I thought this piece from Greg Fielding, a longtime real estate agent, was especially informative. Greg has experience in selling high end property and low end foreclosures, raw land, short sales, development work, apartment buildings, and working with investors,
He blogs at Bay Area Real Estate Trends, about both local markets and the bigger global environment. He covers most of Alameda and Contra Costa counties and lives in Danville with his wife and three kids.
A Short Sale is a very different type of transaction than a normal sale with equity. Parties in the transaction have a different set of priorities, expectations, and concerns. The Short Sale Listing Agent needs an entirely different skill-set.
Here is everything you need to know about how a short sale works. (from a Seller’s perspective
Most of the same considerations you would have when selling under normal circumstances still apply: De-clutter, touch-up the paint, keep the landscaping tidy, etc. Here are some of the extra issues that Short Sellers face and some questions they often ask…
What should you look for in a Listing Agent?
More than anything, you need an agent who has a decent amount of experience with short sales and has shown exceptional market knowledge. Fancy fliers, glamour-shots, and a “neighborhood specialist” won’t do you any good in a short sale. And don’t hire a “Short Sale Expert” just because they call themselves one.
A great Short Sale Listing Agent will have:
- Good Short Sale experience. Seeing as how we’ve been doing them for 4 years, an agent you hire should have done at least 20 or so successful short sales. Be wary of someone who says they’ve done hundreds…many of them won’t have the time or inclination to give you the extra effort when you need it most.
- Excellent industry and market knowledge. Short sale transactions are so much longer and more complex. It seems like there are a lot more things to go wrong. A good short sale agent needs to understand appraisals, different lending standards and practices, inspection and repair issues, and generally be the kind of person who can come up with the solutions needed to keep a deal moving forward.
NOTE: Some agents hire outside short sale negotiators to process the transaction with the Seller’s bank. If you are hiring an agent is going to effectively outsource their work, it is really this other company you are hiring. Ask tough questions accordingly. The biggest concerns here are that your listing agent may not be engaged and working as hard to keep your deal together AND some of these outside firms may charge you additional money.
Should you stage or spend any money on repairs?
No and No.
Do you have to be behind on your mortgage payments?
This is one of the most common misconceptions about short sales. I have personally closed short sale transactions where the sellers never missed a payment.
The issue is one of hardship. The bank will want to see that you have a legitimate reason why you can’t continue making your payments. If you have a legitimate, provable hardship that justifies why you cannot continue to own the house, then you will be a great candidate for a short sale even if you are current on your mortgage. On the same note, exaggerating your pain by not making your payments when you still could probably isn’t going to help you any. The bank will see your pay stubs and your bank statements anyway.
Obviously, credit scores are a big concern for Short Sellers. In theory, a Seller with zero or very few missed payments will have less credit damage than a Seller with many months of missed mortgage payments.
Having said that, I’m not necessarily recommending that would-be Short Sellers continue making their mortgage payments. There are other factors to weigh in that decision…
Should you stop making your mortgage payments?
When making this personal decision, ask yourself the following question: “If the short sale doesn’t work, will I walk away anyway?”
If the answer is no, then maybe keep paying. If the answer is yes, then preserving cash may be the highest priority.
For most Short Sellers, keeping their homes is simply not an option and the cash saved by skipping mortgage payments is far more valuable than a less-bad credit score. Especially if the mortgage payments are high, it gets hard to justify sending more money into what is effectively a black hole.
Should you pull money out of your retirement to pay off the bank?
If it’s a small amount, something that you could easily pay back in a reasonable amount of time, then borrowing from family, credit cards, or even your retirement might be worth preventing a short sale. Paying the bank back in full at closing will save your credit.
Just give careful consideration to what your credit is actually worth. Even with a short sale, you can buy a house again in a few years. You can probably even get a car loan pretty quickly, if not right away…the only issue might be that you could end up with a higher interest rate. Besides, are you really going to need much credit for the next year or two anyway?
Is it more financially-prudent to possibly pay $40 more per month on a car loan? Or owe $30,000 to your uncle?
Should you file bankruptcy?
First of all, that’s a question for an attorney, not a real estate professional.
If you only issue is the house, then the answer is likely no. There probably isn’t anything about the home sale that should cause you to need to file bankruptcy. And, filing bankruptcy probably won’t (at this point) relieve you of the mortgage debts you owe.
I can tell you that a bankruptcy filing will complicate the short sale because not only would we need your lender’s blessing, but that of your bankruptcy trustee as well. This extra step can cause delays and potentially kill a deal.
Generally-speaking, your real estate transaction will go a lot smoother if you can delay filing bankruptcy. Please consult an attorney when deciding what to do.
When marketing your short sale, you can probably skip some of the steps that traditional sellers take.
How much should you list your Short Sale for?
You need to show the bank that you made a decent effort to get them a fair price. Too many Agents and Sellers make the mistake of underpricing property and then having the Seller’s bank reject the offer. Try to figure out what your house might reasonably appraise for and list at that price.
Then, if you don’t get any offers after 3 weeks, drop 5%. After another few weeks, drop again. And again, if necessary. Essentially, just keep dropping 5% or so every few weeks until you sell. By starting at a fair price and making reasonable drops, you show the bank that you are operating in good faith to obtain a fair offer.
What Marketing Do Short Sales Need?
Just put it on the MLS and let your agent to their thing. Flyers, open houses, broker’s tours, newspaper ads…none of these things will benefit you in any way.
Negotiating Your Short Sale with the Buyer
When an offer does come in, setting the Buyer’s expectations is key. Your Agent should let them know that it could take several months to get a response and try to gauge how likely they are to stick with you. Remember, the best offer is the one that will close at the best price.
Other than contract clean-up, don’t bother haggling over the price as long as it is in the right ballpark. Sellers should let their bank guide them in any counter-offer…even if it takes a few months to get to that point.
If you counter-offer a reasonable Buyer to come up in price, three bad things could happen:
- The Buyer could get mad and walk – and maybe the bank would accepted their offer as it was.
- If the Seller’s bank requests another counter, the Buyer could get mad that they now have to negotiate a price a second time (meaning the initial negotiations were a misleading waste), and they might be more likely to walk away.
- If the Seller’s bank doesn’t counter, the Buyer could get upset that, thinking that their original, lower offer might have been accepted as well and that they could have paid less.
In a normal transaction, the Buyer and Seller negotiate with each other. In a short sale, the spirit of the negotiations change: it becomes the Buyer and Seller working together to get the deal approved by the Seller’s bank.
There is no reason for hardball negotiation. Buyers and Sellers will need to maintain a good relationship for several months for the short sale to be successful. Start off on the right foot!
Remember that for a bank to approve a Short Sale, they are really approving two things: the Offer and the Seller.
Here are the basic components of the Short Sale Package that Seller’s Agent will submit to their bank:
Bank Authorization Letter for the Listing Agent
This is a short letter from the Sellers to their bank, authorizing that bank to share their personal information with their Listing agent. The account number needs to be at the top and it needs to be signed and dated by all sellers on record. The text should be short and sweet something like:
“We hereby authorize you to share our personal information with AGENT NAME from AGENT’S COMPANY.”
Be sure to include the Agent’s contact info. Your agent should be able to type this letter for you and have you sign it.
Last Two-Years of Tax Returns
Assuming you’ve filed.
Last Two-Months Bank Statements
(These will likely need to be updated before final approval)
Last Two-Months of Pay Stubs
(These will likely also need to be updated before final approval)
Monthly Cash-Flow Worksheet
Some banks will provide this after the Short Sale Package is submitted. Basically, the bank wants a quick, one-page sketch of your monthly cash-flow. Write down how much monthly income you have, then show your expenses as line items and subtract. Including your mortgage, you should be negative.
A Short Sale Hardship Letter
The whole point of a hardship letter is to explain to the bank how your personal financial situation has changed since you took out the loan. They will want to see specifics: medical issues, job-loss or pay reduction, legal problems, etc. From the bank’s perspective, if nothing has really changed since the money was borrowed, then the Seller either lied then or is lying now and they may not be cooperative.
Again, short and sweet. Keep it to one page.
Copies of all Contracts
The short sale package will include a copy of the listing contract with your agent and a copy of the fully-executed purchase contract with the Buyer, including a pre-approval letter from their lender.
The HUD (Estimated Settlement Statement)
The escrow company will prepare an estimated HUD, which will show the Seller’s lender all of the transaction costs and detail exactly how much money the bank is going to get at the end. The escrow officer should estimate costs based on a close date at least 90-120 days out.
NOTE: The Seller’s bank will pay real estate commissions, taxes, and most other normal closing costs.
All together, a Short Sale Package can be hundreds of pages. The agent will add a cover page and usually fax this package to the bank’s Loss-Mitigation Department. In some cases (Countrywide for example) these papers are actually faxed to India, where they are sorted, scanned, and send back to the Loss Mitigation Department here in the U.S.
It can be frustrating just getting a complete package to a lender. Pages don’t always fax clearly or even get lost. And, it can take a couple of weeks sometimes for a lender to even be able to tell you if they received your fax.
A thorough and persistent Agent will help make sure that the bank has everything they need as quickly as possible.
Processes vary slightly from lender to lender, but generally share the same major components. Here is a roadmap for how the typical short sale approval process…
The Set-Up Department
Most banks have a department whose job it is to make sure that the short sale package is complete and correct before passing the file on to the next department. The listing agent must call into the bank and reach someone in this department as soon as possible to confirm that the file is complete and moving on to the next stop.
If the agent doesn’t follow up, the file won’t go anywhere because nobody from the bank will ever call the agent to say that something is missing.
After Set-Up, the file is typically moved to a “Phase One Negotiator,” where a BPO can be ordered.
If the Listing Agent is on the ball, a file can typically move from Set-Up to Phase One in 1-2 weeks.
Phase One: Ordering a BPO
When a file is moved from one department to another, it goes back to the bottom of the pile. You may have been assigned an actually Phase One Negotiator, but several weeks could pass before they even look at the file. There is usually no direct phone number, no e-mail, and no good way to get a hold of them.
Some banks have a policy where, if you haven’t heard from your Phase One Negotiator in 30 days, then you can escalate your complaints to a supervisor (who may have a week to get back to you). Depending on the workload and the quality of your negotiator, this process can move quickly or slowly and a persistent agent can make a big difference.
When your Phase One Negotiator opens your file, the first thing they’ll do is order a BPO.
A BPO (Broker’s Price Opinion) is similar to an appraisal, except it is done by a real estate agent and the bank pays them $50-$100 vs $300-$500 for an actual appraisal.
When the order goes out, it takes a few business days to actually be assigned to a BPO agent. That agent then has a few days to get it done and return it, where it goes back to the Phase One Negotiator.
If the BPO value and the offer price are close enough, and the rest of the file is complete, the Phase One Negotiator will send the file up to a Phase Two Negotiator. Often, the bank will need updated bank statements and pay stubs.
NOTE: The bank will NOT share the BPO with you (don’t even bother asking).
On average, another 30-60 days has passed at this point, bringing the total to around 60-75 days.
Phase Two: Negotiation and Acceptance
It will probably take the Phase Two Negotiator a week or two to get to the file. Their job is to submit the file to the investors for approval. Depending on who actually owns the loan (remember, this is the Loss Mitigation Department of the servicer, not necessarily the lender) this could be a quick or slow process.
If the Investor wants more money, the Phase Two Negotiator will verbally tell the Listing agent where the price needs to be to get the deal done. At that point, the Seller’s would send a counter-offer to the Buyer. If the Buyer accepts, great. If not, then the investors may choose to accept or decline the short sale.
If the investor accepts the deal, the Phase Two Negotiator will send a letter to the Listing Agent, detailing the terms of the acceptance. In general, the Short Sale Approval Letter will:
- Acknowledge the purchase price, list allowable fees (including commissions), and give a net dollar amount that the bank will accept as payoff.
- Detail that this short payoff either extinguishes the debt, or that the bank may continue to pursue collections after the sale.
- Have an expiration date, usually about 30 days from when the letter is written.
- The dollar amount that they will pay the second lender (if applicable).
- Detail any other terms.
If the Seller is comfortable with the terms in this letter, they can sign it and submit a copy to the Buyer. In California, this would serve as written proof of bank approval of the short sale and the normal escrow process would begin.
If the Seller is not comfortable with any of the terms in the letter, they may be able to negotiate. For example, a seller may demand that the debt be officially extinguished and often the lender will agree to this request.
Getting Short Sale Approval From the Second Lender
If there is a second lender involved, the Listing Agent would send them the same Short Sale Package and manage the approval process with both banks concurrently.
A couple of differences:
- The second lender may not bother ordering a BPO.
- The second lender will not send any type of written approval until after the first lender approves the deal.
Once the second lender sees how much the first lender will pay them, they will either agree to the deal, or demand more money. If they demand more money, the Listing Agent has to negotiate with the Phase Two Negotiator to strike a deal. Typically, the second lender will demand 10% of the loan amount while the first lender will try and offer them $2,000-$3,000.
Obviously, an experienced and savvy Listing Agent can be a tremendous asset at this point.
FRAUD ALERT: Increasingly, second lenders are asking either the Buyer or Seller to send them extra cash, outside of escrow, for them to approve the deal. This is fruadulent and illegal. However, the Buyer or Seller may send extra cash to the second lender IF the first lender knows about it. So get the blessing from the first lender first, and put it on the HUD where everyone can see it.
NOTE: If there is a second loan, but it’s with the same bank as the first loan, they are usually handled together.
This negotiation process and actually getting the approval letter(s) can take another 1-2 weeks. On average a Short Sale will can go from initial submission to full approval in about 90 days. Sometimes it’s faster. Some banks, like Wachovia, can approve a short sale in about 3-weeks. Others, unfortunately, still can take 4-6 months.
Most banks will send the file to a Phase Three Negotiator, who manages the escrow period and closing of the file.
Once official notice is given to the Buyer, the traditional escrow process begins. The Buyer will order their appraisal and any inspections. If, as a result of inspections, the Buyer requests credits for repairs, that request, along with the inspection reports, will go right to the Phase Three Negotiator. They will either approve the credits, or deny them. And the deal will either proceed, or start all over again.
Just before close, the escrow company will send an updated HUD to the Short Sale Lender(s) to sign and approve one last time. They will look to make sure that the credits, expenses, and net proceeds match what they had approved in their approval letter.
Sometimes it happens where the buyer needs some extra time to close the deal. If this happens, the Listing Agent must obtain new approval letters with extended close dates. Generally, though not happy about it, banks will cooperate.
There are three general reasons why unsuccessful short sales die:
- The Seller has no hardship and/or has plenty of money, causing the bank to decline the deal or to refuse to extinguish the debt. Here, the Seller may have no choice but to foreclose and deal with the consequences.
- The property is too close to foreclosure and the bank would rather just foreclose.
- The Seller changes their mind and decides to try some sort of loan modification instead.
Regarding a modification, know that most banks will solicit Short Sellers and try to get they to agree to a modification instead. As the months wear on and morale is low, some Seller agree to this because it’s the easiest way to end the misery of short sale limbo.
It is fairly common that the initial buyer – the one who’s purchase contract was sent to the bank in the Short Sale Package – will give up and go buy a different house instead. For a Seller, this is certainly a setback, but it’s not the end of the world.
In fact, that first, false Buyer did the Seller a favor: they got the short sale process started. Now, the Seller can go back on the market and let a prospective new buyer know that they are that much closer to short sale approval.
Maybe the BPO has been done. Maybe the bank had even accepted a purchase price. New Buyers might be thrilled to submit an offer knowing that the bank will respond more quickly.
The Listing Agent will quickly get the new contract and new HUD over to the negotiator and the process should keep moving forward.
It’s not uncommon that the eventual Buyer is the second or third Buyer that a Seller contracts with. Again, a savvy and experienced Listing Agent can really help at this point, both by getting more Buyers excited and by keeping the process moving smoothly at the bank.
IMPORTANT: Don’t tell the bank the deal died until after you get a new buyer! If you do, you may have to start all over.
It is critical to understand that, Sellers could face credit, collections, and tax consequences as a result of their short sale.
Everyone wants to know the impact on their credit scores, but there is no clear answer. As it stands today, Short Sellers may qualify for a Fannie Mae or FHA mortgage after 2-3 years, but these rules are always changing.
Regarding collections, one of the big advantages of a short sale is that you have a change to negotiate with your creditors up front. If they say that they will remove the lien from the property, but refuse to forgive the remaining debt and intend to collect, try hard to negotiate a beneficial outcome. Generally, it is true that whatever collections consequences a Seller may face after a short sale, they would face the same consequences, or worse, with foreclosure.
However, there may be instances where a Seller is better off foreclosing than doing a short sale. If you are unsure about your situation, please speak with an attorney.
Regarding tax consequences, President Bush signed the Mortgage Debt Forgiveness Relief Act, which absolved Short Sellers of the federal income taxes owed from certain forgiven mortgage debt. From Wikipedia:
The Mortgage Forgiveness Debt Relief Act was introduced in Congress on September 25, 2007, and became law on December 20, 2007. This act offered relief to homeowners who would formerly owe taxes on forgiven mortgage debt after facing foreclosure. The act extends such relief for three years, applying to debts discharged in calendar year 2007 through 2009. (With the Emergency Economic Stabilization Act of 2008, this tax relief was extended another three years, covering debts discharged through calendar year 2012.)
Normally in US law when a lender decides to forgive all or a portion of a borrower’s debt and accept less, the forgiven amount is considered as income for the borrower and is liable to be taxed.
However, after the signing of the Mortgage Forgiveness Act, amendments have been made to remove such tax liability and allow the borrower and lender to work freely together to find a common solution that is beneficial to both parties.
There may still be State tax liabilities and liabilities on second mortgages and home-equity lines of credit. Also, this program only applies to principal residences. Please consult a tax accountant if you have any questions regarding your potential tax liabilities.
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