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The Four Sides of Short Sales

By Mark Karten on November 16, 2009

You've heard the saying, "There's three sides to every story - yours, mine and the truth." Compared to a short sale transaction - that's nothing.

With an almost non-existent inventory of fair market homes and bank-owned homes selling, on average, in less than seven days, many buyers focus on short sales as a viable option to purchase.

According to a recent Applied Analysis report, the success rate for short sales in Las Vegas is 12%, which means that 88% of all short sales fail. In a town built on odds, this is not a bet I'd want to make. Short sales are so intricate that it should be no surprise they usually don't work.

Today, I'd like to explain in detail all the sides involved in a short sale - what we see and what we don't.

What is the definition of a short sale? When a homeowner owes more on their loan(s) than the property is worth and needs to sell the property, they are in a "short" position (short on funds to complete the transaction.) As an example, a home is purchased for $250,000 and the mortgage is $225,000.

Due to the declining market, the home's value according to recent neighborhood sales is $100,000. This puts the homeowner short $125,000 before real estate commissions and other expenses due on the sale. The only way to sell the home is to apply for a short sale with their lender, asking for the shortfall to be forgiven.

Just because the homeowner applies, doesn't mean they'll be approved. Here's each side:

The homeowner - in general, the borrower must demonstrate a hardship to the lender as to why they're selling their home "short." The standard acceptable reasons are issues relating to loss of job, reduction in job hours, divorce, chronic illness, cancer, death, adjusting mortgage rate, etc.

The short sale application includes all the financial details of the borrower (income, savings, assets and liabilities) along with two years of tax returns, pay stubs and a detailed hardship letter as to what happened in their life to require the short sale.

Unfortunately, there is no formula as to what is acceptable and each bank has different criteria (which they don't divulge to anyone.) If the borrower doesn't live in the house (they've moved out or have it rented to tenants), this lessens the short sale's viability because they're not "saving" a homeowner and if the property is vacant, the homeowner is not "protecting" the property from vandalism, or performing routine maintenance to keep the home's value.

I'm not saying that investor-owned, tenant-occupied or vacant short sales don't work, there's just less viability, depending on the bank's criteria.

Even if the bank agrees to write off the total amount due, the homeowner will still receive a 1099 which notifies the IRS that the forgiven amount is still taxable.

If the property was the homeowner's primary residence, the tax will most likely be forgiven under the Mortgage Forgiveness Act of 2007. It's important to consult with your accountant to determine what your tax liabilty will be, if any.

The listing agent - a qualified listing agent should be able to demonstrate to the homeowner (seller) that they understand the short sale process and have been successful in negotiating sales where the homeowner has no liability or a reduced amount due to the bank (this is the most important aspect of a short sale for a seller.)

A short sale is not always the best option for a homeowner. Sometimes foreclosure is a better option and other times bankruptcy is the right choice. The agent needs to understand this and explain this to the seller as well (many don't.)

Why foreclosure? As you'll see at the end of this column, the bank may approve the short sale, but not release the homeowner's liability for the balance due. If there's no release, the bank has the legal right to pursue the collection of the balance for six years after the sale. They'll usually sell the loan to a collection agency, and the agency waits a few years for the borrower to get back on their feet, and then comes after them for the balance.

So, if the bank won't give a full release, then the homeowner would choose to let the home be foreclosed on, this way the bank only has six months to come after them for the balance due (which is unlikely.)

If the bank did file a judgment during that time, the next step would be to file for bankruptcy to release the judgment. Each case is unique and a real estate attorney can guide you through the appropriate steps.

The listing agent has to determine that the hardship is valid and then has to set the selling price at market value. Many short sale listings are overpriced because the listing agent assumes the higher price will reduce the seller's liability. In turn, the agent recommends to their client that they not accept anything less than list price.

Other agents take the opposite approach and price the home far below market value in order to obtain an offer to purchase. We'll see how pricing is handled when we talk about the bank.

The buyer - it's only logical that as a buyer, you think that a home listed for $450,000 will sell for that price. Maybe you think because it's a buyer's market, you should offer less than the asking price. It's also reasonable to think that you will be able to get an answer from the seller and the bank in a short amount of time.

In a short sale, none of the "normal" rules seem to apply. If a home is listed for $450,000 and you submit a full price offer - although the homeowner may accept your offer, it doesn't mean the bank will. The bank will perform a BPO (broker's price opinion) to determine the value of the property. If they determine the value at $470,000, then that's what the selling price will be. The same logic applies if the listing agent underprices the property - the bank determines the price.

The problem is that it usually takes 2-6 months for an approval and price determination and most buyers are not willing to wait that long.

In general, if you submit a lowball offer to a homeowner, their agent will suggest they decline the offer. TIP: If you feel a home is overpriced, submit a full price offer to get the process started and if you'll be obtaining a mortgage, your lender will conduct an appraisal which will determine the true value of the home.

I highly suggest that you don't place offers on homes at a price higher than you're willing to pay - it is a waste of time, energy and paper for all parties involved.

The bank - as I stated before, each bank has their own set of criteria as to what they want to see from a borrower regarding their financial status and ability to qualify for a short sale.

Because the banks are overwhelmed with requests for loan modifications and short sales and are understaffed, this process can take anywhere from 2-6 months for a final answer.

It's the listing agent's job to submit all the paperwork to the bank and follow up to see that the file is reviewed and assigned to a negotiator. This is easier said than done. A short sale application averages 60-80 pages and is sometimes faxed in 3-4 times before it is "received."

Once the file is received and deemed complete, then the BPO is ordered to determine if the price is correct. After this step, the negotiator will communicate the terms that the bank is willing to accept. The best result is acceptance of the terms at face value and the bank forgiving the deficiency. Many banks, like Bank of America on their Countrywide loans, will only approve the short sale if the buyer agrees to pay back a portion of the loan. In most cases, you agree to sign a promissory note to repay the balance of the loan over 10-20 years at 0% interest. No matter how skilled the listing agent is at negotiation, they cannot overcome bank protocol in many instances. (We do have some tricks up our sleeve, depending on the experience of the agent.)

Because most homeowners are not in a position to repay any of the debt, the deal falls apart and the buyer has waited months for nothing.

Another scenario is that the bank does not ask for a promissory note but won't "fully and forever release their obligation." This means the bank has six years to seek repayment of the amount they forgave. Some agents and sellers misunderstand that just because they get a 1099 for the amount forgiven, it does not release them from the liability to repay the loan, unless that is expressly detailed in the agreement.

Here's the worst part. If everything else has been done exactly right (homeowner has a valid hardship, listing agent priced the home right and is skilled at communicating and negotiating with the bank, buyer's offer is valid and they're willing to wait for the bank's response,) this doesn't mean the bank is going to approve the sale.

Banks have their own agenda. In short, most banks are not the real lender, they're only servicing the loan. This means the loan was sold to an investor and the bank does the billing and speaks to the homeowner on the investor's behalf. The bank gets paid for this service, and in many cases, it's not in the bank's interest to modify the loan or approve a short sale, here's why:

According to the October, 2009 report "Why Servicers Foreclose When They Should Modify and Other Puzzles of Servicer Behavior" written by the National Consumer Law Center, servicers have four main sources of income, listed in descending order of importance:

- The monthly servicing fee, a fixed percentage of the unpaid principal balance of the loans in the pool;
- Fees charged borrowers in default, including late fees and "process management fees";
- Float income, or interest income from the time between when the servicer collects the payment from the borrower and when it turns the payment over to the mortgage owner; and
- Income from investment interests in the pool.

In other words, even if everything was done correctly, the bank may decline the short sale and foreclose on the home. To read the full report, click HERE.

To summarize this topic, as a homeowner/seller, it's almost always in your best interest to pursue a short sale. The key is to do it as soon as you realize you're in trouble, as there are definite timeframes involved before the bank will foreclose on you.

As a buyer, the odds are against you. You have no control in the process until the end, and most buyers don't make it to the end. The best chance at success is looking for an "approved short sale" with the help of your Realtor. This is a listing that's been approved by the bank but the buyer changes their mind before the sale is complete. This is the best of both worlds, as you have definite terms and a set price and usually a 30 day timeframe to close.

Even though I've explained this process in detail, there's still more to know. If you're determined to buy a short sale listing, or need to sell your home as a short sale, we are experienced and can help you through the process. Please contact me directly if you have specific issues or concerns that I can answer for you. Have a great week!

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