Sunday, March 1, 2009

Short Sale for Sellers

I have written several blogs about short sales, the last of which was specifically geared towards buyers, this blog will be addressing sellers.

So you have to sell your home for one reason or another but you owe more on it than it is actually worth. You have heard from friends and the “internet” that you can do a short sale and once it’s over, life is good!!

Well that could be true depending on many variables. Getting a short sale transaction approved and closed is a very complicated matter and in most cases will require the assistance of a few professionals.

First of all, let’s define a short sale: It is a transaction where a buyer purchases a property from a seller and gets “clear” title to the property. The buyer is always encouraged to buy title insurance. Not much is really different for a buyer other than some potential delays and frustration, more on that in future articles.

Things are a little different for the seller, since you can’t sell the property for enough money to pay off your loan(s). You appeal to your lender(s) to accept less money than what they are owed, and if they agree and a sale takes place, that transaction is called a short sale. The word “short” in short sale references the “short pay-off” you will be making to your lender.

How you make your appeal to your lender for accepting less money will vary from lender to lender but I will go over some basic rules. But first things first, let’s talk about those professional services I referenced. You will need a competent Realtor, period!! Trying to do this on your own is very frustrating, painful and in most cases a waste of time and energy on your part. It’s hard enough to sell a property on your own in a good market, trying to sell a property in challenging times, negotiate with the bank, and getting to closing on time is just almost impossible and in my view, unwise.

So a Realtor will be your best friend for a while. Next, you will need to consult with an attorney. Depending on where you live and other variables, there is a possibility your lender can sue you for a “deficiency judgment”, the difference between the short pay-off and the amount you actually owe the lender. For example, if you end up selling your house for $200,000 and make a short pay-off to your lender of $190,000 but you actually owe the lender $250,000, the lender may have the option to sue you for the $60,000. So talk to an attorney!

The lender may decide not to sue you, so they decide to “forgive your debt”. The word forgive is actually deceiving, your lender may decide to forgive that $60,000 deficiency we discussed, but the IRS will not hear of it. You may be getting a 1099-C from your lender, a copy of which goes to the IRS. This $60,000 may now become taxable, depending on your circumstances. The forgiven debt is actually called “cancelled debt” by the IRS and becomes “phantom income”, on which you may have to pay “phantom taxes”. And NO, if you owe taxes, you may not pay your taxes with a “phantom check”!! This brings me to the final professional, a competent accountant, who will quickly become your best friend.

Here are some suggested steps to get this process started:

1. List the property with a Realtor.

2. Start assembling financial information such as W2’s, pay stubs, bank statements, a list of assets and liabilities, and a list of monthly debts. The more you can provide the bank, the better chance you have of getting your file looked at in a reasonable amount of time. The number one cause for delay in a short sale transaction is lenders not having enough information or incomplete packages submitted by sellers.

3. A hardship letter telling the bank the reason why they should accept less money than what they’re owed. It is suggested that you keep this letter brief, factual and as precise as possible. I recommend you break the letter in three categories:

a. Tell the lender the nature of the hardship (job loss, death in family, illness, divorce, acts of nature, job transfer, etc...).

b. Explain to the lender why a short sale is beneficial in this case.

c. Explain your circumstances if a short sale is not approved (foreclosure, bankruptcy, etc...).

Once you have an offer (ratified contract), assemble the entire package and send it to the lender for processing. Check with your bank to see what department to send it to but typically it will go to the Loss Mitigation department.

If you have more than one loan, send a complete package to each lender who is being asked to accept less money than is actually owed.

The lender will typically come back with an answer of Yes, No or Maybe:

“Yes” means they have accepted the offer. An approval letter is generally sent to you outlining the terms and conditions of the approval. Typical approval letters state the minimum pay-off they are willing to accept, the sales price, the amount of closing cost credits to the buyer, if any, the total commission to the Realtor and in some cases the letter will disclose what the lender intends to do with the deficiency amount.

Some lenders will actually commit to forgiving the debt and issuing a 1099-C on the approval letter, others will state they reserve the right to collect the debt while others will not say anything at all regarding deficiency, in which case you should know the lender is reserving the right to collect at a future date.

“No” generally means no deal but sometimes it means they want more money.

“Maybe” is where it gets interesting, the lender may want you to sign an unsecured note for part or all of the deficiency. The lender may want you to bring some cash to the table in lieu of paying the note in full. The lender may not ask for anything but after closing takes place they may send the account to collections for the deficiency. There are many ways this can go down so please make sure you have competent professionals helping you throughout this process.

Remember, when dealing with any Loss Mitigation department, their number one priority is to minimize the lender’s losses, not yours, hence the name “Loss Mitigation”. They are required to do what’s in the best interest of the lender not the homeowner. If the lender’s best interest happens to be also in your best interest, then it’s a win-win situation.