Short Sales

I have mentioned short sales in several of my previous posts, but I have never actually defined or discussed short sales at any length. One of the friends of this blog believes it is worth a post (I agree) and has provided me with some information on short sales.

Over the last two years our country has suffered a severe drop in the value of residential real estate. In some areas it appears to have reached a bottom. In some areas home values continue to drop. Currently no reputable projections are calling for a rapid recovery in property values. Traditionally, during a recession, displaced workers sell their homes, move to areas with better employment opportunities, and start over. In this recession the drop in home values has locked many Americans in a situation in which they owe the bank more on their house than their house is worth. For example if they owe $400,000 on a house with a realistic appraised value of $300,000, the bank would expect the home owner to cough up the extra $100,000 when the house is sold. This condition is termed, being underwater or upside down. Since it is impossible for an unemployed or underemployed individual to come up with that kind of cash on short notice, the homeowner is locked into a predicament that severely limits their options.

An option to foreclosure or simply walking away from the house and allowing the bank to take possession of the property is termed a short sale. In a short sale, the bank will accept the market value of the house without further penalizing the mortgage holder, writing off the difference between the current value of the property and the value of the loan as a tax loss. The homeowner is expected to find a buyer using a realtor and present the deal to the mortgage company. Since a mortgage is a contract, the bank holding the mortgage can choose to accept or decline the offer.

Why would a bank choose to allow a homeowner to walk away from a valid contractual agreement knowing that it would result in a serious loss of profit? Consider the option: In a foreclosure, the homeowner would stop making mortgage payments but continue to live in the house. Evicting a homeowner, depending on the jurisdiction, can take as long as a year. During this time homeowners, knowing that they will lose their property, frequently vandalize the house before they are finally evicted. In one such case in my neighborhood, the evicted owners did about $70,000 worth of damage to their home. The bank was then stuck with a substandard property that took over a year to sell. During this time the bank was responsible for maintaining the property and liable for any accidents that might occur on that property. Ultimately the property, once worth over $400,000 was sold at about $210,000. The bank would have only lost $100,000 in a short sale and they would not have been responsible for two years worth of aggravation and legal hassles. In addition if the bank accepts a short sale, it will receive $1,000 from the Federal government. Not much of an incentive, but at least enough to pay for some of the paperwork.

Of course the short sale is good for the distressed homeowner. The homeowner receives mortgage relief without further damage to their credit ratings, the bank agrees not to sue the homeowner for any unpaid balance, and the information I have received indicates that some Federal money ($1,500) will be available to help the homeowner relocate after a short sale. I have not verified that last claim. If the homeowner was not delinquent at the time of the short sale they will be eligible under Fannie Mae guidelines to buy another home immediately. If the homeowner was 60 days or more in arrears at the time of a short sale then they will be eligible to purchase a new home in two years rather than the traditional seven years required to recover from foreclosure or bankruptcy.

Real estate agents benefit from short sales. They will be paid by the bank if the short sale is successful. The real estate agent receives nothing if the short sale fails and the property goes into foreclosure. Even in the instance of failure, the agent receives free publicity and new business through the sales process.

There are drawbacks to short sales. The bank will want to examine the homeowner’s personal financial records in will require a hardship letter requesting mortgage relief. The homeowner will be expect to keep their property in meticulous condition and put up with a stream of prospective buyers for months, as the bank processes the request for a short sale. After all that there is still no guarantee that the bank will accept the offer. From what I have read it appears that the homeowner must be 60 days or more in arrears to qualify for Federal money. This seems odd as it is a catch 22 to the Fannie Mae guidelines.

Banks do not like short sales, but sometimes they will agree to such an arrangement because it will limit their losses. However, the situation is greatly complicated if there is a second or even a third mortgage on the property. In such situations the homeowner is not only asking for the first mortgage holder to take a hit but is asking any additional lien holders to take a total loss. Some of the money from the $75 billion mortgage modification program is going to be applied to provide some relief in this area. If a second mortgage holder agrees to a short sale, then that servicing company will also receive $1,000 from the Federal Mortgage Relief Program.

If you find yourself underwater in a mortgage and are forced by circumstances to consider a short sale, be certain to find a reliable real estate agent to assist you in this process. As laws concerning foreclosure and repossession vary dramatically from state to state, I would also recommend advice from a competent real estate attorney. Evidently short sales are nothing new. Banks have been accepting such offers for years. However, they do not want that information to become common knowledge. In the current real estate crisis the mortgage companies might be more likely to entertain the offer of a short sale than in years past. It is definitely a option worth investigating.