What is a Short Sale?

A short sale is a sales strategy to benefit both homeowners who can no longer afford their mortgage payments and the banks that hold the title to the property as collateral for the loan. Short sales have been around for a long time, but have rocketed to the forefront of the real estate industry in recent years for a number of reasons, most notably hard economic times and fallout from high risk loan products that were wildly popular 5-7 years ago. To put it simply, the home is sold through a real estate transaction where the owner of the property owes more to the bank(s) than the property is worth.

At first, it may appear counter-intuitive that a bank would be willing to accept less than what they’re contractually and legally owed. However, with the average foreclosure costing banks around $50,000 in time and resources and then add that they become vulnerable to somewhat unpredictable real estate market timelines, banks are more inclined to work with the homeowner as opposed to forcing a foreclosure. Additionally, homes sitting vacant have increasingly been the targets of theft and vandalism. Even if the house is completely empty including appliances, criminals inevitably break in looking for HVAC components and pull down walls looking for copper plumbing.

That said, the banks typically will not approach the homeowner about a short sale. The impetus is on them to seek the services of a real estate professional, preferably one familiar with the short sale process. There is a Certified Distressed Property Expert (CDPE) designation that has become widely earned among real estate agents who understand keeping homeowners out of foreclosure is not only crucial to their own financial future, but to the economy at large as well  The homeowner must then qualify by providing thorough documentation of an existing hardship that is preventing them from being able to pay back the loan. A hardship can be the result of many factors; some of the most often include job loss, divorce, medical problems or death of a household member, rate increases on adjustable rate mortgages (ARMs) and drastic drops in property values. Agents familiar with the process will know exactly what paperwork and documentation (called a short sale package) is needed from the homeowner, whose pro-active and complete cooperation is paramount to a successful transaction. Due to the sheer volume of short sales being processed by the banks, one missing or incomplete document can create costly delays, postponing or terminating the purchase contract.

Ultimately, the bank will have the final say on the sales price, but the agent will get the property on the market and negotiate with the bank and any interested buying parties on the homeowner’s behalf.  Once an offer is received and submitted to the bank, it usually takes a minimum of 30-60 days for the bank to come back with a response and it isn’t out of the ordinary for it to take longer. During this time, a bank representative is verifying the hardship, crunching the numbers confirming that the short sale is the most cost effective approach and submitting qualified packages to investors for final approval. If approved, the bank will have all parties involved in the sale execute an Arm’s Length Transaction Affidavit. This is a legal document establishing all parties are not affiliated through relation or business, there are no “under the table” or “special understandings” implying financial gains between any parties, there are no arrangements for the homeowner to stay in the home or regain ownership and no party will receive any proceeds other than the agents’ commission. Although the homeowner won’t walk away from the transaction having received any money, it’s important to note that they generally don’t pay anything either. Seller closing costs, including the agents’ commission, are paid for by the bank.

What happens after the closing is entirely up to the banks as well. All terms of the short sale will be disclosed long before the transaction closes, but banks handle the deficiency, or the short fall between the proceeds of the sale and what was actually left owed to the bank, differently. Many banks will furnish the homeowner with a legal document stating that the debt was settled for less than what was owed. In some instances, they won’t be as lenient and require that the homeowner sign a promissory note for an amount the bank deems acceptable, not to exceed the deficiency balance. Typically, promissory notes are paid back through monthly payments at zero percent interest. In some cases, the forgiven deficiency will be treated as income for the seller’s tax purposes, which will significantly change the way the homeowner will be taxed on that year’s income. The lesson here is the homeowner needs to be 100% clear how the deficiency will be handled before the closing occurs.

It is important to be patient throughout the short sale process. After all, it is essentially a favor being extended to homeowners by the banks as part of a collective effort to improve the nation’s overall economy. Although it ultimately is to the banks’ advantage to work with homeowners on short sales, for the vast majority of them, it certainly doesn’t dictate whether or not they’re able to open for business every day. They could be foreclosing on every delinquent borrower, evicting families and saturating the market with vacant, bank owned homes bringing property values down in every neighborhood across the nation and still continue raking in quarterly profits. So, keep that in mind when overwhelmed bank representatives from inundated Loss Mitigation departments request additional documents, changes to current documents or duplicate documents, only to have you sign everything all over again with a blue pen at closing. The process has improved greatly, especially over the last year and a half, but they’re still ironing out efficiency issues.

The short sale process might not be perfect yet, but the efforts being made by the banks, in cooperation with sellers, buyers and real estate agents are yielding encouraging results. In Colorado, fueled by historically low mortgage interest rates, bank owned properties are flying off the shelf, the real estate market is seeing its best sales figures in three years, prices of homes are on the rise and significant recovery is being seen in all industry sectors.

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