“Short” Sales and How They Work

The term “short” sale” has become an increasingly familiar term in today’s housing climate. Wording such as “subject to third party approval” in a home listing indicates that the home is being sold this way. The process itself can prove extremely difficult and stressful for everyone concerned: the homeowner burdened with the financial distress of seeking a way out of a difficult situation; the lending institution which can be simply overwhelmed by the sheer number of property owners facing similar difficulties; the real estate agent charged with the complex task of negotiating with the lending institution; even the new buyer who may be forced to wait weeks or even months before knowing that the property is really theirs.

At the same time, homes being sold as “short” sales are already a major component of the current real estate market. The process is ultimately advantageous for both the home owner and the financial lender: the distressed homeowner is able to actually sell the property and avoid foreclosure; the mortgage lender is able to avoid the substantial costs and lengthy processing times associated with foreclosing on the home. When a home is sold as a “short” sale, the original homeowner and the lender can walk away from the table with a sense of relief. And the new buyer can more often than not feel confident that they have secured a great deal on their new purchase.

What is a “short” sale?

Simply put, the need for a “short” sale occurs when the market value of a home is less than the amount owed on the mortgage(s). For example, if a homeowner has a $200,000 mortgage left owing and discovers that, because of current market conditions, the home can only be sold for $150,000 then such a sale would be “short” $50,000.

What options are available to the homeowner under these circumstances?

If the homeowner is trying to hold onto their home but circumstances have made the cost of continued monthly mortgage payments too difficult, an important first step is to begin communicating with the lender in order to negotiate a manageable mortgage payment plan. Communicating with the lender is often not easy, however. “Some banks are much more likely than others to negotiate a note modification, principal reduction, or “short” sale” says Patrick Sortor, of Money Source Financial Services Inc. of Ann Arbor. Even making contact with the right person at a lending institution has proved too difficult in many instances and an increasing number of homeowners have been forced into foreclosure after unsuccessfully trying to communicate with their lenders: “Things are changing every day, but not as fast as the News makes it sound,” notes Charles Chapell of Ann Arbor’s United Bank and Trust. And when it comes to protecting credit scores, an unsuccessful attempt to renegotiate a loan and subsequent missed payments can leave the former homeowner facing the challenges of low credit scores for years to come. “In most cases the seller is best off finding a way to pay the difference owed”, says Chapell. “But even the person behind or having trouble is always best advised to still contact their mortgage holder right away and then keep trying, if not at first successful, to get their payments extended or the loan modified. If the mortgage holder agrees to extend the payments then that will usually not hurt credit scores - unless the homeowner misses payments in the future, in which case they will show up as being late as far back as they started with the new or skipped payments.”

If the home needs to be sold, in the case of a job transfer, for example, one way for the homeowner to avoid any negative impact on their credit scores is to pay off the shortfall owed to the lender at the time of closing on the sale of the home. Often termed as “bringing money to the table”, the seller’s debt to the mortgage lender is paid off in full and there is no negative impact in terms of credit scores.

A third scenario, which involves considerably more time and negotiations and should not be undertaken by the homeowner alone, is when a buyer for the home at the reduced market price is found and then the lender is petitioned to “forgive” the outstanding debt. There are no guarantees that a mortgage lender will agree to this kind of “short” sale. However, such sales are becoming more common as banks and lenders decide in favor of cutting their losses early and so avoid the often costly and long-drawn out process of foreclosure.

What is the process for this kind of “short” sale”?

The homeowner should make every effort to begin communicating with the mortgage lender(s) as early as possible. This is where the real estate agent also becomes invaluable. Working on behalf of their client, they can continue to follow-up with the lending institutions to get the necessary answers. “Short” sales can take up to three months to process and good communication can greatly help move the process along. A home that has already been pre-approved for “short” sale will be significantly more attractive to a potential buyer than one that has still to go through the whole process.

In order to convince the lender that the home is valued at less than the owed mortgage amount, the real estate professional will also conduct an in-depth Comparative Market Analysis (CMA). The suggested listing price for the home will probably be even lower (but usually not more than 10%) than the market price analysis would suggest in order to attract a potential buyer as quickly as possible. The lender will also likely commission an independent evaluation of the property before agreeing to the price. If the homeowner is seeking to have the outstanding debt forgiven, a letter stating why the shortfall cannot be paid must be submitted along with all financial records and documentation recording other available assets that the homeowner may still have. It’s important for the homeowner to understand that a lender will only consider forgiving a shortfall in the event that there are no other assets that can be used to pay off the debt. Some assests, such as retirement accounts, may be generally safe but the advice of a competent tax advisor should be sought early to determine the true financial impact of this kind of “short” sale.

Because of the time it can take (up to three months) to complete this process, any sales contract written on the property will include a bank approval contingency. Both seller and potential buyer should be aware that the lender can refuse to accept the terms of a proposed “short” sale, even though a signed sales contract may be in existence.

Why would a mortgage lender even consider this kind of “short” sale?

The cost of foreclosing on a property can be significant to the lender. In addition, the property cannot be sold until the required redemption period has expired. This can be anywhere from six months to a year and is meant to allow the original homeowner a chance to get back the property. This redemption period can be reduced to 30 days if the property is already vacant, but that is still a substantial period of time where a lender has to run the potentially costly risk of property damage due to burst pipes or vandalism as the property sits empty. As can be witnessed by the sheer number of empty homes on the market today, the task of maintaining these properties can become unmanageable and might lead a lender to decide to cut their losses early and agree to a “short” sale.

Will a “short” sale reflect better on a credit report than a foreclosure?

According to Sortor: “A [true] “short” sale will generally cost you 80-100 points in credit score (a foreclosure is 250-300 points)”. This is only the case if the homeowner has continued to keep their mortgage payments current. Three missed mortgage payments can have the same impact on credit scores as an actual foreclosure. Adds Chapell: “A true “short” sale should not hurt your credit as long as you are making the payments on the “short part”. If you are just forgoing the short part then that is like a foreclosure. Most “short” sales are when the seller can agree to pay back the short part or make a settlement with the mortgage lender. A foreclosure is really bad on the credit and can hurt for 2 – 5 years.”

Christine Fitzsimons, Edward Surovell Realtors® can be reached at (734) 475-3737.