- What is a Short Sale?
- Short Sale vs. Foreclosures?
- HELOC and 2nd Mortgages?
- Why Do Most Banks Prefer Short Sales to Foreclosures?
- Mortgage Forgiveness Debt Relief Act Explained
- Tax Consequences of a Short Sale
- Who Determines the Asking Price of a Short Sale?
- Risks of Buying a Short Sale Property
- How Long Do Middle Tennessee Short Sales Take to Close?
- Needed Documents for a Quick Close
- Steps for a Successful Short Sale
- Q & A
What is a Short Sale?
A Short Sale happens when a property sells for less than the amount due on the mortgage loan. A typical sale of real estate is between two parties, the buyer and the seller. However, in a short sale transaction, there are three parties involved, the buyer, the seller, and the lender. You might as well list a 4th party that is definitely involved – the Realtor…the Short Sale Expert that can negotiate and help you navigate through this life-changing event. The way a short sale is handled right now can determine your financial future. One where you can be free of this distressing mortgage situation, or one where you will be in debt for many, many years to come. A word of caution: I said it takes a Realtor – but actually, it takes two Realtors working together to make this happen. It doesn’t matter how capable your Exclusive Buyer’s Agent is if the listing agent is not well-versed in the art of Short Sales. There is a lot of paperwork involved and both these agents MUST be knowledgeable and work together. I specialize in Middle Tennessee Short Sales and Foreclosures. Contact me or call with any questions you have. 615-428-8500
Did you know that the terminology included in the short sale documents can mean the difference in the remaining balance being forgiven, or YOU having to pay the entire difference yourself? There must be certain wording included to relieve you of the outstanding balance. The short sale approval letter must state that “the lender is waiving deficiency rights’. Many times, the lender won’t include this because they have attorneys looking out for their best interests. YOU MUST have someone on your side, looking out for your best interests, to negotiate this rocky road. Can you imagine having to pay every month on a property that you no longer own in addition to paying all your current monthly obligations including new housing expenses for your family?
It’s absolutely critical that this short sale transaction is done correctly and in YOUR best interests! We’ll go over this in detail later, but it’s also critical that you don’t have a 2nd Mortgage or HELOC (Home Equity Line of Credit) on the property. Many times, you will be responsible for paying the balances on these types of loans. So, if you don’t already have one – don’t get one!
Another thing to consider is where the property is located. Different states have different laws, so be sure to check it out.
Short Sale vs. Foreclosures?
The following chart shows the general difference in Short Sales vs. Foreclosure. Your situation may be different or your state may have different laws, so be sure to check with your local Realtor for more information:
|Homeowner Concerns||Benefits of a Short Sale||Foreclosure|
|Financial Fallout||It's possible to sell the home, walk-away and owe nothing!||If a foreclosure is your only option, then repayment of the debt obligation or bankruptcy may be your choices.|
|Credit Score||There is less effect on your credit with a short sale. Your credit score can drop up to 100 points, but less if you have fewer late payments reported to the credit reporting agency. A short sale is typically not reported as an individual item on your credit report.||A foreclosure can lower your score by 200-300 points and will stay on your credit report longer. It will remain on your report for at least 10 years. This can even affect your future employment capability. There is a question on any mortgage application regarding whether you have ever had a foreclosure, and this can affect your terms and ability to purchase another home any time soon.|
|Getting a New Mortgage||You can usually apply for a new mortgage within 2-3 years.||You can apply for a new mortgage within 5-7 years.|
|Re-paying any portion of your mortgage balance||If the terminology is correct, you can walk away without any repayment obligations. However, if you have a 2nd mortgage or HELOC it will have to be negotiated before any short sale can happen.||It depends on your state laws, but the 2nd Mortgage and HELOC repayment remains the same as for a short sale.|
|Live in the Home During the Process||Many times, you can remain in the home even if you are not making payments.||You will be given notice to vacate and the property will be sold after the lender has taken possession.|
|Written Documentation that the Lender Will not Sue||If the short sale approval letter is written properly, you will have written documentation that you will be free and clear of the obligation.||You will receive no written documentation that the Lender will not pursue legal action.|
|Buying a Short Sale Property||The homeowner is usually still in the home and utilities are turned on.||A foreclosure usually has been winterized or at least had the utilities turned off. So, you have to look at in the dark and have the utilities turned on/off at your expense to do your home inspections.|
As you can see, a short sale may be your best option.
As stated above, a short sale occurs when the lender agrees to let the house be sold for less than the mortgage balance. A foreclosure is a repossession of the house by the lender. Many times, the homeowner is responsible for the remaining mortgage balance, which would include any penalties and interest incurred. The foreclosure process often takes months to process, and during that time a lot of bills can easily pile up. When there is a remaining balance, the lender can sue for the difference. This is called a ‘deficiency judgment’. There are situations where foreclosure is the best option, but a short sale should definitely be considered. Remember, your credit score will be damaged, but with careful planning, you can do things to maintain it as much as possible. This means that if you know that you are going to have to sell on a short sale or let the house be foreclosed, don’t wait and have a lot of late payments pile up. If you’re going to have to do it – my best advice is to just get it over with. If you have any small amounts owing, pay it off if you can, and that will be one less mark on your credit report. It should be noted that since the 2007/2008 real estate downturn, there have been new regulations put in place for mortgage forgiveness that extends until the end of 2020. Authorities may extend it further, but that remains to be seen at this point.
My personal thoughts – I find it interesting that most people have to purchase ‘private mortgage insurance when they buy a home. This amount can be considerable, and the buyer pays it. It is basically for the difference in your down payment and the 20% that the lender would like to have. So, who collects on this mortgage insurance when a house goes into foreclosure? The lender!!
It seems that the homeowner would benefit from this insurance since he has paid for it. Private mortgage insurance is there to reimburse the lender if you default when the house sells for less than the mortgage. So, the lender gets paid through this insurance when they foreclose – and you still have to pay the deficiency judgment. I don’t understand this at all! Thanks for letting me rant. This is one of my pet-peeves…it’s like heads, I win…tails, you lose!
HELOC and 2nd Mortgages?
HELOC (Homeowner’s Equity Line of Credit) and 2nd Mortgages? These types of mortgages are liens on your property, but not in first place in case of default. (The main mortgage is called a 1st mortgage.) So, they are usually not covered in a short sale situation. They must be negotiated before a short sale can happen.
They are a problem, for sure! The lender can’t approve a short sale until all liens are satisfied because they will need to give a clear title to the new owner, but it will require negotiating. That being said, the 1st Mortgage holder is the primary decision-maker, and so it depends on the numbers. Most times, the 2nd Mortgage holder isn’t covered in a short sale transaction. Neither are other lienholders, such as a tax or mechanic’s lien. HOA fees must also be current. Make sure your Realtor does extreme due diligence in this transaction.
In most cases, the 2nd mortgage or HELOC balance must be paid by the seller. But again, there’s a lot of negotiation happening here.
It’s a good idea for a potential buyer of a short sale property to pay for a preliminary title search in addition to other inspections. I would recommend doing the title search first before spending a lot of time and money on expensive inspections. Don’t expect any repairs to be made, so be sure you make every inspection that is important to you.
Why Do Most Banks Prefer Short Sales to Foreclosures?
From the Lender’s perspective – A foreclosure is a lot more work:
- It requires more employees to handle a foreclosure.
- They have a lot of legalities involved in taking possession of the property. There are required legal notices to the borrower, then notices in the newspaper…on and on.
- They may have to make repairs to get the house ready to go on the market
- They have to winterize, insure, clean and maintain the property. They have to pay salaries for a team of people to make sure all this gets done.
A short-sale can relieve them of a lot of this work. The average foreclosure costs the bank 20% more than a short sale. With a short sale, they receive a contract, decide whether to approve it and close. It’s a done deal! There can be a lot of time and negotiation involved in this, but it is a more simple transaction. Most banks tend to approve a short sale if the sales price is anywhere near the remaining mortgage balance.
Mortgage Forgiveness Debt Relief Act Explained
The Mortgage Forgiveness Debt Relief Act was passed in 2007, for the purpose of giving tax relief for people who had lost their homes. It enabled them to exclude from specific mortgage debt that had been canceled by lenders. It expired only to be extended (per the Further Consolidated Appropriations Act, 2020) through December 31, 2020. It very may well be extended again, but only time will tell.
To disclose, I am neither a tax advisor or attorney…so please consult with one for your specific situation. This is meant to be a general guide to help you get started on this complicated journey. Basically, this debt relief act extends the Qualified Principal Residence Indebtedness exclusion through the end of 2020. This only applies to your principal residence, and not any investment property.
It allows some taxpayers who have had a foreclosure, loan modification, deed in lieu of foreclosure or short sale to have that mortgage debt forgiven and excluded from their income for tax purposes. If you qualify, this will not be considered ‘income’ and therefore not subject to taxation. This is important because the IRS typically considers discharged debt as taxable income. This exclusion allows borrowers to exclude up to $2 Million of forgiven debt for married taxpayers. One condition: The forgiven debt must have been used to buy, build, or substantially improve your principal residence. Again, your tax advisor and/or attorney will have to help you with all the rules of this game. I’m just making you aware that it is something that might help your finances, so be sure to check it out.
My opinion: Isn’t it funny that ‘forgiven’ debt is considered income? So why, then, are we not allowed to take a deduction for the loss to balance it out? I would like to hear someone answer that question.
Tax Consequences of a Short Sale
You should ask your tax professional about your individual situation, but in general, there are tax consequences. Although tax laws frequently change, you could expect to receive a 1099 for the amount of money forgiven as a result of the short sale. This is the difference in the mortgage balance and what the property is actually sold for. For instance, if the mortgage balance is $250,000 and the property sells for $225,000. If the bank has forgiven the remaining balance, you could receive a 1099 and be expected to pay income tax on the forgiven amount of $25,000. However, this is a time for a good tax consultant.
Who Determines the Asking Price of a Short Sale?
When you see a listing for a short sale property, it should be noted that the lender hasn’t set this price. It has been set by the listing agent, through research into nearby comparables, which is much like an appraisal. The property’s current condition is also taken into consideration.
After receiving an offer for a short sale, the lender will order a BPO, which is a Broker’s Price Opinion. This due diligence gives the lender a back-up opinion of fair value and helps them in their negotiation.
The bank or mortgage company can accept a contract but stipulate that they won’t pay for certain things. Then it must be re-negotiated or someone has to decide who pays for what. An example of this could be HOA transfer fees, title search, and policy, home warranty, etc. The buyer will almost always have to pay for the title policy.
Risks of Buying a Short Sale Property
There could be a risk in buying a Middle Tennessee short sale home. If someone has been having problems paying their mortgage payments, then it stands to reason that home maintenance has suffered as well.
Ordering various home inspections can relieve much of this risk. But, don’t expect any repairs to be made. The bank is not going to make repairs and the seller isn’t either since they are not receiving any money from the sale.
TITLE INSURANCE: This is important. The bank or mortgage company will require the buyer to pay for the title insurance, but it is a lender’s policy. BE SURE TO ALSO PURCHASE AN OWNER’S POLICY, which would insure you, the buyer, against any undiscovered title defects. It should be stated in the contract that the buyer receives the benefit of a simultaneous issue, which would cost less than buying the lender’s and owner’s policies individually.
As long as you make sure the liens are paid and have made an informed decision as to the property’s condition, you should be fine.
A short sale purchase can be a great way to buy property, but be sure to do your due diligence and make it a smart decision as well.
How Long Do Middle Tennessee Short Sales Take to Close?
Short Sales do take more time to close simply because there is more paperwork, negotiation, and sometimes additional liens to work out.
Much of the process depends on the lender receiving required paperwork from both the buyer and seller. Both buyers and sellers should be prepared and have a file containing all financial records in order to facilitate a quick sale.
Once all the paperwork is in and the short sale is approved, it should be able to close within 30 days, just like a traditional sale. However, from start to finish, you should expect at least 90 days, but I’ve seen them go six months and longer. Having an experienced agent that knows how to negotiate short sales and making sure all your paperwork is in order will go a long way to ensure a quick transaction.
Needed Documents for a Quick Close
The lender will ask for the following information from the seller:
- Listing agreement
- Fully Executed Purchase Contract
- 2-Years Tax Returns
- Bank Statements
- Financial Statements
- Hardship Letter explaining why you are in this situation
- Specific documents that the lender requires
The buyer’s lender will ask for the following information:
- 2-Years 1099’s or Tax Returns
- 2-3 Months Bank Statements
- Source of Down Payment
- Any Financial Documents including retirement plans or investments
- Financial Statement
- Any Child Support
- Fully Executed Purchase Contract
- Some lenders want to see a copy of the home inspection report
Steps for a Successful Short Sale
- The first step for a successful short sale is to decide to do it. Tough situations call for tough decisions, and this can be one of the toughest! But, once you decide if a short sale is best for you, then you can start the process.
- It’s now time to schedule a meeting with a short sales expert to determine if this your best option. Make sure the person you call will have your best interests at heart and not motivated by a commission.
- The next step is listing the home for sale. Your Realtor can help you determine the best asking price.
- You should be gathering your lender-required documents at this time. Have them ready so you are prepared when you receive an offer for the property. Remember, having a complete file to send to the lender will be more likely to result in faster approval.
- It’s time to start negotiations with any other lienholder because you won’t be able to close until these parties are satisfied.
- Now we wait for a buyer. Be sure to keep the house ‘show ready’ and cooperate with Realtors showing the property. You won’t be required to make any repairs, but you will benefit by keeping it looking its’ best. A higher-priced offer means a better chance of lender acceptance. Once you accept a purchase contract, your listing agent will prepare a ‘package’ with all documents to be sent to the lender for approval.
- The Realtor will negotiate the short sale with the lender.
- If approved, the lender will issue an approval letter. It will be your time to review and decide whether to accept the approval terms.
- Once all is agreed upon, the sale will proceed the same as any other transaction and close in approximately 30 days.
- The buyer will now schedule inspections, appraisal, title work, etc.
- Finally, the home closes, and the short sale is completed.
Q & A
Q: What is the Most Important Element of a Short Sale?
A: Without a doubt, avoiding a deficiency judgment is the most important element and critical to a successful short sale transaction. I wouldn’t advise working with any Realtor that doesn’t have this as his/her primary goal. Your financial future is at stake here. Your approval letter must state in writing that the lender ‘forgives the excess loan amount or deficiency amount’. Otherwise, you may be responsible for paying the shortfall. You also need a release of deficiency from the PMI (private mortgage insurance) company if you have PMI insurance. It’s good to determine if Fannie Mae or Freddie Mac holds your mortgage.
Q: Are Short Sales Cash Only or Can you Finance the Property?
A: The property can be financed just like any other purchase once the short sale is approved by the lender. But, it is very important to have your financing in place when your offer is accepted. Make sure your Realtor includes this as part of the offer presentation.
Q: Can You Negotiate the Price of a Short Sale?
A: Yes, definitely! But remember, the best deal is a win-win. If you’re serious about the purchase, I would recommend offering a fair price. I always include current comparables (comps) with any offer that I present in order to substantiate the offer price.
Q: Is it Advisable to ‘Low-Ball’ the Asking Price?
A: Possibly. But you should take any current economic situation into consideration. Is this short sale an isolated case, or are there many short sale properties on the market? Make a rational decision regarding the offer price based on all current conditions.
Q: Who Pays Closing Costs on a Short Sale Purchase?
A: These costs will be addressed in the approval letter, but just as in any real estate transaction, the seller (lender) pays their portion and the buyer pays their normal closing costs. These buyer closing fees include attorney fees, title insurance/policy fees, state transfer taxes, tax prorations, homeowners insurance, etc.
Q: Can a Bank Foreclose on a Short Sale?
A: Yes, they could. It all depends on the individual situation. Was the bank ready to foreclose before the short sale was started? Have there been numerous un-acceptable short sale offers? Basically, the bank will do what’s best for them.
Q: Are short sales a good deal?
A: Yes, they can be. You have to evaluate the price, condition, market analytics, etc.
Q: Are short sales bad?
A: Not necessarily. If there are no other options, then it’s best to move forward on a short sale. The bank will almost always be covered for any losses they take. From private mortgage insurance that the buyer has paid for to government subsidies, you can be sure they won’t be losing money in the end. They may show a loss on the paperwork, but they don’t have to disclose monies they are receiving as a result of this short sale approval.
Q: Why Would a Short Sale be Denied?
A: Many reasons. Perhaps the offer wasn’t acceptable or violated the bank’s guidelines. Or maybe they feel the buyer wouldn’t be able to close. Every situation will be different.
Q: Are Short Sales Public Record?
A: Not always. There’s no obligation to report them, so banks don’t always bother.
Q: Where Do You Find Short Sales?
A: Most are listed by a Realtor and will be in MLS or online websites. Just look for the term ‘short-sale’. Your Realtor will be happy to put you on their automated listing search so that you will be notified when a short-sale listing comes up within your search criteria.
Q: Do Short Sales Have to be Listed?
A: Usually. Government-backed mortgages will require it to be listed for several days before the offer. Most other mortgage holders will do the same.
Q: Can a Family Member Buy a Short Sale?
A: No! The lenders will usually require an ‘arms-length’ transaction, and this would prevent family members to benefit from the sale.
I’m here to help you navigate these troubled waters, so please call me with any questions you have. 615-428-8500