Short Sales in a Nutshell
By: Lawrence S. Maitin
The term “Short Sale” is being used more frequently these days with the increasing amount of homes in foreclosure. I find many people either do not completely understand the term, or believe it is a complex process for only the savviest of investors. While negotiating short sales can be a time consuming and frustrating process, you will see from this brief article that is far from complex.
What is a Short Sale? A Short Sale is simply when a lien holder, such as a mortgage lender, accepts less than the full pay off of its debt to release its lien and facilitate the sale of property. It is called a Short Sale because the lender is accepting a “short pay off”. While some lien holders will accept a short pay off in satisfaction of the entire debt, others will release its lien to allow the sale to proceed, but still hold the seller liable for the balance of the debt. (At this point, you all ready know more than the majority of people out there. J)Mortgage holders are the lien holders that are dealt with most in short sale negotiations. Why would a lender accept less than what it is actually owed? A lender might do this if the borrower is in default, and the property appears to have little or no equity. The lender knows that if it forecloses on such a property, it will incur fees and cost for the foreclosure and still not be able to sell it for enough money to cover the loan balance. Additionally, if there are no bidders at the foreclosure sale, the lender will become the owner of the property and then incur further costs to re-sell it at a later date.
The lender is never under any obligation to accept a short pay off. It is strictly an economic decision that a lender will make if it believes it is in its best interest. To approve a short sale, some lenders have a short sale package of paperwork for borrowers to fill out and will require documents to be submitted, such as tax returns and pay stubs. Others do not have short sale packages at all. At minimum, the lender will need to see the purchase contract, and a preliminary Settlement Statement to make sure that the seller will not be getting any funds from the sale and that there are no excessive costs paid to third parties out of the sale proceeds. The lender may want to see an appraisal, or that attempts have been made to sell the property at market value. Basically, the lender wants to feel confident that the amount it must accept to release its lien based upon a particular sale price is probably the best it can do.
A subordinate lien holder will reduce its pay off to a larger extent than a first lien holder. Second mortgages and equity lines are examples of subordinate liens, which are liens recorded later in time. If a borrower is in default on the first mortgage, a foreclosure of this first lien will extinguish the subordinate lien. Most of the time, there is no money left from a foreclosure sale (if a third party bids at all) to cover any of the subordinate lien holder’s debt. Most second lien holders will not receive any funds from a foreclosure sale and will no longer have a lien securing its debt. Therefore, the seller has far more leverage with the holder of the equity line or second mortgage holder to get the debt reduced, than with a first lien holder.
Well, that is Short Sales in a nutshell! If you are a real estate broker, potential short sales must be disclosed when reasonably known. The following disclosure or any similar language must be entered at the time of your MLS input if known, or within one (1) business day upon receipt of knowledge: “List price may not be sufficient to cover all encumbrances, closing costs, or other seller charges, and sale of property may be conditioned upon approval of third parties.” (See Section 6.2.1) CMLS Rules and Regulations. To protect your seller, make sure the offer to purchase contract is contingent upon approval of the third party, so that the seller is not deemed to be in breach of contract if the lender does not accept the pay off offered, thereby preventing the deal from closing at the agreed upon contract price.