A short sale is an “arrangement” between the current owner of a home and the bank that lent them the money to buy their home to accept an offer for less than the total amount owed to pay off the home. The “deficiency” is the difference between the amount owed and what the bank collects at the short sale.
Although, the “arrangement” can take many different forms, there is no other definition of a short sale. I say this because many realtors and some investors simply throw the term around as if it meant “a sale under market value.” No. A bank owned (foreclosed) house is not a short sale. A seller deciding to lower their price and take less profit is not a short sale. An old lady that owns her home free and clear, selling a $150k home for $75k, IS NOT A SHORT SALE. For it to be a Short Sale, someone must be getting “shorted.” Either the seller, or the bank. I will explain how both of those happen in more detail presently.
Another important definition of a short sale is how it differs from foreclosure. In foreclosure, the homeowner falls way behind on their payments and the bank repossesses the house and sells it. In almost all cases, THE BANK PURSUES THE HOMEOWNER FOR THE DEFICIENCY!!! No one seems to know or believe this, but just ask someone who has gone through foreclosure, they will tell you the only way out of this was to file bankruptcy.
How It Can Happen – The Arrangement
Most short sales arise when a seller owes more on their house than they can sell it for (upside down). The owner of the home then attempts to make an arrangement with their lender to sell the house for less than is owed.
The term “arrangement” was used in the definition and is intentionally broad because the arrangement depends on the bank that holds the loan. Though there are general practices, every bank does it differently. This article will give you the most common arrangements, but if you take part in a short sale, it’s crucial you assume nothing until you have the bank’s policies in writing.
There are some overriding principles:
- 1. There is no such thing as a free lunch. This is not some dream come true alternative to foreclosure where the money you owe magically disappears. The deficiency will be accounted for. The deficiency can be 100% loaned to the seller in the form of a promissory note, which they then must repay.
- 2. It is a cumbersome process. If you are entering into a short sale as a buyer or seller, don’t expect it to go as quickly as any other sale. There’s a lot of “back and forth”.
- 3. The employees of the lender that are negotiating the sale ARE NOT there for the benefit of the seller. Their only goal is to collect as much money possible for the lender and they will use whatever means necessary. You can be sure they will misrepresent their own policies and flat out LIE to the seller in order to intimidate and scare them into paying more money. If you think I’m exaggerating, the joke will be on you.For instance, I was once told by a lender negotiating a short sale that, as a policy, they don’t “write off” any of the deficiency and that the seller would have to have a promissory note for $40,000. This lender also told the seller that their hands were tied and this decision came directly from the investor who provides the money for the lender. The lender also said there is absolutely no negotiation on the amount owed, either pay the deficiency, or they will foreclose. The lender made the promissory note very manageable (20 years 0%) so that the seller would be more enticed to just roll over.But the seller called the lenders bluff. The seller then provided a letter from an attorney stating they would qualify for a bankruptcy, thus rendering the lender incapable of collecting anything. That same day, the lender called the seller saying they would reduce the promissory note and write off $30,000 of the debt! It would have to be reported as 1099 income, but it would not have to be paid. Amazing change of policy! Then the seller saw what was happening and just said, “no thanks, we don’t want to owe you anything, we’ll just go ahead with the bankruptcy.” Two days later the seller received a written offer that the lender would completely forgive the debt and simply report it as 1099 income! Wow!The moral of the story is that the lenders will LIE to obtain their money. Many of the managers of the collections departments are paid on COMMISSION on how much they collect. Just imagine if that seller had rolled over on the first offer! That employee would have been responsible for keeping $40,000 of his company’s money with one five minute phone call!One other important thing to remember is that if the lender gets the property back (i.e. short sale doesn’t go through), they have to put it up for auction. This creates the risk that additional money will be lost if the house doesn’t sell for what it’s worth. In the case of the example, the short sale offer was for $550,000, and the amount owed was $590,000. The seller faxed in evidence to the lender that most similar houses in the area were now selling for $480,000. So this enabled the seller to make the argument that it was a much more prudent risk to write off $40,000 instead of running the risk of losing $110,000. This enabled the seller’s representative to intimidate the employee of the lender asking him “did he really want to be responsible for losing his company $110k, when he had the option, right now, to settle for 40k?”If it seems like I know a lot about “this example” it would be because I was the mortgage broker for the people making the offer and seller of the property happened to be my wife.
The Details of the Arrangement
Different banks have different policies. The best case scenario is to get a bank that actually “writes off” the deficiency. All that happens here is that the seller has some minor derogatory credit reporting, but doesn’t actually owe the bank any more money. This credit reporting can consist of anything from “creditor settled for less than the amount due” all the way to “foreclosed.”
As the example noted, many banks will do a promissory note for the deficiency.
Some banks are stupid enough to require that the deficiency be paid at closing. Think about it. This does no good because it’s the same thing as the seller selling their house without doing a short sale and simply bringing cash to the table. If a bank tells as seller they need to bring cash to the table in a short sale, they are either idiotic, or more likely LYING.
In cases where the money is “written off” it’s important to understand that the lenders will never actually “write something off.” In most states (I don’t know the law in every state), the lender has the ability to show any deficiency as 1099 income for the seller. All this really means is that the seller has to pay taxes on that income. Depending on one’s situation, it could mean that people that are dependent on some form of aid because of “low income” will have some explaining to do come tax time
Another way that the deficiency can be written off is in the form of a judgment. This will often occur in conjunction with the 1099 reporting. It might say something on the seller’s credit report such as “judgment filed against John Doe in the amount of $xx,xxx by ABC lender.” This will appear in the “public record” section of the seller’s credit report for 10 years (7 years is only for late payments, 10 years for public record info, don’t argue, trust me). It can either show up as satisfied or unsatisfied. Satisfied is obviously better because it means that the worst thing that can happen is that the lender will report 1099 income.
Unsatisfied could be a problem, because it means that a court has found in favor of the lender to collect the deficiency from you. Now they still might simply do the 1099 thing, or they might try to collect it from you. They can keep trying to collect it from you until they get it. They can garnish your wages. Your only hope then is that you qualify for a chapter 7 bankruptcy.
This brings up an important note. NEVER EVER ASSUME THAT A DEBT THAT YOU OWE A LENDER IS GONE UNLESS YOU HAVE THE DETAILS OF THE RELEASE OF THAT DEBT IN WRITING. For instance, someone who had done a short sale had a first and a second loan. The bank agreed to the short sale, which ended up being enough to pay off the first loan, but not the second. The seller had assumed that because the bank agreed to the short sale that they wouldn’t have to worry about the deficiency from the second mortgage. Now they are surprised that they are being pursued for the deficiency. REMEMBER, the lender(s) will always want ALL their money accounted for somehow. NEVER assume something is written off unless you have a formal, signed, written, unconditional release of lien and/or judgment from the lender specifically stating that no further action to collect this debt will be taken.
How did we get to this place in the first point?
A short sale can come about for many different reasons. In my wife’s case, she was the owner of the house and had been making payments. We bought an investment property and put it solely in her name to protect our family in the event that the market took a turn for the worse. It did. We owed 590k, but the best offer we had after 6 months was 550k.
Despite popular belief, YOU DO NOT HAVE TO BE BEHIND ON YOUR MORTGAGE TO REQUEST A SHORT SALE. You just have to demonstrate that your house can’t be sold for what you owe.
In other cases, short sales happen when a seller can’t afford to make their payments and is nearing foreclosure or bankruptcy. It makes life much more complicated if you are living in the house in question. The bank’s ability to scare you is much greater in that case. In this case, a short sale is only slightly better than the alternatives. You will still lose your house, and your credit is still destroyed just because you’ve made 4-5 late payments on your mortgage.
Despite popular belief, A BANKTUPCY, FORECLOSURE, OR REPOSSESSION DO NOT HURT YOUR CREDIT AS MUCH AS THE MULTITUDE OF LATE PAYMENTS THAT OFTEN LEAD UP TO THEM!!!!! I just cannot stress this enough. People think that a bankruptcy damages their credit beyond repair in and of its own accord. I’ve had many clients file bankruptcy with 750 scores and no late payments only to have their score drop to 680. It’s the clients with 20+ late payments that are having their credit hurt.
A final note on how the short sale can come about… Most banks will not agree to a short sale in writing until you have a formal offer. You can simply call your bank and ask them if you could do a short sale at a certain price and they might say “sure, no problem, we’d be happy to facilitate that offer.” BEWARE. That doesn’t mean a thing. Before your short sale is APPROVED, you’ll have to submit an application, hardship letter, financial statements, tax returns, pay stubs, the purchase agreement from the buyer, a HUD statement from the pending transaction, payoff letters from all lenders involved, and several other things depending on the lender.
Once this huge packet of information is submitted to the lender, you will most likely hear back in 1-4 weeks on the TERMS of their “approval.” Be warned their approval will most likely be thinly disguised attempt to collect their debt and will almost never be the “write off” you were hoping for.
If you’re an investor, by now, I hope I’ve scared you off. Short sales are not some magic way for you to find properties under market value. They are a tool for sellers that owe too much on their homes to sell them at market value.
What you are looking for (or should be if you’re not) are sellers that owe far far less on their homes than what they’re worth. Sellers who don’t care how much they earn because they’re either desperate or have so many houses they don’t care.
Still if you see a house you want, there is one way that a short sale could come into play. Say there’s a distressed property that you’d pay 100k for that you know would be worth 180k if it was fixed up a bit. The seller doesn’t have the money to do it and the house is either vacant or they want out of their situation. In this case, if the seller happens to owe 130k (around there), and you will only pay 100k, AND the seller hasn’t had any viable offers because of the level of distress on the property, then a short might be just what the doctor ordered.
Don’t be unethical and take advantage of people. You’re only going for short sales if the person WANTS to sell their house and no one else but you will buy it because you’re not afraid to rehab a house that’s smells bad and is falling apart.
Again, a short sale is not a magic cure. It’s also not some mystical solution that only an elite few know about. If you’re curious about selling your house as a short sale, you should contact your lender and get information in writing. It’s usually not easy, and hardly ever will truly “win.” But in some cases, it can leave you much better off than the alternative of foreclosure and bankruptcy. If you’re an investor, there are much better ways to obtain undervalued homes.
Remember that this is a complex process and you should always seek the help of a professional when considering a short sale. Call or email us for a no cost, no obligation consultation with one of our experts.
Distressed properties or “fixer-uppers” can be found anywhere, even in more affluent neighborhoods. These properties are characterized as poorly maintained and subsequently command a lower market value than other houses in the neighborhood.Before making such a potentially expensive investment, we recommend that you seek out the least desirable house in the best neighborhood in your area; then make some calculations to determine if the potential costs to raise the fixer property’s value to its full potential market value are within your budget.
If you are a first-time buyer in the fixer category, it may be prudent to consider properties requiring only cosmetic fixes rather than run-down houses that need major structural or complex restoration.
Are there programs for fixer-uppers?
If you require financing to buy a “fixer-upper” and remodel it, consider the U.S. Department of Housing and Urban Development’s Section 203(K) loan program, structured to facilitate major structural rehabilitation of houses with one to four units that are more than one year old. Condominiums are ineligible.
A 203(K) loan is usually done as a combination loan to purchase and rehabilitate a “fixer-upper” property, or to refinance a temporary loan to buy the property and do the rehabilitation. It can also be executed as a rehabilitation-only loan. Investors no longer may participate—this program is no only for owner- occupants.
Owner-occupants are required to come up with only 3 to 5 percent for a down payment. HUD requires that a minimum of $5,000 be spent on improvements, and two appraisals are required. Plans and specifications for the proposed work must be submitted for architectural review and cost estimation. Mortgage proceeds are advanced periodically during the rehabilitation period to cover expenses.
Are there any special tax breaks for historic rehab?
Qualified rehabilitated buildings and certified historic structures currently earn a 20 percent investment tax credit for qualified rehabilitation expenses. A historic structure is one listed in the National Register of Historic Places or so designated by an appropriate state or local historic district also certified by the government. The tax code does not allow deductions for the demolition or significant alternation of a historic structure.
Where are fixer-uppers found?
These distressed properties are found in most neighborhoods, even more affluent areas. Determining if a particular property is a worthwhile investment invariably requires some research. You’ll need to find out average property values in the area, as well as what the values for the most desirable houses in the area.
It may be best for buyers who take this route try to find a “cosmetic fixer”—a property that will be a relatively simple renovation project that can be completely refurbished with simple improvements like paint, wallpaper, new floor and window coverings, landscaping and new appliances. It’s a good idea to avoid houses that need major structural repairs.
A house with a suspiciously low price tag should be scrutinized very carefully. Your strategy for a investing in a fixer is to locate the least desirable house in the most desirable neighborhood, and then calculate if the expenses needed to bring the value of that property up to its full potential market value are within your reach
The U.S. Department of Veterans Affairs offers veterans property loan financing which can be used to buy a property, build a property, improve a property or to refinance an existing loan. VA loans frequently offer lower interest rates than ordinarily available with other kinds of loans. To qualify for a loan, the first step is to apply for a Certificate of Eligibility.
Another program is the Federal Housing Administration’s Title 1 FHA loan program.
What are some guidelines to follow when trying to find a contractor?
The first rule in hiring a contractor is to always checking him or her out prior to retaining them. If your state has a contractors licensing board, you can verify if there are any outstanding complaints against that contractor. You can also check your local Better Business Bureau to see if there are any complaints on file.
If no complaints have been filed, the contractor’s starting to look good, but keep investigating. Conduct interviews with the contractor candidates to find out what kind of worker’s compensation insurance they carry, and be sure to get policy and insurance company phone numbers so you can verify the information.
Why is this important? Because if they are not covered, you could be liable for any work-related injury incurred during the project, so also make sure that the contractor has an umbrella general liability policy.
If they pass the insurance test, next check some of their references. And finally, don’t let yourself be pressured into making a decision no matter how good a price you’re quoted or if you’re being told it’s hard to find an available contractor. A good contractor understands how personal these projects are for people, and he’ll want you to recommend him to your friends.
What kind of return can I expect on a remodeling project?
We recommend picking up a copy of Remodeling Magazine’s annual “Cost vs. Value Report” to gain an accurate idea of what kind of return you can reasonably expect. Keep in mind that remodeling has many benefits: it improves the property’s livability and enhances “curb appeal” for buyers if you ever decide to sell.
Currently, you can count on the best remodeling returns from updated kitchens and bathrooms. Property-office additions and extra amenities in older properties are often popular and enhance potential returns. For example, you can reasonably expect to recoup 58 percent of the cost of adding a property office, according to the Cost vs. Value Report.
Property improvement resources
If you’re planning on a property improvement project involving contracting help, “Ready,Set,Build: A (Click here) for a Consumer’s Guide to Property Improvement Planning Contracts” offers clear directions to guide you through the process.
Discover valuable tips on selecting the right contractor, obtaining competitive bids and what language to look for in contracts. (Click here) for information on consumer rights, liens and financing.
It’s an unfortunate reality, but when the economy slows, property purchasing declines, and more property enters the foreclosure market. Other factors include high interest rates and creative but unsound financing arrangements.
In the foreclosure process, circumstances may seem bleak, but remember: in most cases lenders would rather receive payments than receive a property due to a foreclosure. Lenders are in the money business, not the real estate business, and in many cases will try to make alternate arrangements with property owners who are experiencing financial difficulty.
If the mortgage loan default is due to a failing to make a balloon payment, the lender is entitled to require full payment on the entire outstanding mortgage amount as the only way to cure the default. If the default is not cured, the lender may instruct the trustee to sell the property at a public auction.
In cases of a public sale, a notice of sale must be published in a local newspaper and posted in a public place—usually the local courthouse— for three consecutive weeks. Once the notice of sale has been recorded, the property owner has until 5 days prior to the published sale date to bring the loan current.
If the owner is able to cure the default by paying the amount due, the deed of trust will be reinstated and regular monthly payments will continue as before, and it may be possible for the property owner to work out a postponement on the sale with the lender. If no postponement is reached, the property is listed for sale.
At the sale, buyers must pay the full amount of their bid with cash, cashier’s check or other instrument acceptable to the trustee. some lenders may “credit bid” up to the amount of the obligation being foreclosed upon.
Buying foreclosed properties has increased in popularity lately. However, there are pitfalls that can ensnare the careless investor. Foreclosed properties are very likely to be burdened with overdue taxes, liens and clouded titles.
A buyer should do their diligence and visit a local title company for information concerning any potential outstanding liens and encumbrances. Title insurance may or may not be available following a foreclosure sale and various exceptions may be included in any title insurance policy issued to a buyer of a foreclosed property. In short, caveat emptor—buyer beware!
Finding and financing pre-foreclosures
How can you find pre-foreclosures?
There is less competition in buying pre-foreclosures than when buying at foreclosure auctions. Some people do not know how to find pre-foreclosure or probate house opportunities and some people fear dealing and negotiating with lenders.
Lis Pendens (notice showing a legal action is filed and pending) are documents posted in county and city courthouse buildings listing property owners who cannot pay their monthly mortgage installments and taxes.
How much time do you have?
You can find the best buys by contacting property owners before the lender takes over and come to an agreement with the property owners and lenders. Both parties will be satisfied while you get a good deal.
You can act to make an agreement from the listing day until the property is offered for sale at auction. This may take about 90-120 days in different states.
Advantages for all parties
The lender and property owner are motivated to resolve the default situation at pre-foreclosure phase.
- You “quit claim” the property, take over mortgage payments and now own a property at a substantial discount.
- Previous owner is relieved of his debt and stays sound financially.
- Bank is happy to have a new borrower who is in better financial status.
How can you do it? It’s simple!
- Find Lis Pendens and locate mortgage loans in default.
- Contact property owner and bank.
- Find out what property owner and bank need and assess their motivation.
- Obtain information on prices of similar houses in the neighborhood to determine viable price to offer after calculating the closing costs and your profit.
Get more information on pre-foreclosure procedure in your state
Each state has its own foreclosure procedures in which pre-forclosure procedures also take place. Find the foreclosure law applicable in your state to start, and determine whether you are in a judicial or non-judicial state.
It is prudent to be cautious about a pre-foreclosure purchase of the property especially in states where the owner has a right of redemption (see definition in foreclosure glossary).
Contact pre-foreclosure property owner for friendly conversation
Contact the owner of the pre-foreclosure property by direct mail rather than by telephone. You need to reflect your sympathy in your letter to get an appointment.
Negotiation tips to prepare acceptable low-cost offer
Negotiating a pre-foreclosure property purchase is a very delicate matter. First, you need to exercise great caution not to hurt the feelings of the property owner who is already in an adverse financial position.
To do so, you must demonstrate that you are not taking advantage of the situation and but trying to make a reasonable offer by addressing the needs of the property owner.
Inspect pre-foreclosure property with a professional property inspector
Inspecting a pre-foreclosure property is not very different than inspecting a regular property. However, you need to ensure that the owner did not cause any malicious damage to the property prior to vacating.
Arrange financing for pre-foreclosure property purchase
In most cases, you will be dealing with the lender who is having trouble collecting its mortgage installments. You can negotiate a better deal by arranging financing through the same lender unless you can find a better deal or have a pre-approval letter from your own lending institution.
What is a Lease Option?
A renter can sign a lease with an option to purchase a property for a specific price within a certain time frame, which is known as a lease option. In most lease-option situations see a portion of the rent being applied to a future down payment.
Lease options are most popular among buyers who lack sufficient funds for a down payment and closing costs.
How do Lease Options work and what are there benefits?
A lease option is an agreement between you and a seller to exercise the option to buy a house after you have rented it for a specific period. A portion of your rent is applied toward the purchase if the option is exercised.
This is referred to as rent credit, which most institutional lenders will accept as part of the down payment if rental payments exceed the market rent and if a valid lease-purchase agreement is in effect.
If you are a seller, lease options can give you several advantages, especially in a slow market. These include monthly rental income higher than the current market rate, top-market value for the property and tax-free use of the option consideration until the option expires or is exercised. Additionally, the renter is more likely to treat the property like an owner.
Read any lease-option arrangement carefully for details on transferring the option and other important concerns.
Where do I get information on lease options?
Contact your trusted DiTo Properties consultant (some of our consultants specialize in such transactions) or investigate lease options at the public library or on the Internet. If you have a real estate attorney, ask if they have any information. Most bookstores have a wide variety of real estate books which have a section on lease options.
If you are considering a lease option, be sure you do your property work first. And have an attorney or financial advisor on hand to review any paperwork before you sign.
Renting is an agreement wherein a payment is made for the temporary use of a good or property owned by another person or company. The owner of the property may be referred to as the lessor and the party paying to use the property as the lessee or renter. There is typically an implied, explicit, or written rental agreement or contract involved to specify the terms of the rental.
Renting real estate for the purpose of housing tenure (where the lessee rents a residence to live in), parking a vehicle(s), storage, business, agricultural, institutional, or government use, or other reasons. When renting real estate, the person(s) or party who lives in or occupies the real estate is often called a tenant, paying rent to the owner of the property, often called a landlord. The real estate rented may be all or part of almost any real estate, such as an apartment, house, building, business office(s) or suite, land, farm, or merely an inside or outside space to park a vehicle, or store things. The rental agreement for real estate is often called a lease .
Commercial property includes business property (e.g. office buildings), industrial property, medical centers, hotels, malls, retail stores. Commercial property is intended to be operated at a profit, either from capitol gain or rental income.