Homeowners frequently ask “what does short sale mean”? A short sale is a loss mitigation tool used by lenders to minimize damages for both the lender and the homeowner. Lenders agreeing to short sales avoid additional fees, costs and time delays that they might otherwise incur via traditional foreclosure proceedings. Borrowers agreeing to short sell their homes avoid the stigma of a foreclosure as well as potential deficiency judgements by recourse lien holders. In fact, the State of California passed legislation that prevented lien holders (including 2nd lien holders) from pursuing deficiencies (the short fall) if they agree to a short sale (SB 931, SB 458 – Calif. Code of Civil Procedure §580e). Thus short sales can be a win/win for both lenders and borrowers.
By definition, a short sale is the sale of real estate for less than what is owed on the home. In other words, the consideration (funds received) from the sale are not enough to pay the existing loan(s) off. The purchase price falls “short” of paying all lien holders off in full. Short sales are predominantly used during times where housing prices have fallen and it is impossible for the borrower to liquidate the home for what is owed. Lenders realize that due to the fallen market they will never be able to recover 100% of what is owed on the property whether through a short sale or foreclosure.
Thus, the answer to “what does short mean” is very simple, it means selling your house with the Lender’s permission for less than what is owed on the note.
How to Short Sale – A Step by Step Guide
Step 1: The Decision to Short Sell
The first step for a homeowners considering to short sell their property is to actually decide that a short sale is really what they want or need to do. Most homeowners decide to short sale because they believe that a short sale is their only alternative, that they have no other choice. Besides health and family, a person’s home can be the most important thing in their life. Deciding whether or not to short sale can be an extremely emotional time and can cause a lot of internal turmoil. The first thing a homeowner needs to do is get professional advice. With that being said, homeowners should be careful who they obtain the advice from. While a homeowner’s immediate inclination might be to seek out a real estate agent for advice, it would be prudent for a homeowner to to not put too much stock into what the real estate agent says. Real estate agents have a vested interest in your short sale. Their income and livelihood depends largely on homeowners who desire to sell their home. Nine times out of ten the real estate agents are going to suggest that homeowners sell their home. A better source for homeowners would be for them to seek the advice of an attorney who specializes in assisting distressed homeowners.
Homeowners need to make sure that there are no other viable options to save their house prior to deciding to sell. Otherwise there will always be “what ifs” and “we should haves”. Homeowners considering a short sale tend to fall within three general groups:
Homeowners that are so far underwater that they have come to terms that it does not make financial sense for them to short sell
Homeowners that are absolutely not qualified to receive a loan modification
Homeowners that obtained loan modifications with less than favorable terms. A general rule of thumb for homeowners that are severely underwater should be as follows:
If a homeowner is severely underwater (they owe more on the note than their house is worth) and their lender is not willing to modify their loan into a payment that is equal to or less than they could rent a similar home for then the homeowner should strongly consider a short sale.
The decision to commit to a short sale is a difficult decision that should only be done after thoroughly exhausting all other choices.
Step 2: Check Tax Ramifications of Short Sale
Short sales might carry tax consequences for homeowners. It is important that a homeowner seeking to short sell a home seek the advice of a CPA or tax attorney prior to committing to a short sale. There are, at least, 2 different types of potential tax issues associated with the short sale of the home. The first is debt forgiveness tax and the second is capital gains tax. It is very important for Homeowners desiring to short sell an investment property to seek tax advice. Do not let anyone, including a Realtor, minimize the potential tax consequences of short selling a rental property. As of the date of this article The Mortgage Debt Relief Act of 2007 (“MDRA”) is set to expire at the end of this year (December 31, 2012). The MDRA allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure or short sale might qualify for relief. All indications are that the MDRA will be extended beyond this year, however, to date, it is still set to expire at the end of this year.
When a homeowner retains a Realtor to assist in the short sale of their home the homeowner is giving a plethora of documents to sign. In several of those documents are warnings to the homeowner to perform their own due diligence on the tax ramifications of a short sale. It would be prudent for a homeowner to heed these warnings prior to moving forward with the short sale.
Step 3: Select a Realtor
Selecting the right real estate agent to help you short sell your house can be very challenging. Once you let your friends and family know that you have decided to short sell your home real estate agents will descend upon you like locusts, all assuring you that they are “Short Sale Experts” or that they use an “Experienced Short Sale Negotiator” or that they are a “Certified Short Sale Specialist”. Friends and friends of friends will appear at school or church or soccer games or parties all offering to help you in this great time of need. The reality is that not all short sale agents are created the same. Some agents claim to have years and years of industry experience and still others claim to be outright “Gurus” at selling distressed properties. Beware and take your time. Friends are friends but business is business. A good philosophy is to keep friendship and business separate.
The following are some questions and tips for correctly choosing the right short sale real estate agent for your situation:
1. Does the real estate agent process their own short sales or do they use an “expert”? Real estate agents that process their own short sale transactions tend to have a greater understanding of how short sales work than ones that rely on 3rd party “professional negotiators”. Additionally, real estate agents that use 3rd party negotiators tend to try and pass the cost of the negotiator onto the homeowner. As a homeowner the cost of the negotiator should NEVER come from you. If a real estate agent wants to use a professional negotiator that real estate agent should pay for the negotiator out of their own commissions. Better yet, find a real estate agent that has experience processing their own short sales.
2. Do you have more than 1 lien on your property? Short sales that involve multiple liens on the property are exponentially more difficult to negotiate than short sales with just 1 lien. While anti-deficiency laws in California have protected homeowners from lenders who would otherwise agree to a short sale but still attempt to recover the deficiency they have now made second lien holders more difficult to negotiate with. There is no law that requires either a 1st or 2nd lien holder to agree to a short sale. Since 2nd lien holders can no longer pursue deficiencies they have become more obstinate. An average real estate agent can become overwhelmed or discouraged by the amount of tenacity it can take to bring a 2nd lien holder into line. Typically the first lien holder will agree to pay the 2nd lien holder a small (very small) percentage as a payoff. The 2nd lien holder usually wants more than the first lien holder is willing to give them in order to approve the short sale (thus giving up any deficiency rights that they might have if the property were to go to foreclosure). Getting the 1st and 2nd lien holders to agree can be extremely difficult.
3. Do you have any judgment liens or HOA liens on the property? If your property has any type of judgment liens and/or HOA liens then the short sale cannot be finalized until these liens are taken care of. This is a VERY difficult endeavor and something that 95% of real estate agents are not equipped to deal with.
4. Is the property a rental or is it owner occupied? Short selling a rental property has many nuances that can make it difficult for an average real estate agent. First, the real estate agent should strongly recommend that you perform your due diligence as to the tax ramifications of short selling a rental property. The tax ramifications could be via debt forgiveness or capital gains. If your real estate agent glosses over this issue then you should be very cautious about using that particular agent. A true real estate agent will have your best interests ahead of his own. The truth is that you should seek counsel from a CPA or tax attorney prior to entering into a short sale listing agreement, especially when the subject property is a rental. Second, renters can present another set of challenges that a normal real estate agent is not prepared or capable of dealing with.
5. Are the loans on your home Purchase Money Loans or have you refinanced? Purchase Money Loans refers to homeowners that still have the same note (loan) that they purchased the property with. In other words, if you have never refinanced your house you probably have a purchase money loan. Purchase money loans are important because they carry special protections that are lost if you refinance. The applicability of laws like The Mortgage Debt Forgiveness Act of 2007 are somewhat dependent on the status of your loan as a purchase money loan or refinanced loan.
6. What is the reason for your hardship (like real estate agents, not all hardships are created the same)? Short sales are not guaranteed nor is the lender obligated to approve every single short sale. Like a loan modification one of the important considerations is the nature of the hardship that is forcing you to short sell your house. An experienced real estate agent should have an idea as to whether or not your hardship has a good chance at meeting the investor guidelines for an acceptable hardship.
7. Have you received a Notice of Default or Trustee Sale? If you have already received a Notice of Default (“NOD”) or Notice of Trustee Sale (“NOT”) the foreclosure clock is ticking and you need to find a real estate agent that is 1) familiar with the foreclosure process 2) capable of negotiating your short sale in a shorter amount of time and 3) has the know how to be able to push the sale dates off if necessary. Some lenders are VERY difficult and do not like to push sale dates off just to accommodate a short sale. Likewise, some investors, such as Freddie Mac and Fannie Mae, do not like to push sale dates off at all. You must be cautious and select a real estate agent that possesses the know how and ingenuity to perform under pressure.
8. How many short sales has the real estate agent that you are considering successfully completed? How many of those had multiple lien holders? Every real estate agent that approaches you will claim to be experienced in short sales. They have to say this because they would otherwise have no business in this economy. Remember, real estate agents are sales people. Not only will they attempt to sell your house they will also attempt to sell you on their qualifications. While you might want to help out your neighbor or friend from church that is a real estate agent the bottom line is that you are short selling your house because it is the best financial alternative for your family. Do not be persuaded by personal feelings. Short selling your house is a business decision and friendship is friendship and business is business. Experience is vital in selecting a real estate agent.
9. What type of training and/or educational background does the agent you are considering possess? Let’s face it, not all real estate agents are created equally. Check out your agent’s educational background. Do they have a college degree? Do they have a graduate degree? What tools does the agent bring to the table that will provide you with the best all around service. In addition, check out your agent’s credentials. What additional training courses or certifications do they possess?
Selecting the right real estate agent is a very important decision. Choosing the wrong agent can cause a homeowner to suffer consequences or stress that would have been avoided by performing due diligence during the real estate agent selection process.
Step 4: Contact the Lender
Contacting the lender might sound like the logical next step in the short sale process but many Realtors do not do this and, instead, proceed with a short sale as they think it should be handled. However, due to the fact that there are several short sale incentive programs being offered by lenders these days (including HAFA and Bank of America’s enhanced relocation assistance programs) it is prudent to contact the lender at the process onset to determine the protocal for qualifying for these incentive programs. If a homeowner and his or her Realtor do not follow the correct procedure, the homeowner could lose out on anywhere from $3,000-$30,000 in potential relocation assistance. As discussed in Step 3 above, choosing an experienced and qualified Realtor to assist you throughout the short sale process is crucial.
Step 5: List the Property on the MLS and Secure Offer
The next step in the short sale process is to list the property and market it in order to obtain the highest offer. This part of the short sale is the exact same as a traditional sale. The Realtor markets the property in an effort to obtain the highest and best offer possible. There is no doubt that a homeowner will receive offers from investors attempting to get the homeowner to accept a low ball offer significantly below the fair market value of the property. These offers should be avoided unless absolutely necessary, as the lender is surely going to question whether the low ball offer is representative of the fair market value of the property. A diligent real estate agent will hold off advising his client to accept such an offer and, instead, continue marketing the property in an effort to obtain something closer to market value. However, that could take a little bit of time because finding qualified buyers in a depressed market can be difficult. As of the date of this article, the housing market in Southern California has started to pick up. There seems to be low inventory and higher levels of demand.
Step 6: Submit Offer and Loan Modification Package to Lender
After an offer is procured the next step in the short sale process is to submit the offer and the loan modification package to the lender for review (“Submission”). Some lenders have more fluid short sale departments and processes than others. For example, Chase and Wachovia are two of the more efficient lenders and, typically, they will review and process short sale requests much faster than other lenders. During Submission the lender will require the real estate agent to submit a short sale request, financial worksheet, hardship letter, supporting financial documentation, listing agreement, borrower’s authorization forms, the accepted offer, an estimated HUD1, a pre-approval letter for the buyer, proof of funds, etc. The Submission Stage is very document heavy and will require that the homeowner’s real estate agent be diligent in responding to requests from the lender. The lender may frequently ask for additional information or revisions to the HUD1.
Step 7: Negotiation
Once the lender has received all of the documentation needed to satisfy their internal requirements the negotiations begin. During the negotiations the lender will order internal pieces of information needed for the lender to be able to review the offer accepted by the seller. The lender will order a 3rd party valuation of the property either in the form of a Broker Price Opinion (BPO) or the lender will order an appraisal. The goal of the lender is to obtain a 3rd party opinion as to the fair market value of the property. Once the valuation is complete the lender can then review the offer to see if it is has a chance of being accepted by the investor on the loan. If the lender thinks that the offer is too low or if the lender is unwilling to pay for charges listed on the HUD1, the lender will issue a counter offer to the real estate agent. The real estate agent then contacts the buyer’s agent and the negotiations begin. The seller has very little to do with the final outcome as the real issue is obtaining an offer from the Buyer that the lender will accept. Once a price and HUD1 have been agreed upon the lender will send the file to the investor to obtain final approval. Once final approval is obtained the lender will issue an approval letter (see my website for examples of what a short sale acceptance letter looks like) and the short sale will advance to the next stage.
Step 8: Escrow
Once an approval letter has been obtained for all lien holders involved in the short sale the homeowner is now officially in Escrow. From this point forward the sale of the property is the same as it would be for a traditional sale. The Buyer will conduct inspections and order an appraisal. Once the Buyer has acquired funding Escrow will close and the short sale will be completed.
The content of this article might seem overwhelming, but we’re here to help. Michael Gaddis, Esq., Broker/Realtor® of Dream House Realty, Inc. offers complimentary consultations to homeowners throughout Southern California considering whether or not to short sale their homes. Michael Gaddis’ knowledge and experience as an attorney provides homeowners with a wealth of knowledge and expertise not possessed by the average real estate agent.
To schedule a free consultation with Michael Gaddis to determine a short sale is the right option for you, contact Michael at email@example.com or by phone at 888-242-2272.