Understanding Short Sales

A short sale is a real estate transaction where the lender agrees to accept less money than what they are owed. Typically we call this situation being “upside down" in your home… that is, you owe more than the property is worth. This situation can happen for a number of reasons. It can be caused by a decline in the value of the property, which we are seeing more and more of lately. It can also be caused when an owner takes out a second mortgage or a line of credit using the house as collateral where by the lender loaned up to 105% of the value of the property. Today that would be very difficult to do, but three, four, or five years ago, that was a very common practice. while the Durango real estate market has not been hit like other areas, we have seen an increase in the number of short sales for Durango real estate.

Why would a lender be willing to accept less money than what they are owed? That is a great question. There are two options for a lender in this situation. They can consider a short sale and accept their losses, or they can go through the foreclosure process which increases their expenses and usually makes their losses even greater. The foreclosure process in the state of Colorado will generally take nine months to a year. A short sale, on the other hand, should be just a matter of months to complete. Notice that I said should... some lenders still drag their feet and extend this timeframe. So the bottom line is this: banks will consider a short sale because it helps their bottom line.

How does a short sale situation affect the sale of a piece of real estate? Every lender has different rules when it comes to short sales. There are, however, some fairly standard policies that are followed by all of the lenders. (1) The seller will have to prepare a hardship letter discussing their financial situation and why they are unable to pay the loan off in full. (2) They will need copies of all bank statements and stock account statements. (3) They will need a financial statement showing a list of all assets and liabilities as well as a listing of the monthly expenses. (4) They need copies of the last several months pay stubs. (5) A copy of the listing agreement. (6) A letter authorizing the Realtor access to the lender in order to facilitate the transaction. As a general rule, the lender will not respond to a request for a short sale without a bona fide fully executed purchase agreement. Also any transaction will need to be done at arm's length”… that is, the sale cannot be to anyone that the seller has a close personal or business relationship with including family, friends or neighbors.

How does the process work? Buyer and seller come to terms on an acceptable sales price. The contract must contain a provision providing for lender approval of the short sale. That process can take anywhere from three weeks to three months, with most being in the 60 – 90 day range. If other offers come in during that time, the lender can choose to approve any of those and not the first offer. Once we have lender approval for the short sale contract, closing is generally within three weeks. Even though a buyer does not really know if they will be successful in being approved by the short sale lender, the buyer will still need to invest monies in having the inspections done, appraisal for their lender, title work review and the other normal due diligence expenses. Consequently, there is a definite risk in trying to buy a short sale property, it just has to be weighed against the possible gain. The positives are that you could buy a house in a very good price. The negatives are if you need a quick closing, forget it. And you risk losing due diligence expenses in the event that your offer is not the one chosen by the lender. In a short sale, except in a very few instances, the seller is not allowed to walk away with any money.

If I am a seller, how does a short sale affect my credit compared to a foreclosure? Let me say this: either one of these scenarios will affect your credit report and your credit score. There are no published rules from the credit bureaus as to how these two items would be handled. However, Fannie Mae guidelines to lenders give an idea how they will be treated. I spoke with Tim Burrell, a fellow Realtor, CyberStar and real estate attorney who operates a short sale website called http://shortsalesr.us Tim indicated that for a short sale, if the person showed a good credit history afterwards for a period of 2 to 4 years, Fannie Mae would consider allowing a loan to be underwritten. A foreclosure, on the other hand, carries a longer-lasting effect on your ability to borrow. While in each instance the derogatory will stay on your credit report for the full seven years, the effect of the foreclosure, according to Fannie Mae guidelines, is still looked at as a fatal flaw until after your five, and that assumes that you've had good credit history since the foreclosure.

What liability does the seller have for the monies that were not paid to the lender? First off, you should consult with a CPA for advice on this question. That said I'll try and explain some of the facts as I understand them. There are different scenarios depending on if secondary financing was involved, if the money was used for home improvement vs buying a jet ski, was the property a primary residence and who services the loan. There are no, “one answer fits all” situations. Colorado is called a deficiency state. That means that the seller could be responsible for any amount less than the full amount owed. That is, the lender could go into court and try to obtain a judgment against the seller for the difference. The other item to consider is that the lender may 1099-C the seller for the amount of the shortage so that the seller would then have to pay income tax on that forgiven amount as if it were income. This aspect may be affected by The Mortgage Forgiveness Act of 2007. Here is a link to that for you to review. Click Here

In summary, short sales are clearly a complex issue. Whether you are a seller and a short sale situation or a buyer considering acquiring a property that has to go through a short sale is clear you'll need professional assistance and counsel in order to get through that process. All of us at Team Lorenz would be happy to give you that help, just give us a call.