What is a Short Sale?
A short sale is a sale of real estate in which the sale proceeds fall short of the balance owed on the property's loan. It often occurs when a borrower cannot pay the mortgage loan on their property, but the lender decides that selling the property at a moderate loss is better than pressing the borrower. Both parties consent to the short sale process, because it allows them to avoid foreclosure, which involves hefty fees for the bank and poorer credit report outcomes for the borrowers. This agreement, however, does not necessarily release the borrower from the obligation to pay the remaining balance of the loan, known as the deficiency.
Process
In a short sale, the bank or mortgage lender agrees to discount a loan balance because of an economic or financial hardship on the part of the borrower. The home owner/debtor sells the mortgaged property for less than the outstanding balance of the loan, and turns over the proceeds of the sale to the lender. Neither side is "doing the other a favor;" a short sale is simply the most economical solution to a problem. Banks will incur a smaller financial loss than would result from foreclosure or continued non-payment. Borrowers are able to mitigate damage to their credit history, and partially control the debt. A short sale is typically faster and less expensive than a foreclosure. It does not extinguish the remaining balance unless settlement is clearly indicated on the acceptance of offer.
Lenders often have loss mitigation departments that evaluate potential short sale transactions. The majorities have pre-determined criteria for such transactions, but they may be open to offers, and their willingness varies. A bank will typically determine the amount of equity (or lack thereof), by determining the probable selling price from an appraisal, Broker Price Opinion (abbreviated BPO), or Broker Opinion of Value (abbreviated BOV).
Lenders may accept short sale offers or requests for short sales even if a Notice of Default has not been issued or recorded with the locality where the property is located. Given the unprecedented and overwhelming number of losses that mortgage lenders have suffered from mortgage failures that in part triggered the financial crisis of 2007–2011, they are now more willing to accept short sales than ever before. For "under-water" borrowers who owe more on their mortgage than their property is worth and are having trouble selling, this presents an opportunity for them to avoid foreclosure as a result.
Additional parties
Multiple levels of approvals and conditions are very common with short sales. Junior lien-holders - such as second mortgages, HELOC lenders, and HOA (special assessment liens) - may need to approve the short sale. Frequent objectors to short sales include tax lien holders (income, estate or corporate franchise tax - as opposed to real property taxes, which have priority even when unrecorded) and mechanic's lien holders. It is possible for junior lien holders to prevent the e short sale. If the lender required mortgage insurance on the loan, the insurer will likely also be party to negotiations as they may be asked to pay out a claim to offset the lender's loss in the short sale. The wide array of parties, parameters and processes involved in a short sale makes it a relatively complex and highly specialized real estate transaction. Not surprisingly, short sales have a high failure rate and often do not close in time to prevent the home being foreclosed or repossessed. Short Sale transactions should be handled by a knowledgeable and experienced professional who has successfully completed several short sale transactions and is located nearby the property since real estate is a very hands on business. Experienced Real Estate Brokers will typically handle all the short sale negotiations and this activity should be done by a licensed real estate broker or attorney when the property is in foreclosure. Unlicensed practitioners will fall into the category of foreclosure consultants and may require a fidelity bond in order to negotiate a workout solution with the lender such as a short sale or loan modification. Realtors who are SFR (Short Sale and Foreclosure Resource) or HAFA Short Sale Certified will have been trained on the US Treasury sponsored program under the Making Home Affordable (HAMP Program) which offers homeowner benefits including a relocation incentive and protection against deficiency judgment for second lien holders. It is important for the real estate broker to determine eligibility for this program as it may give the homeowner a better option than a traditional short sale.
Consent
Short sales are different from foreclosures in that a foreclosure is forced by a lender, whereas both lender and borrower consent to a short sale. However, this consent may be revoked at any time as short sales are entirely voluntary transactions for both parties. The borrower may decide to remain in the property and attempt a refinance or modification of their mortgage loan, or may refuse to cooperate with the lender's demand for financial documentation or a cash contribution, and thereby ensure foreclosure. Similarly, lenders can refuse to evaluate or approve a short sale offer, generally due to disapproval of either the buyer's offer amount or high closing costs, which reduces the lender's net proceeds. All short sale contracts should include a contingency clause specifying that the contract is contingent upon approval of the seller's lender(s).
In the state of California, short sales can be tricky in that it is important for the party handling the deal to advise the seller to seek the advice of an attorney and a CPA. There could be tax consequences if the loan(s) on the property are not purchase money (all the funds needed to purchase the property). On the other hand, if the loan(s) on the property are purchase money, then the loans are considered "non-recourse" and the debt is generally forgiven and satisfied at the end of the short sale.
Changing consent can present a perilous situation for potential buyers. It can waste considerable time and money for a prospective buyer who anticipated a sale. Typically, deposits with the bank will be refunded but money for paid inspections or other services cannot be.
There are several defenses against this. If the seller has moved out of a property, that is a clue that they have no intention of staying or negotiating further with the bank. "Bank Approved Short Sales" are advertised by real estate advertisements, indicating that a real estate broker has verified the selling bank's position. This still does not guarantee acceptance, and it often does not take junior lien holders into account, but it is better than situations where the bank holding the mortgage has only been lightly involved in the borrower's decision.
Credit implications
Short sales (AKA pre foreclosure sales) are a type of settlement, and they adversely affect a person's credit report. Under Fannie Mae Guidelines (Conventional Loan), Seven years from the date the foreclosure sale was completed as reported on the credit report or other foreclosure documents provided by the borrower before the borrower may be eligible to buy a home. Template:(Source: FNMA Selling Guide, 6-30-10 at 426 After a "pre foreclosure sale", a consumer can be eligible to obtain credit to purchase a property after two years from the date the pre foreclosure sale was completed, but the consumer is limited to a maximum loan-to-value ratio of 80 percent. After four years, the consumer is limited to a maximum loan to value ratio of 90 percent. Template: Source: FNMA Selling Guide, 6-30-10, at 427
Approval timeline
Short sale time frames vary from state to state, bank to bank and file to file. Each lender has their own process for review of a short sale and the amount of documentation that is required. Response time will depend on the amount of files being handled, how adequately staffed the department is and how much follow up is done on behalf of the borrower. The borrower’s financial situation will be reviewed by the lender to determine if there is a documentable hardship, determine occupancy status of the property, and determine if it will be a traditional or a HAFA Short Sale and if the homeowner has any available funds to cure the delinquency. Other factors that can significantly affect the approval time frames include the complexity of the homeowners financial situation, number of lien holders, the investor that owns the loan, if there is Mortgage Insurance (MI) company who needs to also approve the short sale.
To help provide Short Sale Resources to homeowners and Realtors, California Association of Realtors has released a website that focuses on short sales. Additionally the US Treasury Department has created the HAMP Solution Center which handles complaints or escalations for homeowners in any of the programs which fall under the Making Home Affordable Plan. These include the MHA loan modification, HAFA short sale, deed in lieu, and others. Homeowners who wish to file a complaint or see if they have a valid reason for a lender or servicer complaint should first determine who the investor is since that will determine how and where you will file the complaint.
Business
Short sales are common in standard business transactions in recognition that creditors are not doing debtors a favor but, rather, engaging in a business transaction when extending credit. When it makes no business sense nor is economically feasible to retain an asset, businesses default on their debt. It is common for commercial debt to trade on the secondary market for a small fraction of their face value in realization of the likelihood of these future defaults. This is known as distressed debt.
Fraud
In 2011 CNBC reported on a story from entrepreneur Jeremy Brandt that some lenders have been accused of engaging in fraud during the short sale process. The fraud involves lenders in second position demanding kickbacks in the form of cash payments from the home buyer or real estate agent, and that are not disclosed anywhere on closing documents or HUD-1 statement. This is in violation of RESPA rules, which require disclosure of such payments.
Deficiency judgment
By nature, all short sales will have a deficiency balance. Laws governing the right of the lender to pursue a borrower for the deficiency balance vary state to state. There are three main factors determining if there is lender recourse on a loan. The first is if the foreclosure action is a judicial or non-judicial foreclosure. This will vary from state to state. The second factor is if the loan is a purchase money loan or non-purchase money loan. For a residential 1-4 unit property, the third factor is whether the property is owner or non-owner occupied. Lastly, if the loan is a senior loan or a subordinate or second lien is also a factor.
Effective Jan 1, 2011 California passed SB 931 which says "Unless otherwise exempt, no judgment shall be rendered for a deficiency for a first trust deed lender of one-to-four residential units if the borrower sells for less than the amount owed with the lender’s written consent. A first trust deed lender’s written consent shall obligate the lender to accept the sale proceeds as full payment and to fully discharge the remaining debt on the first trust deed." This protection, however does not apply to junior lien holders and still allows the lender to require cash contributions as a prerequisite for approving the short sale. If a lender can legally pursue the deficiency and does not specifically waive its right to pursue the deficiency, the borrower is at risk for a deficiency judgment.
Nevada law potentially grants lenders a six year window of time to sue for the deficiency based on breach of contract in contract law, not foreclosure law. Other states may differ.
Borrowers considering a short sale should be aware of this risk and ask every party involved in the process (Realtor, lender, third party, ...) what can and will be done to protect against a deficiency judgment. Consult an attorney in the state where the property resides to determine specific risks.
Once a short sale has been completed, a Chapter 7 bankruptcy is a possible remedy that the borrower can use to remove the risk of the deficiency judgment or to discharge the judgment itself.
One way in which a borrower or homeowner may eliminate the deficiency judgment is by completing a HAFA Short Sale which is under the Making Home Affordable Program. This option is the next step for homeowners denied for a loan modification should they not be able to afford their home. Incentives for homeowners, servicers and investors are given by the US Treasury. Eligibility is limited by loan size, must be owner occupied, and other restrictions apply. The HAFA short sale program is more beneficial than a traditional short sale because of the government subsidy from the US Treasury Department.
