Comprehensive Homeowner’s Guide to Short Sales to Avoid Foreclosure
Homeowners at risk for foreclosure often choose to short sale their home to avoid foreclosure proceedings. However, there is some general confusion about the short sale process- including how long it takes, eligibity, and the responsibilities of each party. This guide covers these topics in depth to make any homeowner in danger of entering foreclosure make an informed decision. Simply put, a short sale is the process of selling a primary residence for less than the mortgage balance with approval from the current lender. In other words, if you must sell your home that you owe $400,000 on but the home is only worth $300,000 - the bank may approve a “short sale,' allowing you to sell the home for a reduced price.
How long does the Short Sale process take?
The duration of the short sale process varies greatly, depending on a number of factors- primarily who the lender is. Some lenders may approve a short sale in as little as two weeks whereas others may take up to a year or longer. However, as a rule, the majority of short sales are completed in a three to five month period.
Why do homeowners sell via Short Sale?
Short sales are typically used when a home is currently 'upside-down,' meaning the loan outstanding exceeds the property's value. In this case the homeowner will be responsible for paying the difference if the property is sold on the market. If the homeowner is not able to pay the balance between outstanding loans and the new valuation, both the lender and borrower are in a jam. A short sale allows the property to be liquidated and the loan paid off in full or in part, releasing the homeowner and allowing the borrower to receive a payout.
Why do Lenders Agree to a Short Sale?
Short sales are primarily used when a homeowner is in danger of entering foreclosure. Upon completion of the foreclosure process, the lender is able to legally take possession of the home and sell it. However, this process is often incredibly costly and time-consuming for banks and lenders. The foreclosure process can take up to several years and cost tens of thousands of dollars in addition to the costs associated with placing the home on the market. As a result, many lenders are willing to take a small loss via short sale to avoid the time, attention, and costs of foreclosure.
Who is responsible for the remaining balance on the loan?
This depends solely on the contract between the homeowner and the lender- be sure to resolve this crucial detail in writing before beginning a short sale. By default the borrow may be responsible for the difference between sale price and outstanding balance unless stated explicitly otherwise. Several states have Anti-Deficiency legislation which offers protection to homeowners. Be sure to seek legal counsel to review binding contracts and possibly draft a new agreement if applicable. Examine all outstanding debt obligations to ensure that you do not get caught with liabilities after the sale of the property.
Homeowners are not guaranteed approval when seeking a short sale. Qualifications must be met and vary based on the lender, but typically banks are looking for the following:
-Property's value is beneath outstanding mortgage balance
-Homeowner is behind on payments and does not have substantial assets
-Additionally, some lenders are more likely to approve a short sale application if the homeowner is experiencing hard times or financial issues.
Short sales are merely a single avenue that a homeowner may take when experiencing issues with their home loan. Below are several alternatives to a short sale for your consideration.
A loan modification or 'loan mod' is when a lender alters the terms and conditions of the mortgage to make it more affordable for the homeowner. Some banks may do this on their own, but many lenders use a modification program called the HAMP- Home Affordable Modification Program. A government program created in 2009 to help homeowners, HAMP requires lenders modify mortgage terms to be more manageable. HAMP programs usually reformat the loan to a 30-year period and reduce monthly payments to a maximum of 30% of the homeowner's gross income. Please note that loan modifications have not been identified as a permanent solution for distressed borrowers and are often viewed as a quick fix which eliminates the risk of foreclosure in the short term.
Deed in Lieu of Foreclosure
Alternatively known as a 'mortage release,' a deed in lieu of foreclosure is a midpoint between foreclosure and shortsale. The homeowner cedes the property rights and title back to the lender. Many lenders will want to verify that the homeowner has attempted to list and sell the property with a Realtor for at least 90-120 days before approving a mortgage release.
Foreclosure, though not the best option for most, is still the go-to for many distressed homeowners. Once a foreclosure is completed, the property reverts back to the lender for sale to a third party. Homeowners still occupying the property may be evicted though in recent years many lenders use a 'Cash for Keys' method to encourage smoother transactions. In some cases, a foreclosure may be better than a short sale, but as a rule it is recommended that borrowers enter foreclosure only as a last resort.
When the property is worth more than the outstanding loan balance, a standard sale of the home is often the best option. This represents the best course of action available to the homeowner. Selling a property may prove difficult if the home's condition is substandard or if there is not sufficient equity to hire a Realtor to sell the home.
Remember, short sales and foreclosures are major blemishes on borrower's credit reports, so utilizing one of these alternate options may protect the borower's credit rating despite late or missed mortgage payments.
The Short Sale Process
Though the process can be a headache for many, following proper protocol and maintaining complete and accurate records will take a lot of the confusion out of the picture. I recommend that any homeowners thinking about a short sale should speak with a Real Estate Attorney to review their situation in it's entirety. Real estate agents will be involved to transact the sale, but should not be relied on as the sole source of legal and tax advice. Every case has unique legal and tax ramifications and challenges and it is vital to fully understand our options.
Step One: Find a Trusted Realtor
Short sales are somewhat complicated compared to the standard purchase or sale of a home, and distressed homeowners should work with an experienced Realtor specializing in short sales and foreclosures. Do your homework and ask relevant questions to assure the agents you speak with will represent you fairly and professionally. Sample qualifying questions for potential realtors include: how long they have been assisting short sales, their success rates, and relevant accreditations and certifications.
Step Two: Submit Offer to Lender
After a 'purchase and sale' agreement has been executed between the homeowner and buyer, the homeowner must begin interfacing with the lender. Fortunately the homeowner just needs to authorize the bank to speak with the Realtor directly, saving the homeowner a lot of time and energy. Lenders have a lot of paperwork that must be completed quickly pending approval. It is vital to meet all requirements and submit requisite documents on time. Generally, this paperwork includes:
A cover letter
Information Release Authorization
Seller's Letter of Hardship
W2's for past 2 years
Recent pay stubs and bank statements
Supporting Hardship Documentation such as past due bills, lien documents, and other statements
Repair estimates and comparable sales of the property
After receiving the above documents, the bank will assign a negotiator to the transaction and order a valuation of the property. It may take several months to reach this stage, so be patient!
Step Three: Valuation
Before permitting a short sale, a lender must get a handle on the value of the property. This valuation is usually determined using a Broker's Price Opinion (BPO) or Appraisal. A BPO is a somewhat formal statement from a licensed real estate broker regarding the property's value, less formal than an appraisal. In cases with multiple lenders, each lender will handle their own valuation and many lenders require 90-day updates regarding shifting values. When the bank understands the property's value, they will accept (Step 5), reject (return to Step 3), or negotiate (Step 4) the arrangement.
Step Four: Negotiation with the Lender
Note that during these negotiations, the bank is attempting to alter the arrangement with new buyer, not the homeowner themselves. The homeowner has transitioned to an authorizing signature, but can still reject to close the sale if their interests or positions change. This process may take some back-and-forth, but upon mutual acceptance the transaction will move forward.
Step Five: Finalizing the Short Sale
At last, the bank has approved the short sale and both the new buyer and lender have agreed on terms. After execution of all required documents and contracts, the sale moves to the Title and Escrow company. From this point the transaction is completed identical to standard sales.
Tax Consequences of a Short Sale
An important note when considering a short sale is that the IRS views forgiven debt as income. Simply put, if you had $400,000 outstanding and the lender forgives $250,000, the IRS may try to tax you on the $250,000. Be sure to seek the counsel of a tax specialist to see if this additional liability will apply to you.
Though a somewhat complicated procedure, short sales have saved thousands of homeowners from entering foreclosure. In conclusion, be sure to understand in writing where the liability for outstanding debt will go and consult experienced real estate, law, and tax professionals each step of the way. If done properly, a short sale can save homeowners from thousands of dollars in unsustainable debt payments and years of tarnished credit from a foreclosure.
Written by Gregory Lyons in Association with Harris Team Real Estate