What is a Short Sale? - and how can it save you money?
In real estate, a short sale refers to the sale of a property in which the sale price is insufficient to pay off all encumbrances and pay the expenses of the sale. If the Lender is convinced that the owner, for various reasons, is unable to continue making the payments, the Lender will often agree to take less than the full amount owed to allow the sale to close escrow. The incentive for the Bank to approve a short sale is to have the property sells before the loan becomes a problem account on their books.
Before a Lender approves a short sale they will make two key decisions. First, can the owners afford to continue making the payments on the property? If they can there is no reason for the Bank to take the loss. In this case, the Bank may be willing to proceed with a short sale, but will most likely ask the borrower to sign an unsecured note for the difference or the loss. Second, will approving the short sale leaves the Bank in relatively the same position as they are likely to be in by going though the foreclosure process and then selling the property? If the Bank can do significantly better by foreclosing they are likely to do so.
The Seller must not receive any sale proceeds for themselves. In most cases, there is no out of pocket expense for a Seller to execute a short sale. If there is a junior lien holder the discounts can be substantial, sometimes as high as 90% or more. Question two is the primary determinant here. If the senior Lender forecloses the junior may get nothing so they may take a deep discount to get something out of the property.
 Short sale Sellers need to be careful and understand the income tax implications. The Seller may end up with taxable income equal to the amount of debt that is forgiven which is commonly referred to as "Phantom Income". The Mortgage Cancelation Relief Act of 2007 was passed by President George W. Bush. The Act was designed to waive this "Phantom Income" for the years 2007, 2008 and 2009. The Federal Government has since extended this waiver through the year 2012. Anyone considering short sale or foreclosure should seek the advice of competent legal and tax advisers before entering into the transaction or letting your home go to foreclosure. Be aware too that if the home goes to foreclosure, a 1099 is received for the FULL amount of the mortgage, plus late fees, legal fees, etc. Every individual situation is different so a CPA or Tax Attorney should be consulted. The Seller may also end up with adverse entries on their credit in either situation.
Short Sales are not a part of real estate basic training. An experienced Realtor is a required to handle the complex transaction. A Realtor must list the home, market the home, negotiate with the Lender, negotiate with the Buyers and successfully close the sale. Lenders will pay a reasonable selling commission so Realtors have an incentive to get involved in short sale situations. The price, terms, closing costs and Broker commissions are always subject to Lender approval. The Realtor will ask for a full commission, but in almost every case total commission will be between 2-5% total.
The basic requirements for a short sale are a Listing Agreement with a Realtor and a Sales Contract from a Buyer which are submitted to the Lender along with a Hardship Letter from the Seller explaining why they cannot continue to pay the mortgage and supporting documents such as tax returns, bank statements, information and photos of the home and the Comps, or comparative home prices supporting the offer. The way mortgages are sold the mortgage holder can be located anywhere and not be aware of local real estate conditions. If the package is complete, the Lender will order a BPO, or Broker's Price Opinion, from an independent Realtor. This BPO is the key to the whole process. If it is too high, the Lender will not accept a low offer. Sometimes your Realtor can meet with the Agent doing the BPO and offer information supporting the offer, such as the average time on market of comparable homes, recent selling prices and point out any defects in the home. The sales contract should specifically state that the offer is contingent on the Lender accepting the purchase price in full and forgiving the Seller deficiency on the mortgage.
The benefit of a short sale is that when Lenders agree to allow a short sale and the transaction is completed, all mortgages owed against the property are settled. If the property is let go to foreclosure, some debt may still follow the borrower even after the foreclosure sale. The process does take time and Lenders are overloaded. 2-3 months is very common for a Lender to respond to an offer on the property, however, Lenders do have the ability to delay the foreclosure sale if there is an acceptable offer on the table.
The short sale is a detailed but fairly straightforward process that can work to benefit Buyer, Seller and even the Lender. The Buyer gets a good price on a home, the Seller gets to avoid the disruption and credit hit of a foreclosure, and the Lender avoids the delay and expense of foreclosing on a property they don't want to own and that would negatively impact their ability to make more loans.
What documentation will I need for a Short Sale?
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