I recently re-read the materials for a legal seminar I attended in 2012, How to Deal with Troubled Real Estate Loans. The seminar covered topics from refinancing to foreclosure, topics that were very relevant at the time. While the housing market has clearly re-bounded, we’re not yet in the clear. Accordingly, I think it appropriate to briefly review one of the more common ways to avoid a foreclosure – the short sale.
A short sale is the sale of real property – home, condo, cabin – for less than the amount owed the lender. For example, a short sale would be like trying to sell a piece of property for $80.00, presumably the fair market value, when the mortgage is worth $100.00. Because of the potential risk factors faced by a lender, and the likely loss in revenue, acceptance of such a proposal is ultimately left to the lender. In making this decision, lenders are known to consider the following:
- The borrower’s financial condition;
- The property’s “as is” value;
- The cost to put the property into resale condition;
- The property’s value after repair;
- The cost of securing and maintaining the property while it is being marketed for sale; and
- The cost of marketing and selling the property.
Most lenders will also focus on the borrower’s financial condition and whether he or she has the ability to pay any potential deficiency. A deficiency is the difference in amount between the eventual sale price and the amount still owed on the mortgage; it’s the $20.00 between $100.00 and $80.00 from the above example. It is crucial for the borrower to know whether they will be left responsible for this amount. Read, and then re-read the short sale agreement before signing. Look for language stating that potential deficiencies will be satisfied by the borrower. If you are unsure, contact an attorney familiar with these transactions. As a borrower you may not be in the best position to negotiate, but you still have the power to say no.
Most lenders subject their borrowers to a financial hardship test before deciding whether to accept the short sale offer. The following are common situations examined:
- The borrower or an immediate family member experienced a catastrophic illness that destroyed his or her financial position;
- The borrower’s spouse died or the couple divorced and the borrower does not have sufficient income to make the mortgage payments;
- The borrower was transferred by his or her employer and can’t sell the home;
- The borrower was called to active military duty for an extended period and can’t make the mortgage payments;
- The borrower suffered a disabling illness or injury and can’t work again;
- The borrower lost his or her job and has no chance to get a job given current economic conditions;
- The borrower is financially insolvent and there is no expectation for his or her financial situation to turn around in the near future;
- The borrower is in jail and doesn’t have the income to make the mortgage payments.2
If the borrower, lender, and potential buyer can all agree, the short sale will likely proceed. Please remember that while entering into this type of transaction will prevent foreclosure, a short sale will have a negative impact on the borrower’s credit.