A short sale is a real estate sale by the private owner (not a bank) where the home’s market value is less than the what the seller owes the bank. Therefore, the seller is asking the lending bank to allow them to sell the home short (at a loss). Because the lending bank is not receiving complete pay off, they have the right to approve or not approve the sale. The short sale lender will weigh the cost of selling short against the cost of foreclosing and make a decision about how to proceed. This decision is very much based on the housing market in which the home is located, the amount the sale will be short, and the cost of completing a foreclosure in the state where the home is located.
In the beginning
When short sales first returned to our housing market in 2008, the lenders were reluctant to approve and many times proceeded to foreclosure. Over the last three years we have seen a change in the approval process and more short sales are being approved every day. The second challenge to selling a short sale was the amount of time it took to process the short sale. The banks were overwhelmed and simply did not have the staff to keep up with volume of short sale requests. Third, the banks did not really have a process in place for how to approve a short sale in this current market and arbitrary decisions were being made in regards to which seller/borrowers qualified.
The initial short sale packets required by the short sale lender included pretty much every piece of documentation they possibly think of from the seller/owner and all via fax. Pages were missed, packages were deemed incomplete, and the clock kept ticking along for months. Now, the packages have been reduced and many banks allow for electronic uploads through systems like EQUATOR. This has allowed the process of qualifying the seller quicker and the process of obtaining approval has been improving. Further improvements come in the government program HAFA. This program sets timelines for approval and provided incentives to the short sale lender and to the seller via $3000.00 for relocation.
Complicating the short sale process
The complications of short sales normally come in the manner of additional liens on the property. If there is one loan and one bank to deal with, many times the approval process is fairly straightforward and reasonably quick. The challenges to short sales come when there is more than one loan on the property, further exaggerated when it is a different lender than the first or senior lien holder, un-paid property taxes, and unpaid HOA (Home Owner Association) dues. In this situation, instead of asking one lien holder to take less than what is owed, you are asking multiple lien holders to approve the short sale. Multiple lien holders equals complexity around the approval and time.
Who gets paid?
Lien holders are ranked in order of pay off position. Taxes are always first. Therefore, back taxes must be paid prior to any other lien being satisfied. The “first position” loan lien is normally called the senior lien holder and after taxes, they are paid first. Lien holders after these two, are considered subordinate lien holders. In a foreclosure, these subordinate liens will most likely receive nothing. But their approval in a short sale is required. The senior lien holder (1st position lien) will typically offer the subordinate lien holders a small pay off to obtain short sale approval. The thinking is with a short sale they will receive something in comparison to a foreclosure subordinate liens will receive nothing. It is fairly common to offer $3,000 to remaining lenders but more recently, subordinate lenders are requiring 10% of unpaid balance to approve a short sale.
Lenders are very reluctant to pay delinquent HOA dues in conjunction with a short sale. From the lender’s perspective the borrower may not have been able to pay the mortgage but surely they could pay the HOA fees as they are normally less than $500 per month. Only in extreme circumstances do you see a lender include delinquent HOA dues in a short sale payoff. The hardship must be clear and convincing. Therefore it very important that as a seller, HOA dues are paid if a short sale approval is the goal. From a buyer’s perspective, always know how delinquent the HOA dues are and who intends to pay for them. It is not uncommon for the seller or short sale lender to come back and ask for someone else to pay the delinquent dues in order to approve the short sale. Also included in the pay off are the seller’s closing costs. This includes escrow fees, title fees, transfer taxes, and commissions. The short sale lender must approved these charges as well.
How do know what liens are on the property?
Your agent should be able to obtain a preliminary title report which outlines all liens and balances as of the date the report is issued. Make sure it is the most recent preliminary report. Your agent can also request to see a HUD-1. This is an estimate cost and proceeds sheet used by the short sale lender to approve the deal. The agent can write this into the contract under “additional disclosures” . This allows the buyer to understand during the contingency period whether or not all liens are included and can help prevent surprise seller or buyer contribution request late in the game. It is great if your agent can get these items prior to writing an offer but sometimes it is difficult to do so. Always worth asking.
Overcoming challenges to purchasing short sales:
1.) Know the lien holders involved. How many? Same bank? Back taxes? Delinquent HOAs? The fewer lien holders, the better chance of a straight forward approval.
2.) Patience is key but the file should be progressing or someone is not on top of it. It takes constant communication with the lender to keep a file moving. The listing agent should be providing your agent weekly updates. Your agent should be providing you weekly updates.
3.) Property is sold AS IS. Very, very rarely will banks consent to any repairs. Only in extreme conditions will they allow a credit for repair. Do not assume, as a buyer, anything will be fixed or credited. If you find something you are not happy with during inspection you can ask for a repair/credit but don’t be surprised at all if the lender says no. Sellers typically have no money or motivation to make repairs.
4.) Don’t become a landlord. Your agent can write into the contract the property must be vacated 5 days prior to close of escrow with a 40 day close of escrow. Sometimes short sale sellers have not been making payments for over a year. With bad credit and no rent, they sometimes have a hard time find motivation to move out. If they are there after close of escrow, you are now a landlord. Eviction laws prevail and it can cost money to hire lawyers to facilitate the vacancy.
5.) Just because it is a short sale does not mean it is a deal. The banks are becoming more and more savvy about market conditions and market value. They are attempting to obtain as much of a repayment as possible. The short sale lender will complete a BPO (Broker’s Price Opinion) or an appraisal to know whether or not the offer price is competitive for the market place.
More and more, we are seeing listing agents for short sales require a deposit from the buyer and they want the buyer to complete physical investigation prior to short sale approval. In certain situations, this may be appropriate. However, if the buyer signs a short sale addendum stating they will wait for 45 days for short sale approval and deposit money into escrow, it sets up for a challenge if you cancel early. If money is spent on inspections prior to short sale approval and for some reason it is not approved, the buyer is out that money. There are contractual ways to protect the buyer and the buyer’s agent should share these options with you.
In the San Jose market, nearly 35% of all sales are short sales. With 1/3 of the market being short sales, your agent can not avoid showing you these homes. Short sale knowledge helps the transaction go smoother and can help keep the stress down for all involved. Understand with short sales, there are speed bumps. Ask your agent about their experience and how they work to avoid the pitfalls of short sale purchases. Experience, investigation of title, tenacity, patience, and contract management are keys to a successful short sale transaction.
For reference here is a short sale process flow chart. If you have questions about short sales, contact me.