The Definitive Short Sale Article

The Definitive Short Sale Article

This article will attempt to address the following:
1.        Define a short sale
2.        Talk about the different ways it can come about and be structured
3.        Talk about how it's different that foreclosure or bankruptcy
4.        Talk about the implications for the seller
5.        Talk about the implications for the buyer

Definition:
A short sale, as defined by the U.S. Department of Housing and Urban Development "will allow you to
sell your property and pay off your mortgage loan to avoid foreclosure and damage to your credit
rating."

* from HUD's pamphlet "HOW TO AVOID FORECLOSURE" HUD-PA-426-H

To put another way, a short sale is an "arrangement" between the borrower of a home loan and the
bank that lent them the money to buy their home to accept an offer for less than the total amount
owed to pay off the home. The "deficiency" is the difference between the amount owed and what the
bank collects at the short sale.

Although, the "arrangement" can take many different forms, there is no other definition of a short sale.
I say this because many realtors and some investors simply throw the term around as if it meant "a
sale under market value." No. A bank owned (foreclosed) house is not a short sale. A seller deciding
to lower their price and take less profit is not a short sale. An old lady that owns her home free and
clear, selling a $150k home for $75k, IS NOT A SHORT SALE. For it to be a Short Sale, someone
must be getting "shorted." Either the seller, or the bank. I will explain how both of those happen in
more detail presently.

Another important definition of a short sale is how it differs from foreclosure. In foreclosure, the
homeowner falls way behind on their payments and the bank repossesses the house and sells it. In
almost all cases, THE BANK PURSUES THE HOMEOWNER FOR THE DEFICIENCY!!! No one seems
to know or believe this, but just ask someone who has gone through foreclosure, they will tell you the
only way out of this was to file bankruptcy.

DO NOT WORK WITH A THIRD PARTY WHO:
• Does not have appropriate paperwork so If your property is sold under a short sale, the lender is
prohibited from requiring the borrower to make up the difference, either through a personal obligation
or a collection (ie. Garnishment).

•   Does not have appropriate paperwork so If your property is sold under a short sale that the IRS will
not be involved with transaction against the borrower. Uncle Sam will otherwise come looking for the
borrower because you are seen as receiving a relief of debt and may be treated as income.

How It Can Happen - The Arrangement
Most short sales arise when a seller owes more on their house than they can sell it for (upside down).
The owner of the home then attempts to make an arrangement with their lender to sell the house for
less than is owed.

The term "arrangement" was used in the definition and is intentionally broad because the
arrangement depends on the bank that holds the loan. Though there are general practices, every
bank does it differently. This article will give you the most common arrangements, but if you take part
in a short sale, it's crucial you assume nothing until you have the bank's policies in writing.

There are some overriding principles:
1.        There is no such thing as a free lunch. This is not some dream come true alternative to
foreclosure where the money you owe magically disappears. The deficiency will be accounted for. The
deficiency can be 100% loaned to the seller in the form of a promissory note, which they then must
repay. If any portion of the deficiency is "written off" meaning that the bank eats it, you can be sure
that they will report it as 1099 income to the seller or even as a judgment which will show on your
credit for 10 years (not 7 years, 10 years).

2.        It is a cumbersome process. If you are entering into a short sale as a buyer or seller, don't
expect it to go as quickly as any other sale. There's a lot of "back and forth".

3.        The employees of the lender that are negotiating the sale ARE NOT there for the benefit of the
seller. Their only goal is to collect as much money possible for the lender and they will use whatever
means necessary. You can be sure they will misrepresent their own policies and flat out LIE to the
seller in order to intimidate and scare them into paying more money. If you think I'm exaggerating, the
joke will be on you.

For instance, I was once told by a lender negotiating a short sale that, as a policy, they don't "write
off" any of the deficiency and that the seller would have to have a promissory note for $40,000. This
lender also told the seller that their hands were tied and this decision came directly from the investor
who provides the money for the lender. The lender also said there is absolutely no negotiation on the
amount owed, either pay the deficiency, or they will foreclose. The lender made the promissory note
very manageable (20 years 0%) so that the seller would be more enticed to just roll over.

But the seller called the lenders bluff. The seller then provided a letter from an attorney stating they
would qualify for a bankruptcy, thus rendering the lender incapable of collecting anything. That same
day, the lender called the seller saying they would reduce the promissory note and write off $30,000
of the debt! It would have to be reported as 1099 income, but it would not have to be paid. Amazing
change of policy! Then the seller saw what was happening and just said, "no thanks, we don't want to
owe you anything, we'll just go ahead with the bankruptcy." Two days later the seller received a
written offer that the lender would completely forgive the debt and simply report it as 1099 income!

The moral of the story is that the lenders will LIE to obtain their money. Many of the managers of the
collections departments are paid on COMMISSION on how much they collect. Just imagine if that seller
had rolled over on the first offer! That employee would have been responsible for keeping $40,000 of
his company's money with one five minute phone call!

One other important thing to remember is that if the lender gets the property back (i.e. short sale
doesn't go through), they have to put it up for auction. This creates the risk that additional money will
be lost if the house doesn't sell for what it's worth. In the case of the example, the short sale offer was
for $550,000, and the amount owed was $590,000.

The seller faxed in evidence to the lender that most similar houses in the area were now selling for
$480,000. So this enabled the seller to make the argument that it was a much more prudent risk to
write off $40,000 instead of running the risk of losing $110,000. This enabled the seller's
representative to intimidate the employee of the lender asking him "did he really want to be
responsible for losing his company $110k, when he had the option, right now, to settle for 40k?"

If it seems like I know a lot about "this example" it would be because I was the mortgage broker for the
people making the offer and seller of the property happened to be my wife.

The Details of the Arrangement
Different banks have different policies. The best case scenario is to get a bank that actually "writes
off" the deficiency. All that happens here is that the seller has some minor derogatory credit reporting,
but doesn't actually owe the bank any more money. This credit reporting can consist of anything from
"creditor settled for less than the amount due" all the way to "foreclosed."

As the example noted, many banks will do a promissory note for the deficiency.
Some banks are stupid enough to require that the deficiency be paid at closing. Think about it. This
does no good because it's the same thing as the seller selling their house without doing a short sale
and simply bringing cash to the table. If a bank tells as seller they need to bring cash to the table in a
short sale, they are either idiotic, or more likely LYING.

In cases where the money is "written off" it's important to understand that the lenders will never
actually "write something off." In most states (I don't know the law in every state), the lender has the
ability to show any deficiency as 1099 income for the seller. All this really means is that the seller has
to pay taxes on that income. Depending on one's situation, it could mean that people that are
dependent on some form of aid because of "low income" will have some explaining to do come tax
time.

Another way that the deficiency can be written off is in the form of a judgment. This will often occur in
conjunction with the 1099 reporting. It might say something on the seller's credit report such as
"judgment filed against John Doe in the amount of $xx,xxx by ABC lender." This will appear in the
"public record" section of the seller's credit report for 10 years (7 years is only for late payments, 10
years for public record info, don't argue, trust me). It can either show up as satisfied or unsatisfied.
Satisfied is obviously better because it means that the worst thing that can happen is that the lender
will report 1099 income.

Unsatisfied could be a problem, because it means that a court has found in favor of the lender to
collect the deficiency from you. Now they still might simply do the 1099 thing, or they might try to
collect it from you. They can keep trying to collect it from you until they get it. They can garnish your
wages. Your only hope then is that you qualify for a chapter 7 bankruptcy.

This brings up an important note. NEVER EVER ASSUME THAT A DEBT THAT YOU OWE A LENDER
IS GONE UNLESS YOU HAVE THE DETAILS OF THE RELEASE OF THAT DEBT IN WRITING. For
instance, someone who had done a short sale had a first and a second loan. The bank agreed to the
short sale, which ended up being enough to pay off the first loan, but not the second. The seller had
assumed that because the bank agreed to the short sale that they wouldn't have to worry about the
deficiency from the second mortgage.

Now they are surprised that they are being pursued for the deficiency. REMEMBER, the lender(s) will
always want ALL their money accounted for somehow. NEVER assume something is written off unless
you have a formal, signed, written, unconditional release of lien and/or judgment from the lender
specifically stating that no further action to collect this debt will be taken.

How did we get to this place in the first point?
A short sale can come about for many different reasons. In my wife's case, she was the owner of the
house and had been making payments. We bought an investment property and put it solely in her
name to protect our family in the event that the market took a turn for the worse. It did. We owed
590k, but the best offer we had after 6 months was 550k. The short sale prevented her from having to
file bankruptcy, and there was no derogatory credit reporting because there were no late payments
made.

Despite popular belief, YOU DO NOT HAVE TO BE BEHIND ON YOUR MORTGAGE TO REQUEST A
SHORT SALE. You just have to demonstrate that your house can't be sold for what you owe.
In other cases, short sales happen when a seller can't afford to make their payments and is nearing
foreclosure or bankruptcy. It makes life much more complicated if you are living in the house in
question. The bank's ability to scare you is much greater in that case. In this case, a short sale is only
slightly better than the alternatives. You will still lose your house, and your credit is still destroyed just
because you've made 4-5 late payments on your mortgage.

Despite popular belief, A BANKRUPTCY, FORECLOSURE, OR REPOSSESSION DO NOT HURT
YOUR CREDIT AS MUCH AS THE MULTITUDE OF LATE PAYMENTS THAT OFTEN LEAD UP TO
THEM!!!!! I just cannot stress this enough. People think that a bankruptcy damages their credit
beyond repair in and of its own accord. I've had many clients file bankruptcy with 750 scores and no
late payments only to have their score drop to 680. It's the clients with 20+ late payments that are
having their credit hurt.

A final note on how the short sale can come about... Most banks will not agree to a short sale in
writing until you have a formal offer. You can simply call your bank and ask them if you could do a
short sale at a certain price and they might say "sure, no problem, we'd be happy to facilitate that
offer".

BEWARE: That doesn't mean a thing. Before your short sale is APPROVED, you'll have to submit an
application, hardship letter, financial statements, tax returns, pay stubs, the purchase agreement from
the investor, a HUD statement from the pending transaction, payoff letters from all lenders involved,
and several other things depending on the lender.

And without key clauses and paperwork you may end up with enormous tax bills and deficiency
judgements. Then, once this huge packet of information is submitted to the lender, you will most likely
hear back in 1-4 weeks on the TERMS of their "approval." Be warned their approval will most likely be
thinly disguised attempt to collect their debt and will almost never be the "write off" you were hoping
for. Work closely with a solid real estate investment company.

Conclusion
Again, a short sale is not a magic cure. It's also not some mystical solution that only an elite few know
about. If you're curious about selling your house as a short sale, you should contact your real estate
investor who sent you this article. It's usually not easy, but in some cases, it can leave you much
better off than the alternative of foreclosure and bankruptcy. Remember that this is a complex
process and you should always seek the help of a professional real estate investor when considering
a short sale.

If you have not already spoken with a Homes Pro specialist call (260) 436-5000.
Or fill out the seller questionnaire if you have not done so, by clicking here

Northern Indiana Real Estate Investors Association | 5 Figure Paychecks | Get Unreleased Home Listings | Avoid Any Foreclosure