Short Sales Explained, Part 1

By now we’ve all heard the term “short sale,” but what does it mean and how do short sales work?

A short sale occurs when the bank that holds a mortgage on a home agrees to accept less than the full balance of the loan as payoff.  Homeowners who need to sell their home, but owe more than the current market value, can get approved by their mortgage lender for a short sale, allowing them to sell their house, without paying off their mortgage balance in full.

But there are several myths about short sales that set a lot of home buyers and sellers up for disappointment during the short sale process.  This blog is part one of a two part series about how short sales really work, this time from a seller’s perspective to be followed by a blog about how short sales work from a buyer’s perspective.

As a seller, before beginning the short sale process, it is a good idea to contact your lender and ask them if a short sale is possible. Every lender has different requirements for allowing a short sale and only your lender can let you know the appropriate way to start the process. After you’ve touched base with our lender, short selling your home can be broken down into four basic components.

1. Demonstrating Inability to Repay Loan

Some lenders require that you be behind on your mortgage payments before you they allow a short sale and others don’t, but in almost all cases, you must to demonstrate to the lender that you can no longer pay your mortgage and that short selling the house is the only way to avoid foreclosure.

Proving your financial hardship is one of the two critical components of getting approved for a short sale. What a lender requires in order to demonstrate you inability to pay varies from lender to lender, but there are some elements that are common. Most lenders require that you provide several paycheck stubs, your income tax return from the previous year including your W-2, all your current bank statements which must be updated monthly throughout the process, a financial worksheet demonstrating a monthly deficit, and finally a hardship letter explaining why you can no longer pay your mortgage. Usually all of these things must be provided up front in order for the lender to open a file for your short sale.

Of all these elements, the one that most people struggle with the most is writing their hardship letter. There are various hardships that justify a short sale such as a divorce, the death of one of the borrowers, an illness in the family, or a job loss or relocation.  Another factor that lenders consider when reviewing the hardship status of a borrower is the other expenses associated with owning the home. For example, if you have been keeping your mortgage payments current, but in order to do this you have had to let other expenses fall behind such as payments to your home owner’s association or maintenance on the home, the hardship letter is the time to tell the lender this. If your mortgage payment is current but there’s a hole in the roof and the air conditioner doesn’t work, let the lender know in your hardship letter. Also, the hardship letter is a good time to tell the lender what efforts you’ve made to pay your mortgage. If you’ve borrowed money, either in the form of a personal loan on against your retirement accounts, mention it in your letter. Be sure to also let them know about any efforts you have made to modify your mortgage, refinance, or sell your home.

Depending on your lender’s requirements, you can either submit this information to have a short sale file opened for your house at this point, or if your lender requires a purchase and sale contract be in place before opening the file, you can list your house for sale and wait until a contract is in place to have the file opened.

2. Finding a Buyer

Selling your home as a short sale works much the same way as a traditional sale in the early stages. An experienced and qualified agent will list and market your home. However, it is required that the fact that the home is a potential short sale be included in the listing information.  It is also important to list the home as being sold in “as is” condition. In a traditional resale, repairs of problems found during the home inspection are usually negotiated during the due diligence period when a buyer can terminate the contract. Because the short sale approval depends upon the seller having limited financial resources, they are not able to perform any repairs on the property. The buyer will typically still want to have a home inspection during the due diligence period, but afterwards their choices are either to terminate the contract or proceed with the contract, rather than approach the seller to ask for repairs.

When a potential buyer makes an offer on your home, you negotiate the terms of the agreement with the buyer just as a seller would with a traditional resale.  Many sellers are inclined to accept any offer, since they will not be getting any money from the sale of the home anyway, but it is important to remember that the contract has to be approved by the lender.

3. Getting Lender Approval of the Contract

As I mentioned that first requirement of short sale approval is accessing the homeowner’s ability to repay the loan by reviewing their current financial situation. The second requirement of short sale approval is getting the contract approved by the lender. There are certain guidelines that are common with most lenders, such as they will not approve a seller contribution to the buyer’s closing costs that is more that 3% or the purchase price and they will not approve a commission for the agents higher than 6% of the purchase price. Beyond those guidelines, the other major factors are the fair market value of the property and the net loss on the home. In order to determine what the fair market value is, the lender will order a Broker Price Opinion (BPO). The BPO is a sort of hybrid of an appraisal and a Comparable Market Analysis. The BPO is performed by a third party real estate broker who is not affiliated in any way with any parties involved in the transaction. The broker will provide the lender with his opinion on what the home is worth based on the condition of the home and recent comparable sales.  With the BPO in hand, the lenders calculate what their net loss is on the property and then analyze the purchase and sale contract to determine if it matches their expected net.

Another requirement of short sale approval is that the transaction be what is known as an “arm’s length” transaction. This means that there is no pre-existing relationship between the buyer and seller. Many homeowners innocently believe that they can arrange for a friend or family member to purchase the home as a short sale and then either buy back the house from that person or continue to live in the house as a rental. This is mortgage fraud and you can go to jail for it. Essentially, it amounts to stealing the balance of the mortgage from the lender.

4. Contract Contingencies

If both the seller’s financial situation and the purchase and sale contract meet all of the lenders requirements, they will issue a short sale approval letter, allowing the sale to take place. This is a major milestone in the short sale process, but from this point on, the sale is still subject to the regular contingencies of a traditional resale such as the buyer’s financing being approved, the due diligence period and the property appraising for at least the purchase price in the appraisal required by the buyer’s lender.

Short sales are complicated and they take time and work. An experienced real estate agent can help walk you through the process, step by step, and get your home sold. There is hope if you are upside down in your home and need to sell. Please feel free to contact by at my website Corners Realty Group with any questions or to get started selling your home.