a monthly payment.
However, most clients research short sales once foreclosure proceedings have been commenced and they have been served with a Lis Pendens. In general, until the auction date has been set, there is still time to negotiate a short sale.
Finally, it is vital that any outstanding judgments or tax arrears be brought to our attention as these costs must be reflected in the offer to the short sale lender. Often judgments or liens can be negotiated lower as well provided there is enough time to do so.
The Property
We have successfully negotiated shorts sales across New York and Long Island including Nassau county, Suffolk county, and Queens.
Besides the location, another factor which must be addressed is the condition of the house. In particular, it must be determined if the plumbing, heating and air conditioning, electrical systems and appliances are in working order. If not, these items should be brought the prospective purchaser's attention immediately. This will ensure that their offer accurately reflects the premises "as is" and that an appraisal will be able to be conducted, if necessary.
Other concerns include termite infestation or damage and Certificate of Occupancy issues. If either of these issues exists, they must be brought to our attention immediately. It is possible for the lender to pay for these problems provided there is enough time to do so.
Finally, some short sales are for investment properties as opposed to principal residences. For instance your tenant defaulted on their rent which was in turn being used to subsidize the monthly mortgage payment. It is possible for short sales to be negotiated for investment properties; however, the lender is more likely to pursue a deficiency judgment because the circumstances surrounding the default are more of a business hardship instead of one personal in nature.
Keep in mind that even if the lender does pursue the deficiency there is room for negotiation (balance, rate, term, etc.) which is not the case with the alternative; foreclosure.
The short sale process cannot begin until an executed Contract has been submitted to the lender. Contrary to what others might say, there must be an accepted offer which is then turned into a formal Contract along with a downpayment held in escrow. It is important to understand that the lender will continue to foreclose until the short sale closing takes place.
It is your attorney's job to draft and review the Contract to ensure that your rights are protected. The Contract should contain a contingency that if the terms of the short sale are unacceptable to the seller, the Contract can be canceled at any time for any reason.
There can only be one Contract executed at the same time. The Contract is a legally binding document which will contain a short sale contingency similar to the standard "buyer financing contingency". That is to say, the Contract is "subject to" the short sale lender's consent. If they fail to do so, the transaction is rescinded and the downpayment is returned to the purchaser.
If you were to contact the lender directly, they will suggest the real estate agent gather as many offers as possible within 2 weeks and then submit all offers to them. This does not have to happen provided you submit an offer that represents today's "fair market value". In fact, to date, we've never submitted multiple offers to the lender; only 1 which reflects a reasonable purchase price.
Obviously their incentive to suggest the real estate agent solicit multiple offers is to ensure they get the best offer possible; i.e. the highest offer. Typically, "all cash" offers are not as impressive as the bottom line proceeds they will receive at the end of the day. However, as previously stated, a realistic offer is all you need to proceed with a short sale.
Please recall who negotiates real estate in the rest of the country; real estate agents. Here in New York, attorneys are responsible for closing the transaction. Therefore, most members of the loss mitigation department are influenced to some degree by the fact that they are speaking with an attorney.
The real estate agent has a very important role in the short sale process. They are responsible for listing the home; however, they must do so in a particular way so as to inform all parties as to the nature of this transaction.
In other words, if prospective purchasers are not initially advised that the transaction is a short sale they may become unnecessarily frightened and shy away from making an offer. Alternatively, if the purchasers are educated as to what a short sale entails from the beginning all concerns may be properly addressed.
The real estate agent must also ensure that the potential purchaser is capable of securing a mortgage. Lending guidelines have become increasingly stricter; without a qualified purchaser, the transaction will not go through.
Additionally, the role of the real estate agent is especially important when it comes to realistically listing the home. An overpriced home in a market with flooded inventory can be devastating in receiving timely offers. The short sale process cannot begin until an executed Contract has been submitted to the lender therefore time is of the essence for the qualified real estate agent to solicit a legitimate offer.
Most clients want to know what the average percentage a short sale lender will reduce the outstanding principal when considering a Short Sale offer. The answer is it does not matter whatsoever! It may initially seem counterintuitive; however, this is the reason why it is a reality.
When deciding whether to accept a short sale offer the lender will compare the offer to the alternative: simply letting the home go to foreclosure. At a foreclosure auction potential bidders will take the "fair market value" into consideration; not the outstanding principal balance owed by the homeowner.
The short sale lender is aware of this fact and will apply the same principle to the offer that is presented. As long as the offer reflects the current appraised value the lender will ignore how much of a cut the deficiency is because that is what will happen at a foreclosure sale!
The real estate agent will prepare a Comparative Market Analysis which will show prices of similar homes. This is necessary in order to substantiate offer which has been submitted to the foreclosing bank.
The lender will also send out their own independent appraiser to verify whether the submitted offer is reasonable. At this time the real estate agent should present the engineer's inspection along with written estimates for any repairs to the appraiser to further validate the offer.
Best of all, similar to attorney's fees, the lender will also pay for the entire real estate commission.
The Homeowner
Although all lenders have varying requirements and may demand that a borrower submit a wide array of documentation, the following steps will give the homeowner a pretty good idea of what to expect:
Last Statement for All Loans: This is necessary so that we may verify the amount necessary to pay-off the loan. If the homeowner has defaulted for an extended period of time the payoff must reflect all default interest, penalties, attorney's fees and escrow deficiencies.
Hardship Letter: This statement of facts describes how you got into this financial bind and makes a plea to the lender to accept less than full payment. Lenders are not inhumane and can understand if you lost your job, were hospitalized, etc.
Proof of Income and Assets:
2 Weeks Paystubs: If you are unemployed, a simple letter explaining your circumstances will be sufficient.
2 Months Bank Statements: Lenders will want to know if you have savings accounts, money market accounts, stocks or bonds, negotiable instruments, cash or other real estate or anything of tangible value. If your bank statements reflect unaccountable deposits, large cash withdrawals or an unusual number of checks, it's probably a good idea to explain each of those line items to the lender. In addition, the lender might want you to account for each and every deposit so it can determine whether deposits will continue.
Last Year's Tax Returns: If you did not file taxes last year, a simple letter explaining your circumstances will be sufficient.
Unfortunately financial issues sometimes lead to marital issues. If the homeowner's are in the process of filing for divorce this fact must be disclosed immediately. We want to ensure all parties feel that their rights are being protected; therefore we would be more than happy to send a copy of all correspondences to each spouse's attorney for their review.
The Purchaser (Investors)
If you are considering purchasing a short sale, there are some inherent risks which must be taken into consideration. Our information is based on the experience gained in successfully closing countless short sale transactions thus rendering it efficient and reliable.
First, it is important to understand that the purchaser is "subject to" the lender's consent of the offer. Typically, the offer must reflect today's "fair market value". Consequently "all cash" offers are not as impressive as the bottom line proceeds the foreclosing bank will receive at the end of the day.
Further, the vast majority of the time, the lender will not entertain a "seller's concession" where the purchaser inflates the purchase price in order to assist financing the closing costs. From the prospective of the short sale lender, who is losing tens of thousands of dollars, the purchaser is admitting that the property is worth more than they are paying for it (as the buyer's own lender must receive a satisfactory appraisal reflecting the purchase price plus seller's concession). Moreover your attorney must thoroughly review the Home Equity Theft Prevention Act to ensure that the transaction is insurable.
Additionally, the timeframe necessary to complete the transaction must be contemplated. For instance, the buyer must make a wise decision when deciding whether or not to lock the mortgage rate.
Also, it is your attorney's job to draft and review the Contract to ensure that your rights are protected. The Contract should contain a contingency that if the short sale is not successfully negotiated within a certain timeframe (usually 60 days) that the Contract can be cancelled by the purchaser at any time for any reason with the entire downpayment being returned to the purchaser.
Finally, there is no reason to put down a large downpayment for an indefinite amount of time. Your attorney should be able to negotiate a reasonable downpayment allowing you to retain your money where it can potentially earn interest.
Call Cristina Callegari today if you are considering a Short Sale for your home at 917-921-5397.
