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Understanding Short Sales

A short sale occurs when an existing mortgage lender agrees to accept payment in an amount that is less than what is currently due under the promissory note (thus falling "short" of what they are owed). A mortgage lender might agree to to forgive the remainder of the debt when the time and expense of a foreclosure proceeding, and selling the property at auction, is not a realistic alternative.


When most property owners purchased their homes, they envisioned that its value would increase and when it came time for him or her to sell, the sale price would be high enough to payoff and release all mortgages on the property. However, when market prices fall, homeowners experience a decrease in their home equity which significantly affects the ability to refinance or sell at a high enough price. When this is coupled with an adjusting loan, or other hardship, it might become impossible for the homeowner to meet his or her financial obligations. In such a situation, the homeowner may not have any other option other than to negotiate a short sale to avoid foreclosure.


The following are some factors that make it more likely that a mortgage lender will agree to accepting less than what they are currently owed:

* The homeowner is unable to make payments as evidence by at least two months of missed mortgage payments.
* The homeowner’s default is due to an unavoidable hardship which can be adequately documented and described for the mortgage lender.
* The homeowner’s hardship is likely to endure for the foreseeable future.
* The mortgage that is in default was obtained within the last five years.
* The homeowner uses the property as his or her primary residence, and not as a vacation home or investment property.
* The homeowner was provided with a loan that contained unfair terms.
* The real estate appraises for at least seventy 75% of the unpaid balance of the first mortgage.
* The contract price is for about 95% of the appraised value.
* The net amount to the lender on the HUD Settlement Statement, after all closing expenses, is at least 87% of the appraised value.


Keep in mind that a typical short sale will normally take about 4 months to complete but can take even longer. It is therefore important to plan for this extended time frame and set realistic dates from the very beginning. Typical steps included:


* Hiring an attorney to help you navigate through the process that is ahead of you, and a certified public accountant to determine whether any adverse tax consequences could result (forgiven debt can constitute income under IRS guidelines).
* Having your Realtor determine the fair market price and begin listing the property.
* Obtaining your lender’s short sale package from its "loss mitigation department" (or "home retention department") and beginning the assembly of the necessary information with your attorney.
* Obtaining an offer on the property to provide to your lawyer so he or she can submit it to your lender with any other required documents.
* The lender then conducts an appraisal and verifies whether the offering price is reasonable. If not, more substantial negotiations will ensue and a cash payout over a certain number of years after the closing may be required.
* The transaction is approved by the mortgage lender in writing and a letter is provided ideally stating that the lender will not pursue a deficiency judgment against the owner (not all lenders will state that they will not pursue a deficiency action and may leave leave this open ended).


Your lawyer will typically need to submit all of the following documents to your lender’s loss mitigation department:

* A signed letter from the homeowner authorizing his or her attorney (and/or real estate agent) to communicate with each mortgage lender. The letter should include the owners names, property address, social security numbers, loan number, and contact information for the seller’s short sale attorney.
* A preliminary HUD-1 Settlement Statement which provides a breakdown of all of the estimated closing costs that will be deducted from the lender’s proceeds at closing.
* A letter stating the reason for the unavoidable hardship which lead to the default, and a request for the mortgage lender to accept less than it is currently owed on the loan. Some examples of unavoidable hardships might include death or illness within the family, job relocation or loss of employment income, divorce or separation, adjustments in mortgage payments, etc.
* Proof of income and assets will need to be provided in the form of original pay stubs, bank account statements (usually 2-4 months), tax returns, W-2 forms, and 1099 forms. Each page of any document to be submitted will need to be marked with the mortgage account number. Large deposits and cash withdrawals on any account statement will likely need to be fully explained to the lender.
* The comparative market analysis showing pending and recent sales of similar homes in the area will need to be prepared and submitted by your real estate broker.
* A copy of the Offer to Purchase and Listing Agreement (the lender might require you to make a counter offer or renegotiate other terms, fees, commissions, etc., if the asking price is too low).


A homeowner can expect a loss of at least 100 - 200 points on their credit report after a short sale which is generally less than would be expected from a foreclosure proceeding (between 200 and 300 points).  Another benefit of a short sale, is that the waiting period to buy another home is much shorter. After a foreclosure proceeding, the homeowner likely will not have enough credit to purchase another home for about 24 to 72 months. After a short sale, Fannie Mae guidelines only require a 24 month waiting period before eligibility.


A short sale might not be an option for every homeowner and it must be compared against foreclosure, and other debt forgiveness options like modification, "deed in lieu" or foreclosure. An attorney, realtor, and accountant should be a part of every transaction to help you market the property, and navigate through the complex legal and tax issues you will likely encounter.

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