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Short Sales 101
March 18, 2010 - Dylan Renz
If you live or visit Southwest Florida you have heard the term “short sale”, but unless you have purchased or sold a short sale home (or make a living dealing with them) you likely do not fully understand exactly what a short sale is. The short sale process is constantly changing and I am learning new things everyday, but here are the basics…
What is a short sale?
When a homeowner find themselves in a position where they owe more on their home than their home is worth in the current market they have three options:
First, they can continue to pay their mortgage and keep the home until either the real estate property value increases or until they have adequately paid down their mortgage. This of course is the most ideal situation, but many homeowners find that this is just not an option for them. Some homeowners may not be able to continue making the mortgage payments because of the loss of a job, some may need to move out of the area for personal reasons or because of a job transfer, and some may be investors who are being financially drained by a property they never intended to hold on to.
Second, they can walk away from the property, stop making mortgage payments and let the bank foreclose on the property. A foreclosure can destroy their credit for seven years or more and the bank can still impose a judgment against them for the debt.
Finally, they can come to an agreement with the bank and sell their home for less than they owe. This is known as a short sale.
Example: You purchased your home in 2005 and paid $250,000. You made a down payment of $30,000 and mortgaged $220,000. However, the current market value of your home is only $100,000. In order to sell your home you either need to bring the $120,000 difference to the closing table or have your bank agree to accept the $100,000 for the home and relieve you of the responsibility of paying the $120,000 difference.
Who can short sale their home?
Every bank has different criteria and every situation is unique, however most banks are willing to agree to a short sale with any homeowner who needs to sell their home and owes more than the home is worth. This is true regardless if the homes value and is often true even if the home is a second home, third home or investment property. A short sale is a possibility for a homeowner who has no money and is behind on their payments or for someone with assets who has never missed a payment. Everyone does not qualify for a short sale with every bank, but most homeowners who need to sell their home for personal or financial reasons can qualify with most banks.
Why would the bank be willing accept a short sale?
This is the question I get more than any other. Why would a bank be willing to pursue a short sale? The answer is actually quite simple. The bank knows that if a homeowner has no other option many will simply walk away from their home and let the bank foreclose. Foreclosing on a home can be expensive and can cost the bank up to $30,000 in legal and administrative cost. A short sale however will save the bank all of these costs therefore making it far more beneficial than foreclosure. In addition, the federal government offers banks incentives to accept short sales rather than pursuing foreclosure in order to help stabilize the housing market.
Example: You owe $220,000 on your home, but the home is only worth $100,000. It costs the bank $30,000 to foreclose. After the foreclosure is complete the bank will still only be able to sell the home for the market value of $100,000. This means the bank losses the $120,000 difference between the sale price and the mortgage amount and the $30,000 it cost the bank to foreclose making the banks total loss $150,000. And this does not take into account real estate fees, property taxes, etc. If the bank accepted a short sale on this property and the house sold for $100,000 the bank would only lose the $120,000 difference. The bank would save $30,000 or more by accepting a short sale. Add to this any incentives offered by the federal government and you can see why sometimes a short sale is a far better option for the bank.
How does a short sale work?
The short sale process can be complicated, but usually begins with completing a short sale package and presenting it to the bank. A short sale package will be made up of financial documents and information the bank requires before making a decision about accepting a short sale. Once the bank has agreed to a short sale the home needs to be marketed in order to find a buyer. When a written offer has been submitted by a buyer and accepted by the seller the offer goes to the bank for approval. It can often take weeks or months before a bank responds to an offer. When the bank accepts an offer than the closing process begins and the home is sold.
What are the ramifications of a short sale?
A short sale is not a perfect option for homeowners and may have negative ramifications. A short sale will have an affect on your credit score, but this is minor compared to a foreclosure. Also, it is legal for a bank to seek a judgment against you for the balance of the loan or for part of the debt, though this is becoming rare. Many of the incentives offered by the federal government require that the bank release the homeowner from liability for the debt. The bank may also turn over their loss to the IRS and you may be taxed on the debt you were forgiven as if it were income. There are things that can be done to try and protect homeowners from some of these ramifications, but it is important that you seek the advice of a qualified attorney and accountant to fully understand the possible legal and financial implications of a short sale.
Why don’t I just have a family member buy the short sale and sell it back to me?
I hear this question often so I wanted to make sure I addressed it. Having a friend or family member purchase the short sale and sell it (or even lease) it back to you is considered mortgage fraud. If you short sale a property you must move out of the home and will not be able to repurchase the property. The banks are watching very carefully for this. It is illegal and you will get caught.
What are the benefits and downsides of buying a short sale property?
You can find some really great deals with short sale properties, but buying a short sale can be tricky. First and foremost you need to understand that purchasing a short sale property is not a quick process. It can take banks weeks or months for the bank to respond to your offer. I have personally seen it take eight months for a bank to respond to an offer and they rejected it. Second, there is quite a bit of competition for short sale properties. If you are financing property you may have difficulty competing with cash offers. Finally, keep in mind that many short sale asking prices have not been approved by the bank. Even if you make a full price offer the bank may reject it. This does not mean that you should avoid short sales, just make sure you know what you are getting yourself into!
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