Short Sale Questions

The main stream media continues to be rich with stories about the struggling real estate market, here in the Sacramento area as well as across the country. They generally revolve around the increasing number of foreclosures, the mortgage crisis and now some of the government programs that may or may not be any help. What I am not seeing is any mention of short sales. In June 2007 I published, "Short Sale: Road to Riches?" to answer some questions I was receiving at the time on my website, www.jalone.com.

Today, the number of short sales in the Sacramento real estate market has increased exponentially and I continue to get calls and emails asking what they are, can we do one, and are they a good way to buy a house?

What is a short sale?

A short sale is when the lender on the property will accept less than the full amount due on their loan when the property is sold. Lenders will accept a lower dollar amount to avoid the expense and time of a foreclosure. Generally a short sale occurs when the loans on a property are greater than what the property can be sold for. The short sale is an alternative for a home owner who no longer can afford to keep their mortgage payments current and desires to avoid foreclosure or even bankruptcy.

Is a short sale a way for me to sell my home?

The easy answer to this question is it depends on your individual situation? Here are the three primary criteria that would constitute eligibility to seek a short sale to avoid foreclosure.

1. The value of your home is less than what you owe. This means if you sold the house you could not get a price high enough to pay off the combined mortgages.

2. You cannot make the mortgage payments and are in default. Generally lenders will not accept a short sale offer if the payments are current.

3. You must be experiencing a financial hardship and be able to provide the lender with documentation that support your inability to make payments or cover the short fall if the property was sold. This means you can’t have assets that could be converted to cash to pay the lender. Some examples of events that lead to financial hardship are loss of a job, divorce, medical situations and death. It can’t be that you have decided to stop making payments because the house is no longer worth what you paid for it.

If your situation matches the above criteria a short sale may be a good option for you to avoid foreclosure and/or bankruptcy but there are other considerations.

Before contacting a realtor to set up a short sale make sure you understand what it may cost you, how it will affect your credit rating and the tax consequences.

Lenders who are willing to accept a short sale offer will insist that the seller, their borrower, not get any proceeds from the sale. A title company will prepare a draft closing statement as part of the short sale presentation to the lender that shows all available proceeds from the sale going to the lender and no cash for the borrower. What this means is that there are likely going to be some selling expenses that will need to be paid for. These may include pest inspections and repair, and other maintenance repairs that need to be completed to satisfy the buyer. Often these can be avoided but now always.

A short sale will negatively impact your credit report. Although there are some industry professionals that say having a short sale on your record is not as bad as a foreclosure they do agree that some creditors looking at your report will not differentiate between the two. Clearly it will leave a large blemish. The good news here is that as more and more borrowers go through foreclosure and short sales the more common it will be on credit reports and the impact less sever.

There may or may not be tax consequences as some lenders will issue you a IRS form 1099 reporting the amount they forgave as income to you. The recently passed Mortgage Forgiveness Debt Relief Act of 2007 may protect you from having to report forgiven mortgage debt as income but it is always best to consult a tax accountant or attorney.

Should we buy a home listed as a short sale?

Don’t be scared off by a short sale property as they may turn out to be a great deal for you. But you should know a few things before deciding to make a short sale purchase.

In a conventional home sale, you generally only need the seller’s acceptance of your offer to go forward with the transaction. With a short sale the lender’s approval is also needed for the sale to close and this can take up to six to eight weeks. Yes, lenders are moving faster today with short sales but there is still a process and most lenders won’t even discuss a short sale until there is an offer to review. What this means is it could be two months before you know if your offer is going to be accepted or worse not accepted.

Pending receipt of a complete short sale package the first thing a lender will do is have the property appraised. They are looking for market value and you cannot expect them to settle for a fire sale price. This is where the listing agent can be a big help for the buyers as it will be their analysis as why the offer is fair in light of current market dynamics that goes to the lender.

Lenders will not approve any requests for repair or provide closing costs to buyers. From their perspective it is an “as is” sale. Often in short sales the sellers, who have been unable to make mortgage payments, have not maintained the property and it may be in need of repair. This may mean a buyers request for repair will be declined by the seller because they do not have the financial resources to comply and are not going to receive any sale proceeds.

Bottom line, be prepared for short sales to take more time and know the purchase will more than likely be “as is” with you making needed repairs after the purchase is closed.

If you are going to make an offer on a short sale property there are some items that can protect and provide you with some sense of how the transaction is proceeding.

1. Make sure your Realtor (now required in California) outlines the short sale contingency terms and conditions. This essentially sets the time frame for approval by the lender which may or may not help.

2. Be sure to include a provision in the contract that allows you to withdraw at any time up until the lender approves the sale. This way you can get out of the contract without penalty if it looks like the transaction has little chance of closing.

3. Request from the seller confirmation of submission of the short sale package and confirmation that the lender has received the package.

4. Even though the sale is more than likely going to be “as is” it is essential for the buyer to conduct a home inspection. You want to know what you are buying and what repairs will need to be made.

5. Make sure there is a pest report and understand the seller may not be able to make Section 1 repairs resulting from wood destroying pests.

6. Be sure to discuss issues and questions with your Realtor before proceeding, preferably someone who has some experience with short sales. I recommend only making a short sale purchase with a experienced and knowledgeable agent. There is too much at risk for you and the listing agent represents the seller's interests, not yours.

The answer to, is a buying a short sale property right for you depends on your situation. From a buyers perspective there have been some good deals done but they take time, require a level of cooperation not normally found between buyers and sellers, a good Realtor willing to work hard and a responsive lender.

A significant issue with short sales is you are dealing with a seller and a lender and often when the transaction fails you are weeks and even months into it before you end up walking away or the lender takes a position you can’t live with. If you are interested in pursuing short sale acquisitions, talk it over with your Realtor and find out if your objectives can be met. If you think it is a way to get a deal, I’d suggest there are much easier ways.