A short sale is where the sales price of the property is less than what the seller still owes and the lender is willing to accept less than they are owed.

Why would a lender agree to a short sale?  Mortgage lenders are in the business of making loans not owning property.  When a loan is in default, it is viewed by the lender as a non-performing loan.  In addition to not earning interest on their loan the Federal Reserve requires the lender to put aside funds to cover the bad debt.  These funds are called a reserve and cannot be lent to other clients.  In addition there are some rules about how many non-performing loans can be kept on the books and the punishments for exceeding these limits are serious so banks and other lenders are anxious to get these loans resolved.  It should also be noted the foreclosure process is long and expensive for lenders.  The reason many investors look for bank owned properties is, historically banks have not been very good at selling property.  All of these reasons are why lenders are willing, in some cases, to take less than they are owed.

Steps to a Successful Short Sale

1.     Determine if the property qualifies for a possible short sale. There are two elements to determine if your home qualifies for a short sale. First is what you owe on your combined mortgages more than what you could sell your house for less the selling costs?  In other words after you have paid all the closing costs will there be enough money left to pay off the lenders?  If the answer is no to this question your property qualifies for short sale consideration.

2.     Determine if you qualify for short sale consideration from your lender.  Mortgage companies make loans to borrowers and use the home as collateral.  Their first source of repayment is you, your income and capacity to pay.  Their second source of repayment is the liquidation of the collateral, in this case the house.   Since we have already determined the selling of the collateral is not going to repay the mortgage in full the lender will look to the borrower to pay the balance. 

You will only qualify for short sale consideration if you have had a hardship and can demonstrate to the lender you have no capacity to pay the balance that will be owed after the sale is complete.  A financial hardship can be death of a co-borrower, divorce, unexpected medical bills, loss of a job, reduced income, and even a job transfer that requires you to relocate.  Any or a combination of these must have drained your capacity to pay.  The lender is not going to grant a short sale if you have a large investment portfolio, savings accounts, and/or a 401k pension account.  In reality they may accept the short sale contingent on the borrower paying the balance from savings.

3.     Hire a Realtor with experience.  Find a Realtor with direct hands on current experience in working with lenders to secure a short sale or at least make sure they have access to such a person.  Selling the home is easy; you just keep lowering the price until a buyer shows up.  Having an experienced agent who knows how to contact the right department within the lender’s organization and find out exactly what their short sale package requirement are and knows how to put it together in a way that makes the decision for the lender easy is who you must have working for you.  This agent will also be able to explain the process to you and, as importantly, to your buyer and their agent.

4.     Willingness to bare your financial soul.  The requirements for a short sale vary from lender to lender but they all will want to verify your claim that you are going through difficult financial times and do not have the capacity to pay any unpaid loan amounts after the sale of the home.  This means they will want items like pay stubs, bank statements, pension, credit card and other statements.  In addition they will want copies of recent tax returns.  They will want to understand what your monthly obligations are including alimony, child support, insurance, utilities, etc.  In most cases the lender will be asking you for more information than you may have provided to get the loan.  Here again your experienced Realtor can help you put together the package in a manner that will limit subsequent information requests and speed up the process.

5.     Patience and flexibility.  These are key ingredients in many things but are vital in the short sale process.  Lender employees working on short sales are swamped right now, most packages require many requests for more information and they have no emotional attachment or need to have a relationship with the borrowers they are dealing with.  Consequently it may take days or even weeks to get an initial response.  In my opinion, I think some are trained to give non-encouraging feedback.  They will generally hire an appraiser to come out and give them a value; they may question your Realtor on the negotiated price.  In other words it is often a back and forth process that can take weeks to complete and most lenders are not very good about keeping you and/or your Realtor informed.

6.     Understand the credit and tax consequences.  Although recent changes to the tax laws appear to relieve the forgiven amount as taxable income consult with a qualified CPA to make sure you have a complete understanding.  There is a misperception that a short sale will not be a negative on your credit report.  That is not true; it will negatively impact your credit and ability to get a loan in the future.  Talk to a credit professional and make sure you understand exactly what a short sale will do to your credit.

Many homeowners, especially here in the Sacramento area where we had such rapid appreciation and a large number of homes built in the 2004-05 time frame, are finding their homes are not worth what they paid for them and worst yet, they now owe more than the house is worth.  These homeowners should not panic or start working on utilizing a short sale unless they are experiencing a severe financial hardship.  In that case a short sale may be an option to avoid foreclosure.  The best advice I can give is, contact and talk to an experienced professional and make sure you explore all your options because there may be others.