What's A Short Sale?

In a declining housing market, the value of a home sometimes falls below what is owed on it. When you can no longer pay the amount owed, you have several options. You can try to hand over your deed to your first mortgage holder. But they might not accept it, since they'd still be on the hook for legal fees, taxes as well as your second mortgage. Or you may just let the house fall into foreclosure. But that should only be a last-ditch approach because it severely hurts your credit rating.

Another alternative is a short sale -- that is, a sale in which the proceeds fall short of what you owe. It can be a win-win situation for you, the lenders and the buyer (often an investor) of your house. But since you're asking lenders to accept less money than you promised to pay them, there's no guarantee that they'll go along with such a sale. And preparing for it will take considerable work on your part. The main benefit is that you avoid having a foreclosure on your credit.

The so-called "short sale" of a home can be a viable alternative to foreclosure and will become more prevalent as millions of adjustable-rate mortgages reset over the next 18 months.

Short sales are an agreement between the lender and the property owner that allows a home to be sold for less than the amount owed. The lender makes the final decision in approving a short sale. Potential buyers need to understand a short-sale transaction before entering any purchase contract. While a buyer and seller may agree on the price, it's up to the lender to accept that price or not. It's a potential option based on the value of the property, the underlying fundamentals of what is owed and the anticipated marketing time. The lender has predetermined guidelines for the minimum amount they will take in the loan sale. When the sale proceeds do not satisfy the remaining balance, the after-sale balance is forgiven. The credit is then reported as satisfied for "less than full" amount.

Though short sales have been around for a long time, they have come to prominence lately because of the unprecedented increase in foreclosures. While short sales are by no means a slam dunk, lenders are more willing to negotiate with borrowers today who are in default on their mortgage payments.

First, you must prove that you really can't pay your loans -- and that the reason is new, not something that you concealed from your lenders when you originally applied for the loan.

Then you or someone else, like a real-estate agent, must find a buyer willing to purchase your house at market value. Market value can be determined through a formal appraisal (your lender may insist on one) or by an agent's comparative market analysis.

You or your agent also must figure out all the costs of selling the property. That includes the balance of both loans, accrued interest up until the day of closing, closing costs and fees, and unpaid property taxes.

You then must present the facts to your first mortgage holder, which has the top lien position and gets paid first. This isn't as simple as it may sound. What the lender wants upfront is a hardship letter from the seller, a contract between a buyer and seller and an estimated settlement statement. The lender may counteroffer and you continue to negotiate. Remember, the last thing a lender wants to do is foreclose on a home. If a lender puts the house in foreclosure, it has to clean it up, paint it, replace the carpet, list it on the market, pay a broker's commission and other closing costs as well as maintain the property while it sits waiting for a buyer.

Many lenders are not prepared and not accustomed to short sales and that can be a challenge for real estate agents and their clients. Realtors need to build a relationship with the bank on a short sale, when possible, they should meet with the loan officer and provide them with as much data as possible on the house and the market.

If your plan will bring them more money than they'd get if the house were sold at auction, they'll most likely go along with it -- and sometimes pick up some of your costs as well, like real-estate commissions and closing costs. However, it may be difficult to get your second mortgage holder to sign off on the deal because if they do, they might not be repaid what they’re owed. But they may be willing to go along with a short sale if the buyer or the first mortgage holder offers to pay them some money, especially if the amount you owe on your second mortgage is small.

As you can see, setting up a short sale is complicated and requires some negotiating finesse. Although money is probably tight for you right now, I think it would be worthwhile to consult local professionals with experience in the process, including a tax advisor and a real-estate agent.

Many lenders are not prepared and not accustomed to short sales and that can be a challenge for real estate agents and their clients. Realtors need to build a relationship with the bank on a short sale, when possible, they should meet with the loan officer and provide them with as much data as possible on the house and the market.

A short sale can benefit everyone involved in the transaction; financially troubled homeowners save the embarrassment and marred credit associated with a foreclosure. Investors and entry-level buyers have the opportunity to buy a home below market value. Lenders avoid the hassle and expense of seizing a home and putting it up for auction.

Short sales can occur before a home goes to foreclosure or during the foreclosure process.

Remember, lenders are not looking to bail out borrowers who simply overextended themselves during the recent real estate boom. In most cases, a lender will only consider a short sale if a borrower has clearly suffered a serious financial hardship that directly caused him or her to default on the mortgage. Short sales are a common practice within the mortgage industry and are determined on a case-by-case basis.

While banks still realize large losses on short sales, there are some benefits, including the elimination of foreclosure attorney fees and costs, the marketing costs should the property go to REO and any potential risk of damage or deterioration due to prolonged vacancy.

As far as short sales, those will continue to grow as folks with little or no equity realize they can't hold on. The problem is, most banks are not really discounting for investors yet on these properties.

Despite the current mortgage credit crunch, which is most pronounced in subprime borrowing, there remains significant favorable financial support for home buyers, especially in the FHA and VA and prime conventional conforming mortgage markets.