What is a Short Sale?
A short sale is a real estate transaction where a homeowner sells their property for less than they owe on the mortgage.
Typically, short sales involve a seller that is facing a financial hardship that may prevent them from making their mortgage payments, therefore putting the lender/servicer in a position of choosing between foreclosure or working with the homeowner and their agent to find a buyer to purchase the property at market value.
One main benefit for a seller is that the the lender may accept the sale as payment in full (or “paid as agreed”) for the loan.
The difference between the accepted sales amount and the loan balance is called a deficiency.
Example Of A Short Sale Scenario
John has a $200,000 mortgage balance on a property that is worth $175,000 in today's market. Since John is already a few month's behind on his mortgage payments, he hires a real estate agent to list and sell his property before he goes into foreclosure.
Since there is a difference of $25,000 between what John owes on his mortgage and what the property will sell for, John will have to negotiate a short payoff with his bank in order to proceed with the sale, unless he can personally come up with the difference at closing.
Homehelper Consultants handles scenarios like John's every day, where sellers are upside down by $25,000 to $500,000 and need to find a solution for selling their property and avoiding foreclosure.
What Is A Deficiency?
As mentioned above, a deficiency results when a property is sold for less than the value of the loan on the property. A deficiency is the difference between the sales and loan amounts. Homehelper Consultants attempts to secure a purchase contract that results in the smallest deficiency amount possible. The smaller the deficiency, the more likely the bank will accept the terms of the short sale.
In many states, a homeowner may be pursued legally for a deficiency balance. However, this is not the case in Arizona. As outlined in Arizona Revised Statutes, Title 33, Chapter 6.1, a person may not be sued by his lender if the property is located on 2.5 acres or less and is a single-family residence or duplex. Please note that the statutes only apply to foreclosure and do not specifically pertain to short sales. Understanding the homeowner’s rights through foreclosure greatly impacts the leverage we have in the short sale negotiation – knowing how to utilize this leverage is what separates Homehelper Consultants from the thousands of other agents that are new to the short sale process.
Homehelper Consultants is a team of licensed real estate agents operating under Keller Williams Arizona Realty. We are not attorneys and cannot issue legal advice. We highly recommend that, if you have legal questions, you consult with a licensed attorney prior to pursuing a short sale.
Though a homeowner may not be pursued legally for a deficiency in certain situations, the forgiven debt may be taxable income. Homehelper Consultants strongly encourages all homeowners to discuss this matter with a licensed accountant prior to pursuing a short sale. HHC is not a licensed accounting firm and does not advise clients regarding tax matters.
Why Would A Lender Agree To Do A Short Sale?
Generally, if it is determined that the proceeds the bank will receive in a short sale exceed any other options (usually foreclosure) the bank has to recover its funds, the short sale has a high likelihood of being approved. Of course, there are several other criteria used in the bank’s analysis, hence why it is imperative to have a skilled short sale negotiator representing you in the transaction.
A lender would agree to a short sale for several reasons including:
- The mortgage is in default or foreclosure, and foreclosure is inevitable
- The property is in poor condition
- The homeowner has suffered a hardship and can no longer afford payments
- The area or neighborhood has depreciated in value
- New homes in the area are being chosen over existing homes
- The bank’s shareholders are concerned when there are too many defaulting loans on the books
- Some banks are required to have loss reserves of 6 times the retail value of each REO on hand
- An REO is a liability, not an asset, and too many liabilities will cause the bank to go under
Why Would A Lender NOT Agree To A Short Sale?
There are a few reasons why a lender would not agree to a short sale. These reasons may include:
- Two-thirds of all mortgages are securitized and sold on Wall Street.
- Servicers must abide by agreements with Wall Street investors
- Carrying out a foreclosure eliminates junior liens
- The lender is covered by private mortgage insurance
Who Qualifies For A Short Sale?
Lenders state that the decline in market value of a property below the total debt owed on that property does not automatically qualify a homeowner for a short sale. However, the fact of the matter is that if a bank is faced with a decision to choose between short selling a property or foreclosing on that same property, going the short sale route is almost always the best financial decision for the bank.
Banks take several factors into consideration when determining if they will allow for a short sale to occur.
First and foremost, the bank will evaluate the homeowner’s hardship situation, and will require a written letter that details what is preventing them from being able to continue living in the property or making mortgage payments.
What Are Typical Hardships?
- Unemployment or Reduced Income
- Medical Emergency
- Job Transfer
- Adjusted Interest Rates & Increased Mortgage Payments
After evaluating the hardship, the bank will analyze the homeowner’s current financial situation by requesting items such as bank statements, pay stubs, tax returns, and/or other relevant financial detail. The reason for this is twofold – first, the bank wants to corroborate that what is stated in the hardship letter ties to the homeowner’s financial data, and next the bank wants to be assured that the homeowner does not have significant cash reserves that could be utilized to make future mortgage payments.
Current Housing and Short Sale Market Statistics
Across the nation, nearly one in every seven homeowners owes more on their mortgage(s) than their property is currently worth. That is roughly 12 million homeowners; nearly double the number “upside down” at the end of 2007 according to Moody’s Economy.com (www.economy.com). In Arizona the ratio of homeowners underwater is even greater; approximately one in every four homeowners owes more than their property is worth according to recent data published by the Arizona Republic (www.azcentral.com). The majority of homeowners in this predicament purchased their properties between 2003 and 2007.
Nationally, home prices dropped roughly 10% in 2009 bringing to about 14.6 million the number of homeowners upside down by the conclusion of the year. By contrast only 2.5 million homeowners had negative equity in their properties in 2006. Leading economists believe a rebound in the housing market is still months if not years away. To make matters worse nearly $500 million worth of adjustable rate mortgages are expected to reset from mid 2010 through 2012, driving up monthly mortgage payments for homeowners. This could potentially lead to a new wave of foreclosures that will ultimately drive prices down and leave even more homeowners underwater.
Given this data, if a financial hardship exists homeowners are clearly left with few options in order to avoid foreclosure and salvage their credit. For many Arizona homeowners the short sale is a viable solution to the problem.
Laws That Impacts Short Sale Transactions
In December 2007, the United States Government passed H.R.3648 Mortgage Forgiveness Debt Relief Act of 2007 (“Mortgage Cancellation Relief Act”). The Act amends the Internal Revenue Code to exclude from gross income amounts attributable to a discharge, prior to January 1, 2010, of indebtedness incurred to acquire a principal residence.
What does this mean to you?
This means that, in most cases, when a short sale is negotiated on a homeowner’s primary residence and the lender(s) opts to cancel or forgive the remaining debt (deficiency amount) the cancelled debt is no longer taxable income to the homeowner. Prior to this Act, the homeowner had to report the cancelled debt as taxable income. This usually resulted in a hefty, unaffordable tax bill! Needless to say, Homehelper Consultants strongly encourages all homeowners considering the short sale to speak with a licensed accountant to learn if they qualify under the conditions of the Mortgage Forgiveness Debt Relief Act. There may be other alternatives to limiting the potential tax liability resulting from the sale that a licensed accountant may be able to assist you with as well.
HHC has successfully negotiated and closed over 600 short sale transactions since 2006, and we fight hard to protect our sellers from deficiency judgements or owing money at closing. Contact us today for a strategy session.