If you are a homeowner in foreclosure or considering a short sale and you are thinking about selling your house then it is important for you to understand the short sale process and how you can successfully complete a short sale. Below is an explanation of why banks allow short sales and how the process works.
When a bank loans money by giving a mortgage to a homeowner, the bank expects to be paid back in full when the homeowner sells or refinances the property. A typical bank mortgage is a loan at a loan to value (LTV) ratio of 80%. The standard conventional loan requires a 20% down payment and an 80% mortgage.
As long as the property does not decline in value, the bank has the house as collateral and can be assured of getting their money back by selling the house via the foreclosure process in the event that the homeowner does not pay.
However, sometimes prices decline so rapidly that the equity in the home is diminished to the point that there is no equity left in the property for the homeowner. In extreme cases, such as over the past few years, homeowner’s may be “upside down” meaning that they owe the bank more money than what their house is worth. This is not a great situation to be in, especially if the house is worth a lot less than what the homeowner owes the bank.
Upside down situations usually result from either a sharp decline in prices, high LTV loans or mortgages that do not have fixed rates like negative amortization mortgages and adjustable mortgages. The foreclosure crisis that we have all experienced over the last few years is a direct result of poor lending standards and sharply deteriorating property values.
When a homeowner is “upside down” and cannot afford to stay in their home then the best option is for them to try and sell their house. However, if prices have dropped dramatically and they cannot sell the house for anything close to the loan value then when they do receive an offer from a buyer, the purchase price will be substantially lower than the amount that is owed to the bank. In this situation they will have to receive prior approval from the bank to accept an amount less than the full amount owed on the mortgage. This is called a “short sale”.
In this situation, the bank will have to decide if they want to accept the “short sale” offer which is an amount less than the full value of the mortgage balance. The bank has to carefully weight many factors including the condition of the house, the time it will take to foreclose on the property and the legal costs and holding costs of lost mortgage payments. Typically banks will easily accept a 5% to 10% discount off the face value of a mortgage when faced with a homeowner in foreclosure. However, many banks are not willing to negotiate with a homeowner that is current on their payments. They are only willing to negotiate with homeowners that are behind on payments or are facing foreclosure. From the banks perspective as long as the homeowner is still paying they can afford to pay and there is no reason for the bank to negotiate. This creates a dilemma for the homeowner who has a good credit record and would like to maintain their good credit.
In order to proceed with a short sale, the bank has to feel that the homeowner is willing to walk away from the property and is going to allow the bank to foreclose on the property and take the property back. Usually a homeowner needs to be at least 90 days late in order for the mortgage bank to file a foreclosure notice called a “Lis Pendens” (which means law suit pending in Latin). Once the property is “in foreclosure” the bank will be more willing to entertain offers that are less than the full value of the mortgage balance owed to them since the bank now has an incentive to negotiate.
The bank has to carefully analyze what they believe the house is worth, and what they think it would sell for at a foreclosure auction or as a bank owned REO property. Then they need to consider the time it would take to get the house back and how many months of monthly interest payments they would lose and how much that would cost them. They also have to consider the legal costs of the foreclosure lawsuit as well as the holding costs and disposition costs to sell the property. The bank also looks at the current condition of the property and if any repairs are needed.
Occasionally the bank will consider selling a property for as little as 50% of the fair market value which can be much less than the face value of the mortgage. Usually this occurs when there is substantial damage and rehab required to bring the property to a marketable condition. A more typical short sale is probably at around 80% of current fair market value although each property is different and there are no set guidelines (although with some lenders there are). I have seen banks decline high offers which they should have accepted and I have seen banks accept very low offers where I was surprised that the offer was accepted. Each case depends on the property in question, the comparable sales, the condition of the property and many other factors. The ability to have a good short sale negotiator and a good working relationship and understanding of loss mitigation is also a key factor in the negotiations.
Of all the factors that the bank considers, the condition of the house and how much damage it has is one of the most important from the perspective of the lender. Houses that are in pristine move in condition do not sell for a lot less than fair market value. Some lender guidelines allow for an offer of no less than 88% of current fair market value. However if the property is substantially damaged from fire, flood or any other damage that makes the property uninhabitable then the bank will be willing to accept substantially less than the 88% guideline. If the house is abandoned, or is in a high crime area with visible signs of gangs, graffiti, squatters or illegal activity such as drugs then the bank will be very willing to negotiate a quick sale at a reduced price since the bank does not like the liability of these types of properties. The key is to communicate this information to the bank which is why it is so important to have an experienced short sale negotiator.
Negotiating a short sale is a time consuming and cumbersome procedure. It can typically take a few months of back and forth negotiations between the buyer, the seller and the banks loss mitigation department. This is best handled by an experienced short sale negotiator who negotiates short sales full time.
The short sale negotiator will request supporting documentation from the seller that the bank will request in order to process the short sale file. The ultimate goal is to have the short sale offer approved by the bank so it is imperative to give all documents to the negotiator as soon as they are requested in order for the short sale file to be processed as quickly as possible.
The bank will request the following items:
After all of this information is gathered by the short sale negotiator, it needs to be put together in a “short sale package” and then submitted to the bank. The loss mitigation department at the bank then reviews this package and takes it to their supervisors for review. The process is extremely time consuming and cumbersome and there is no guarantee that loss mitigation will even be interested in negotiating at all. They can also ask for additional bank statements, more documents repeatedly so it is important that the seller is willing to cooperate with the negotiator in a timely manner.
Any buyer will have to be a cash buyer so a proof of funds or a bank statement is an absolute necessity in order for the bank to take the buyers offer seriously. The buyer needs to show that they have the ability to pay for the property and that they can close quickly for cash. The buyer must be willing to show the bank a HUD (also called a “net sheet”) of exactly how much the bank will net on the sale of the house after all closing costs, commissions etc. The homeowner cannot derive any economic benefit and must be prepared to walk away from the house without receiving any compensation at all from the buyer or anyone else (violating this is mortgage fraud which is a felony).
It is preferable that the negotiator submit an offer with the condition that there will be a “non-deficiency judgment” meaning that the bank will not go after the homeowner for the difference between the amount owed on the mortgage and the amount that the bank is accepting on the short sale. The previous owner will be required to report the difference as income (although currently this requirement has been waived for primary residences for another 12 months by the Obama administration). The bank will issue a 1099 since they will be deducting the loss for income tax purposes and the banks loss will be the sellers gain which by definition means income. Filing bankruptcy will not absolve the previous owner from any taxes that are due in the following year as a result of this 1099 so the negotiator should make sure that the seller is aware of this fact.
There is no guarantee that the bank will accept, review or even communicate with the negotiator once they have submitted a short sale offer. However over the past few years banks have become much more receptive to short sale offers than in the past and some banks are expediting the process with some short sales being completed in as little as six weeks.
It can be quite disheartening for a seller to spend a lot of time on a short sale with a negotiator and then to get a denial from the bank. Remember that as the seller there is no guarantee that the bank will accept the buyers offer. Many cash buyers that purchase these properties are buying the property with the intention of keeping the property as an investment property. These buyers will not over pay for the property and the buyer needs to offer high enough for the bank to accept the offer. There is no guarantee that the buyer will offer enough and there is no guarantee that the bank will accept the buyers offer. For this reason it is very important if you are considering a short sale to act immediately in order for the negotiator to have sufficient time to negotiate the offer and in order for the real estate agent to have sufficient time to market for buyers for the property. If you are behind on your payments and considering a short sale please remember that time is your enemy and you must act quickly.