Short Sale Realities
Before considering a short sale, you should consider the consequences that a short sale will have on you in the future. A short sale will be damaging to your credit. In most cases a short sale is a better alternative to foreclosure and bankruptcy.
Talk with your bank. Explain your hardship. The bank may have internal programs to help you. Most banks will allow 1-3 months payments to be moved to the back end of the note. This is called an “extension”. You may also be able to work a payback of your arrears payments with small additions to your monthly mortgage payment. You may be a candidate for loan modification. You don’t know till you ask. The bank has every incentive to work with you, if at all possible. This back and forth with the bank is called a “work out”.
Another method of avoiding foreclosure is a Deed in Lieu of Foreclosure. The seller saves the bank the costs of foreclosing by signing the deed over to the bank and vacating the property. This is not as bad as a foreclosure but pretty close. The bank is still stuck with selling the property at a greatly reduced price. In this case, if no agreement exists with the bank, the bank could seek the loss from the homeowner. The loss to the bank will be much more selling as a foreclosure than a short sale.
A short sale is the best case scenario for the bank with the least loss. The home is listed and shown like a normal home for sale. With the seller still living in the property, the property will show much better and likely get a price closer to market value.
The biggest immediate reality is replacing your home after the closing. Before placing your home on the market as a short sale, make sure that you have a rental home or a place to live arranged. With poor credit, some landlords may reject your rental application. Arranging a place to live after the sale of your home is imperative.
After a short sale or foreclosure there will be a deficiency. The bank will need to account for the loss in 1 of 2 ways.
- The entire deficiency can be loaned to the homeowner in the form of a promissory note, which then must be repaid.
- The deficiency can be “written off”.
If any portion of the deficiency is “written off”, the bank assumes the loss. You can be sure they will report it as 1099 taxable income to the seller or even get a judgment against you which will show on your credit for 10 years.
If you owe a debt to someone else and they cancel the debt, the cancelled amount may be taxable. When the bank accepts a short sale, the deficiency is a loss to the bank. To the IRS, when there is a loss, somebody had a gain. The gain is to the homeowner.
The Mortgage Debt Relief Act of 2007 generally 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, qualifies for the relief.
This provision only applies to forgiving debt (up to $2 million) in calendar years 2007-2012.
Short Sale Basics
Banks grant short sales for 2 reasons;
- Homeowner has a financial hardship,
- Homeowner owes more on the mortgage than the home is worth.
Examples of Hardships are:
- Unemployment/Reduced Income
- Medical Emergency
- Job Relocation
Once you have a hardship acceptable to the bank, then you need a Comparative Market Analysis (CMA) to determine your current market value. A tax valuation is not a reliable source for your current value. Your real estate broker can provide you with a CMA. If the CMA indicates that you home is worth less than the mortgage, then you are qualified for a short sale. You will need to prepare a financial package for submission to the lender. Each bank has its own guidelines, but the basic procedure is similar from bank to bank.
Example of Financial Package:
- Letter of Authorization (Allows us to negotiate with the bank on your behalf)
- HUD-1 or preliminary net sheet
- Seller’s Hardship Letter
- Completed Financial Statement
- 2 Years of Tax Returns
- 2 Years of W-2s
- Recent Payroll Stubs
- Last 2 months bank Statements
- Comparative Market Analysis (CMA)
Homeowners with multiple mortgages are especially challenging. A short sale negotiation will involve multiple banks with different systems and timetables. The financial package above will need to be submitted to each bank. In some cases, the net proceeds from the home sale will satisfy the 1st mortgage but not the 2nd or 3rd mortgage. These are difficult negotiations because the 2nd or 3rd mortgage holder can “hold out” and prevent the sale unless they get some accommodation. The bottom line is that these 2nd & 3rd position banks must negotiate reasonably or they will likely get nothing in a foreclosure.
Each bank is different but most have a bottom line percentage of the debt they must recover. Every seller’s situation is different. Guidance by a professional is needed. Knowledge and experience with hundreds of banks gives our negotiators the edge.
Short Sale Listing Your Home
The short sale process consists of two full time jobs. First, negotiating with the bank and second, effectively marketing and attracting a buyer for the home. We do not know of any homeowner that has successfully negotiated and sold their home by short sale. We don’t know any single real estate agent that has successfully negotiated and sold a listed home by short sale. If they did, you can trust they weren’t able to conduct their normal real estate business or care for their clients.
The best scenario is hiring a top notch Realtor that has aligned with a full time professional short sale negotiator. With two professionals at work full time, your odds of success are much better.
There is a bright side for the seller in a short sale. There is no cost. All fees to real estate agents, short sale negotiators, title representatives, appraisers etc. are paid by the bank. In FHA Short Sales, the seller can even get financial incentives!
Once your home is listed for sale, you can expect to have several showings per day/week on your property. This is because your home will be priced at (or below) market value to attract market attention.
Once a buyer submits an offer, the bank does not make the initial decision. The seller must find the offer acceptable in price and terms. Once the seller accepts the offer, it is contingent upon the bank’s acceptance of the short offer. If the bank does not approve, the contract with the buyer is void.
After the seller accepts the offer, the listing agent or negotiator sends the following items to the bank;
Real estate brokers should submit these documents (**) to lender at the time of the listing;
- Listing Agreement **
- Seller’s Short Sale Financial Package **
- Buyer’s Preapproval Letter and Copy of Earnest Money
- Executed Purchase Offer
You can expect a lot of time for the bank to respond. This is completely normal. Banks are overwhelmed with the number of short sales and foreclosures they are processing. Countrywide had to lay off 20,000 people, yet their loss mitigation department has more work than ever. They have less people to do more work. It takes patience from both buyer and seller.
The Bank’s Short Sale Process
The typical short sale process;
- Bank acknowledges receipt of the file. (10-30 days)
- A negotiator is assigned. (15-60 days)
- A Broker Price Opinion (BPO) is ordered. This is an opinion of value from a non-interested 3rd party Real Estate broker. The bank will probably refuse to share the results.
- A second negotiator may be assigned. Turnover rate of these employees is significant. It is not unusual to have 2-3 negotiators during the short sale transaction. (30 days)
- The file is sent for internal review. (14-30 days)
- The bank may request that all parties sign an “Arms Length Affidavit” which stipulates that all parties are unrelated in business or personally with the transaction.
- The bank issues a short sale approval letter or offers alternate terms to the buyer.
- If the bank does not approve the buyers offer, the buyer may cancel or modify terms.
FHA Short Sales
If you have an FHA mortgage, you are in luck. FHA short sales are the easiest to process. FHA short sales are easier because there is a systematized process defined by HUD (Department of Housing and Urban Development) that absolutely must to be followed when doing the short sale. The bank doesn’t have free reign to do anything outside of what is already defined by HUD.
Here are a few things you should regarding FHA short sales;
FHA requires at least one of the homeowners to be occupying the home at the time of short sale. This requirement may be waived due to severe hardship that causes the seller to vacate.
The seller MUST be at least 31 days delinquent on the loan.
The seller MUST be approved into the pre-foreclosure program before the lender can consider any offers. This approval is evidenced when the Seller receives HUD Form 90045 from the loss mitigation department at the lending institution. This form is titled “Acceptance into the Pre-Foreclosure Sale Program.” This form will reveal the property’s appraised value!
The minimum NET PROCEEDS (not purchase price) to the FHA 1st mortgage is based on the “As-Is” Appraised Value and the Length of Time from Date of Approval;
Less than 30 days = 88% 30-60 days = 86% 61+ days = 84%
The net proceeds that the lender needs to receive at closing MUST be no less than the above listed percentages of the appraised value, which is referenced on HUD form 90045. This means that everything in the transaction to be paid (i.e. Real Estate Broker commissions, closing costs, liens, judgments, seller incentives, prorated taxed, etc.) has to be accounted for before reaching the 84-88% threshold. The lenders will not take a penny less!
Once accepted into the pre-foreclosure sale program, HUD gives the homeowner 90 days to sell their home. The bank is required to postpone all foreclosure proceedings 90 days past the date of approval.
FHA will provide a seller incentive of no more than $1,000 to the homeowner if they can contract and close within the 90-day period. That’s right, a gift to the homeowner for not going to foreclosure! The incentive is reduced to $750 if the property is under contract within the 90-day period but doesn’t close until after the 90 day period. EXTREMELY IMPORTANT!
FHA will allow up to $2500 as a payoff to a 2nd mortgage or other junior liens affecting the property. However, the seller will then be required to forfeit the $1000 incentive to the 2nd lender or junior liens. The incentive is applied first before applying the additional $1,500.
There are some closing costs that the lender will not pay on behalf of the seller at closing. The will not pay for a home warranty, HOA delinquent dues, HOA transfer fees or the water and sewer escrow. This does not prevent the homeowner from using the seller incentive for these costs.
HUD will not allow any seller paid buyer closing costs if the buyer is receiving conventional financing. If the Buyer is obtaining FHA financing, then FHA will allow a maximum of 1% seller paid buyer closing costs. The buyer cannot “bid up” the purchase price to cover seller concessions on an FHA short sale. HUD will NOT allow it. The incentive noted above CAN be used for seller concessions. So, any buyer that needs seller concessions over $1,000 will not be able to purchase your home by short sale.
An FHA short sale requires a different strategy than working with a VA or conventional short sale. Most Realtors do not even know about this FHA incentive and the way it works. We at the Home Source Group constantly strive to keep up to date on all the changes in how each bank and investor works so we can help every homeowner the best chance of success.
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