A short sale is a sale of real estate in which the sale proceeds fall short of the balance owed on the property’s loan. It often occurs when a borrower cannot pay the mortgage loan on their property, but the lender decides that selling the property at a moderate loss is better than pressing the borrower. Both parties consent to the short sale process, because it allows them to avoid foreclosure, which involves hefty fees for the bank and poorer credit report outcomes for the borrowers. This agreement, however, does not necessarily release the borrower from the obligation to pay the remaining balance of the loan, known as the deficiency.
In a short sale, the bank or mortgage lender agrees to discount a loan balance because of an economic or financial hardship on the part of the borrower. The home owner/debtor sells the mortgaged property for less than the outstanding balance of the loan, and turns over the proceeds of the sale to the lender. Neither side is “doing the other a favor;” a short sale is simply the most economical solution to a problem. Banks will incur a smaller financial loss than would result from foreclosure or continued non-payment. Borrowers are able to mitigate damage to their credit history, and partially control the debt. A short sale is typically faster and less expensive than a foreclosure. It does not extinguish the remaining balance unless settlement is clearly indicated on the acceptance of offer.
Lenders often have loss mitigation departments that evaluate potential short sale transactions. The majority have pre-determined criteria for such transactions, but they may be open to offers, and their willingness varies. A bank will typically determine the amount of equity (or lack thereof), by determining the probable selling price from an appraisal, Broker Price Opinion (abbreviated BPO), or Broker Opinion of Value (abbreviated BOV).
Lenders may accept short sale offers or requests for short sales even if a Notice of Default has not been issued or recorded with the locality where the property is located. Given the unprecedented and overwhelming number of losses that mortgage lenders have suffered from mortgage failures that in part triggered the financial crisis of 2007–2010, they are now more willing to accept short sales than ever before. For “under-water” borrowers who owe more on their mortgage than their property is worth and are having trouble selling, this presents an opportunity for them to avoid foreclosure as a result.
Multiple levels of approvals and conditions are very common with short sales. Junior lien-holders – such as second mortgages, HELOC lenders, and HOA (special assessment liens) – may need to approve the short sale. Frequent objectors to short sales include tax lien holders (income, estate or corporate franchise tax – as opposed to real property taxes, which have priority even when unrecorded) and mechanic’s lien holders. It is possible for junior lien holders to prevent the short sale. If the lender required mortgage insurance on the loan, the insurer will likely also be party to negotiations as they may be asked to pay out a claim to offset the lender’s loss in the short sale. The wide array of parties, parameters and processes involved in a short sale makes it a relatively complex and highly specialized type of real estate transaction. Not surprisingly, short sale deals have a high failure rate and often do not close in time to prevent foreclosure when they are not handled by a knowledgeable and experienced professional, Short sale negotiators, Realtors who are short sale certified (a National Association of Realtors designation), loss mitigation specialists, and real estate lawyers who specialize in short sales are often brought in to handle these deals. Quite often, the average consumer is not aware that the lien holder pays the Realtor commissions, often exacerbating the difficulties.
Short sales are different from foreclosures in that a foreclosure is forced by a lender, whereas both lender and borrower consent to a short sale. However, this consent may be revoked at any time as short sales are entirely voluntary transactions for both parties. The borrower may decide to remain in the property and attempt a refinance or modification of their mortgage loan, or may refuse to cooperate with the lender’s demand for financial documentation or a cash contribution, and thereby ensure foreclosure. Similarly, lenders can refuse to evaluate or approve a short sale offer, generally due to disapproval of either the buyer’s offer amount or high closing costs, which reduces the lender’s net proceeds. All short sale contracts should include a contingency clause specifying that the contract is contingent upon approval of the seller’s lender(s).
In the state of California, short sales can be tricky in that it is important for the party handling the deal to advise the seller to seek the advice of an attorney and a CPA. There could be tax consequences if the loan(s) on the property are not purchase money (all the funds needed to purchase the property). On the other hand, if the loan(s) on the property are purchase money, then the loans are considered “non-recourse” and the debt is generally forgiven and satisfied at the end of the short sale.
Changing consent can present a perilous situation for potential buyers. It can waste considerable time and money for a prospective buyer who anticipated a sale. Typically, deposits with the bank will be refunded but money for paid inspections or other services cannot be.
There are several defenses against this. If the seller has moved out of a property, that is a clue that they have no intention of staying or negotiating further with the bank. “Bank Approved Short Sales” are advertised by real estate advertisements, indicating that a real estate broker has verified the selling bank’s position. This still does not guarantee acceptance, and it often does not take junior lien holders into account, but it is better than situations where the bank holding the mortgage has only been lightly involved in the borrower’s decision.
Short sales are a type of settlement, and they adversely affect a person’s credit report. The negative impact may be less than a foreclosure, Unlike bankruptcy line items, short sales DO show on a credit report like Experian, TransUnion, or Equifax and remain on your credit report for 7-10 years. Some people may have some credit available to them within 18 months or so. Depending upon other credit information, it is possible to obtain another mortgage 1–7 years after a short sale.
While lenders sometimes forgive the remaining loan balance, other lien-holders likely will not. Further, it is possible for a lender to omit updating a credit bureau to zero out a mortgage balance after a short sale. However, willfully misrepresenting information on a credit report can constitute libel in some jurisdictions, and lenders may be sued in civil court for engaging in this behavior.
Short sale success rates vary from state to state and from bank to bank.
Short sales are common in standard business transactions in recognition that creditors are not doing debtors a favor but, rather, engaging in a business transaction when extending credit. When it makes no business sense nor is economically feasible to retain an asset, businesses default on their debt. It is common for commercial debt to trade on the secondary market for a small fraction of their face value in realization of the likelihood of these future defaults. This is known as distressed debt.
CNBC reported that some lenders have been accused of engaging in fraud during the short sale process.. The fraud involves lenders in second position demanding kickbacks in the form of cash payments from the home buyer or real estate agent, and that are not disclosed anywhere on closing documents or HUD-1 statement. This is in violation of RESPA rules, which require disclosure of such payments.
By nature, all short sales will have a deficiency balance. Laws governing the right of the lender to pursue a borrower for the deficiency balance vary state to state. States considered recourse states allow the lender to pursue. Non-recourse states generally prevent this, though some allow pursuit of deficiency though set forth limits on the amount that can be pursued.
If a lender can legally pursue the deficiency and does not specifically waive its right to pursue the deficiency, the borrower is at risk for a deficiency judgment.
Once a short sale has been completed, a Chapter 7 bankruptcy is a possible remedy that the borrower can use to remove the risk of the deficiency judgment or to discharge the judgment itself.
If you are still unsure about what a short sale is or how it works and if you think this might be a viable solution to your upside down status and want to avoid foreclosure please contact me .