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The real estate market runs in cycles. Presently, the housing market has been in an economic period of decline for the last eight quarters in which mortgage delinquencies are reaching historical high numbers. The primary cause of this are the increasing default rates for sub-prime loans and resulting lender's more stringent loan qualification guidelines. Additionally, eight depressed quarters in residential real estate sales has has made it extremely difficult for homeowners with resetting adjustable mortgages to either refinance or sell as an alternative avoiding foreclosure. Homeowners who either purchased or refinanced in the last few years with adjustable interest rates are particularly stressed as their payment amounts increase, stretching their budgets to the limit. In this climate, we can anticipate seeing more foreclosures, "distress sales", and short sales. The information in this primer will help you understand the short sale and how you can prepare for this transaction even before you begin the escrow process.
What is a Short Sale?
This term refers to a transaction in which the sales price will not generate enough money to cover the payoff of the Seller's existing loan and closing costs. Working with a willing Lender, a Seller may be able to negotiate a payoff amount which is less than the actual amount that would ordinarily be required to payoff the loan. The lender agrees to accept the equity available in the property, and the Seller receives no proceeds from the sale of the property.
Mortgage Debt Relief Act: H.R. 3648: Mortgage Forgiveness Debt Relief Act of 2007 passed into law Dec 20, 2007.
Why would a Lender or Seller find a Short Sale appealing?
Homeowners benefit by avoiding the long-term negative consequences to their credit which are associated with a foreclosure. Lenders benefit because they can avoid the substantial expense of a foreclosure proceeding. Most lenders do not want to own the properties used as collateral for their loans, because the maintenance costs and taxes add to their cost and decrease profitability.
What are the First Steps?
The agent and Seller should start by having an extensive, truthful discussion about the Seller's financial status. People who are in financial trouble may be hesitant to discuss the details of their unfavorable situation, but honesty and full disclosure are essential to the successful closing of a short sale transaction.
- The Seller should contact the Lender to find out whether the Lender is willing to consider a short payoff arrangement. The process of convincing a Lender to reduce its loan balance to close the transaction is often challenging, requiring the negotiating skills of a seasoned agent. Be mindful of the additional work that short sales require of both the agent and the Seller.
- Ask your Escrow Officer to prepare a "net sheet" as soon as possible and update
it regularly as information becomes available. This is a detailed estimated statement of the payoffs and closing costs that will be charged to the Seller at close of escrow.
Working with the Lender
Determine the Lender's guidelines. You can anticipate a very specific list of required documentation that begins with a copy of the Listing Agreement or some other form of written authorization from the Seller. Additional requirements include:
- Strong evidence of financial hardship to the Lender
- Pay stubs or other proof of current income flow
- 2 years of Tax Returns and W-2's
- Latest personal checking account statement
- Copies of all past due secured and unsecured debt notices o Copies of the latest mortgage statement
- Copy of the current tax bill
- Copy of a current appraisal, including comparable sales in the area o Copy of the Purchase Agreement
Entering Escrow
The short payoff is a condition of closing that must be set out in both the Purchase Agreement and Escrow Instructions. When the Lender's payoff demand is received in escrow, it is likely to include restrictions on closing costs and the payoff amounts to other lenders and creditors. Throughout the escrow process, the Seller and real estate agent should be proactive about the numbers that the lender will see. Take care to include every possible expense in the Seller's "net sheet", and be aware of the bottom line" as the process unfolds. Your Escrow Officer can advise you immediately of any significant changes or discrepancies. Remember that the Lender will establish a minimum payoff figure which it is prepared to accept, and its willingness to adjust that final figure may vary.
Short Sale Addendum now Accompanies Purchase Agreements
In November 7, 2007, California Association of Realtors released a form called the Short Sale Addendum (form SSA) that is intended to be an addendum to a purchase agreement. In essence, this form makes any short sale transaction subject to lender approval by a particular date. Thus, this form will create an express contingency, for the benefit of both parties to the transaction, whereby both sides agree that the entire agreement is contingent on the seller´s receipt, by a particular date, of written consent from all existing secured lenders and lien holders to reduce their loan balances by an amount sufficient to permit the proceeds from the sale to pay the existing loan balances as well as other costs, (including commissions) without requiring the seller to place any funds in escrow. On this form the parties would also agree whether the time periods in the purchase agreement for inspections, contingencies etc. should begin as specified in the purchase agreement or on the day after seller delivers to buyer the written notices of the lenders´ consent to the short sale.
Note: The information is intended to present general guidelines and is not a substitute for personalized financial advice. Always consult with a tax adviser or legal counsel before entering a Short Sale transaction.
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