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What’s A Short Sale?

Q: We are in financial trouble. Our house will not sell for enough money to even pay off the mortgage, let alone a real estate commission. Our real estate agent suggested that we do a “short sale”. What exactly is this?

A: This is a method of disposing of your home without having the lender foreclose on you. You are unfortunately what lender’s call “upside down”.

Let’s take this example: you bought the house last year for $500,000, and foolishly took advantage of the mortgage broker’s sales pitch and obtained a 100 percent loan. Now, the house will probably only sell for $475,000, and you lost your job and cannot afford to continue with the monthly mortgage payments.

A short sale is an arrangement with your lender whereby they will allow you to sell the property for less than the amount of the current mortgage.

Why would a lender permit this? First, you should understand that not all lenders will allow a short sale. Their decision depends on a number of factors: where is your house? how much loss will the lender suffer? What is the possibility that a speculator/investor will buy at a foreclosure sale?

Lenders have their own requirements, so I can only provide general information; you will have to consult your specific lender to determine what they need in order to move forward with the short sale process.

The first step is to contact your financial and legal advisors. Do not contact the lender until you fully understand the potential risks involved. Under Federal law, when a debt is forgiven, it can be treated as ordinary income on which tax must be paid. Thus, if your lender allows you to sell the property to $475, less a 2 percent commission, you will pay off your $500,000 mortgage and have a deficit of almost $35,000. According to many tax professionals, you will have to pay income tax on this amount even though you did not actually receive the money.

Furthermore, you want to make absolutely sure that even should the lender approve the short sale, you will not be obligated to make up this difference, which is called a deficiency, Unfortunately, most lenders will not put their agreement in writing, so your legal advisors will have to satisfy themselves – and you – on this matter.

In fact, many lenders have been known to use this “forgiveness of debt” issue as a way of dissuading their borrowers from pursuing the short sale approach.

After you are satisfied that you understand the concept and are prepared to move forward, you should contact your lender. Go up the corporate ladder as high as you can and talk with the manager of the short sale department. Typically, the lender has a “loss remediation” department that handles these matters.

If you have authorized your attorney or your real estate agent to act on your behalf, the lender will need a letter of authorization from you. The Privacy Laws enacted after 9-11 prohibit lenders from discussing personal and financial information with a stranger without such written authorization. This letter will include your name, property address and loan number.

You (or your agent) should then prepare a comprehensive letter explaining why you are requesting the short sale. Emphasize – but not as a “sob story” – your hardship. It would also help if you include a market analysis which will show what houses in your area are currently selling for. And finally, spell out your request in detail: what price are you asking the lender to approve, what percent commission will the real estate agent be allowed to accept, and what closing costs will be associated with the settlement. Keep in mind that in many jurisdictions, there is a recordation and transfer tax which is typically split between buyer and seller.

Your proposal should be as specific as possible. You don’t want to learn at settlement that you still have to come up with a lot of cash, because your lender did not authorize certain out-of-pocket expenses.

You should also request from your lender the amount of your outstanding balance. The lender has a legal obligation to provide this to you on request, and the burden is on the lender to provide an accurate accounting. Review this carefully to make sure that there are no charges which have been erroneously added. If you have missed some payments, you will be assessed late fees. When you present your proposal to the lender, try to get these charges deleted from the amount of the outstanding mortgage balance.

Your proposal should also include your financial situation. Keep in mind that many loans in the past few years were what are called “no-doc” – in other words, the lender made the decision to fund your loan based on the value of the property and not on your financial status. In your case, since you lost your job, include proof with your letter.

The more documentation you can provide the lender, the faster the decision will be. However, currently lenders are swamped with these requests, since you are not the only one facing a possible foreclosure.

Thus, the earlier you can start the process, the better chance you have of getting it approved. But the lender’s approval to proceed with a short sale does not end the process. When you or your real estate agent find a prospective purchaser, the contract must state that it is contingent on lender’s approval. You have to send the contract to the lender, and it would help if you would include an accounting of all expenses which you will have to pay at settlement, and a final number that the lender will receive when settlement takes place.

In fact, if you can have a HUD-1 settlement statement prepared, this would be helpful and would expedite the process. Your lender will then review the documentation, and may reject certain expenses. For example, if the contract provides that you will give your buyer XX dollars for “closing costs” – or that you will pay some items which are traditionally the buyer’s obligation (such as title search and survey) – the lender may not allow such payments.

You want to go into the settlement knowing exactly all of the terms and conditions on which your lender will accept the short sale, including whether or not you will have to come up with money at the settlement table.

You are in financial trouble. If you have already missed some payments, your lender may already have reported this information to the credit reporting companies. You should try to convince the lender not to report any more delinquencies, but unfortunately, that’s in your lender’s sole discretion.

The short sale process works, but is complicated, time-consuming and uncertain. If you can start now – before you are actually in default – you will be ahead of the game.