| What is a Short Sale
A short sale is the sale of a home from a homeowner that is in default for less than the principal balance (what is owed). During the process there is an offer for the property which should be close to fair market value and the lender accept less than full payment. Short sales are a way out for homeowners that can no longer afford their current mortgage payments and submits financials to the lender as proof. Many times a homeowner will find that the property is worth less than what is owed and they can not sell so they feel trapped. In the disposition of the property, a lender is paid off with a dollar value short of what it is owed, thus the term short sale. This article briefly explains why this happens and why they are so common.
The root of this issue is in collateralization. The vast majority of properties are purchased with the aid of financing. In order to pay for a property, a homeowner places a small down payment. Since the down payment is not sufficient to purchase the property, a loan is used to pay the remainder of the acquisition value. In other words, the homeowner finances part of the purchase value of the property with a loan from a lender. To guarantee payment, the homeowner pledges the property as collateral. This is called collateralization. This is an agreement between the owner and the lender, such that in case of default, the lender has the right to dispose of the property in order to get paid. In the U.S., properties are collateralized by trust deed, mortgage, and security deed. The term “mortgage” is generic.
Complete and timely payments incrementally reduce the loan payoff value. That is called amortization. The longer payments are made, the more amortized the loan becomes. A fully amortized loan is a loan with zero balance and paid off. On the other hand, because of interest, missed payments increase the loan payoff. That is called accrual.
At sale, unless the loan is fully amortized, the homeowner needs to payoff the remaining debt balance. If the property sale value is high enough, the proceeds of the sale will be sufficient to pay off the loan and for the homeowner to earn a profit or break even. If not, there will be a shortfall. To make up for this shortfall, either the homeowner will have to make up for the amount needed to pay off the loan, or the creditor will have to take less than the amount owed.
A property worth less than what is owed is “over-mortgaged”. The main reasons properties become over-mortgaged include the owner paying too much, refinancing for too much, market decline, damage, deferred maintenance, negative neighborhood changes and disasters.
Often, owners of over-mortgaged properties needing to sell are unable to make up for the loan payment shortfall. It gets worse if they are insolvent. Usually, seeing only losses, they sooner or later get discouraged and become uncommitted to the property. This leads to default. Once this happens, it gets worse. The loan starts to accrue. Unpaid property taxes, utilities, and other costs also accumulate. In addition, usually maintenance is deferred. The property may even be abandoned. This results in further loss of value.
Once the property enters into this cycle, it becomes the lender’s problem. The longer it passes, the worse it gets. Urgently, the lender needs to recover as much of the debt as possible. Lenders in this situation have only two alternatives. One of them is to foreclose. The other is to allow the homeowner to sell the property for less than what is owed. This is a shortsale. Either way, the creditor will take a loss.
Unless the property value is high enough, a lender that decides to foreclose only stands to lose. Only cash-in-hand investors looking for great deals buy at foreclosure sales. If the property is not sold at a significant enough discount, the creditor will have to keep the property. If this happens, the creditor will be liable for maintaining the property, insuring it, paying taxes, and many other costs. Not only that, to sell it, the lender will have to pay commissions!
Foreclosures are costly, lengthy and hostile transactions. Even in an appreciating market, every day the property is worth less. Once in foreclosure, the property enters a legal limbo full of risks for the lender. Hopefully, the homeowner stays until shortly before the foreclosure, does not damage the property and leaves amiably. However, there is a high chance that the homeowner will abandon the property. Vandalism often follows. If neither happens, it is because the homeowner wants to stay longer. These homeowners usually file for bankruptcy. The result is a longer foreclosure and further loss to the lender.
Short sales are lower cost, shorter and more amiable transactions. They are a much less risky alternative to foreclosure because most of the above mentioned problems are avoided. The insolvent homeowner sells the property for less than what is owed. The lender gets paid off sooner and forgives any debt shortfall. That is a short sale. That is why they happen and why they are so common.
Although all lenders have varying requirements and may demand that a borrower submit a wide array of documentation, the following steps will give you a pretty good idea of what to expect.
- Call the Lender
You may need to make a half dozen phone calls before you find the person responsible for handling short sales. You do not want to talk to the "real estate short sale" or "work out" department, you want the supervisor's name, the name of the individual capable of making a decision.
- Submit Letter of Authorization
Lenders typically do not want to disclose any of your personal information without written authorization to do so. If you are working with a real estate agent, closing agent, title company or lawyer, you will receive better cooperation if you write a letter to the lender giving the lender permission to talk with those specific interested parties about your loan. The letter should include the following:
- Property Address
- Loan Reference Number
- Your Name
- The Date
- Your Agent's Name & Contact Information
- Preliminary Net Sheet
This is an estimated closing statement that shows the sales price you expect to receive and all the costs of sale, unpaid loan balances, outstanding payments due and late fees, including real estate commissions, if any. Your closing agent or lawyer should be able to prepare this for you, if you do not know how to calculate any of these fees. If the bottom line shows cash to the seller, you will probably not need a short sale.
- Hardship Letter
The sadder, the better. This statement of facts describes how you got into this financial bind and makes a plea to the lender to accept less than full payment. Lenders are not inhumane and can understand if you lost your job, were hospitalized or a truck ran over your entire family, but lenders are not particularly empathetic to situations involving dishonesty or criminal behavior.
- Proof of Income and Assets
It is best to be truthful and honest about your financial situation and disclose assets. Lenders will want to know if you have savings accounts, money market accounts, stocks or bonds, negotiable instruments, cash or other real estate or anything of tangible value. Lenders are not in the charity business and often require assurance that the debtor cannot pay back any of the debt that it is forgiving.
- Copies of Bank Statements
If your bank statements reflect unaccountable deposits, large cash withdrawals or an unusual number of checks, it's probably a good idea to explain each of those line items to the lender. In addition, the lender might want you to account for each and every deposit so it can determine whether deposits will continue.
- Comparative Market Analysis
Sometimes markets decline and property values fall. If this is part of the reason that you cannot sell your home for enough to pay off the lender, this fact should be substantiated for the lender through a comparative market analysis (CMA). Your real estate agent can prepare a CMA for you, which will show prices of similar homes:
- Active on the market
- Pending sales
- Solds from the past six months.
- Purchase Agreement & Listing Agreement
When you reach an agreement to sell with a prospective purchaser, the lender will want a copy of the offer, along with a copy of your listing agreement. Be prepared for the lender to renegotiate commissions and to refuse to pay for certain items such as home protection plans or termite inspections.
Now, if everything goes well, the lender will approve your short sale. As part of the negotiation, you might ask that the lender not report adverse credit to the credit reporting agencies, but realize that the lender is under no obligation to accommodate this request.
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