Avoiding Foreclosure by Using Short Sales - What Are the Risks?
In essence, a short sale occurs when a lien holder agrees to take less than the amount owed on a property in order for the owner to successfully sell it. There are varying reasons to short sale a property. Owing more on a property than it is worth is obvious, but most owners could just wait until a market recovers if other circumstances in their lives would allow for this. This is not a reason for a short sale on its own however.
With the current crisis be sure to review our article on Covid-19 loan forbearance and the help it could provide for those with federally backed loans. As well, all things have a dark side so be sure to review the risks associated.
Real estate values always go up and down but life's needs don't always correspond. Dealing with a down market, job loss, reduced income, relocation, medical needs, family needs, or divorce can force you to move. In these instances, sellers must approach their lenders or lien holders to ask for a reduction on the principal loan amount if they owe more than the property is worth and they cannot afford to make up this difference. This will avoid foreclosure and reduce the likelihood of legal implications later on.
There are some things to keep in mind if you are considering a short sale, however. More often than not, banks will not cooperate in a short sale unless the owner is behind on their payments. Late payments affect the seller's credit as the past due payments are reported to credit bureaus. Usually, a short sale is also considered a "pre-foreclosure" and has a limited amount of time before the bank will foreclose on the property due to missed payments.
The amount of time to negotiate a short sale varies by the terms of the loan, the bank, and the seller. In general within Utah, there are at least 180 days from the first missed payment to successfully negotiate a short sale. While the exact repercussions of a short sale to your credit are unknown at this time, it is generally assumed it is less damaging to have a short sale than to have a foreclosure and there are possibilities of other legal benefits.
The key to successfully completing a short sale is to 1- get an offer and 2- get it negotiated with the bank. Most property owners have a hard time talking to their lenders regarding the situation. Fortunately, there are alternatives to negotiating your short sale yourself.
Short sale facilitators are firms specializing in short sales as well as loan modifications, they charge a one time fee to help you through the process. Facilitators use attorneys to negotiate with the banks and usually have a good idea of what will be accepted by a bank because of previous deals. Attorneys are an excellent choice, whether you use the attorney to negotiate a short sale or not, you should absolutely consult one no matter how you choose to negotiate a short sale. Verify they have experience with short sales. The possible effects of a short sale can be discussed, including 1099's write-offs, current exemptions, and deficiencies.
Real estate agents are another solution, especially if they are already trying to get you an offer on your home. They can be a good choice if they have experience with short sales and understand the process. Again, consult an attorney whether you negotiate the sale or use another professional to assist you so you have a very clear understanding of your circumstances.
As the owner you will be required, at a minimum, to send in a hardship letter describing your current situation. The most common additional documentation includes two months bank statements, previous year's tax returns, itemized expenses, a profit and loss if tax returns are not available and your most recent paystubs. All of these items will need to be submitted to the bank. It is a good idea to submit these documents early so your packet is ready when an offer is received. Here is how to write a hardship letter to help get you started.
Once an offer is received, it will be assigned to a negotiator in the loss mitigation department. The negotiator will then reply with changes, a counteroffer, acceptance, or a rejection. There are no guarantees a short sale will be accepted but the current financial climate is rapidly making lenders much more agreeable.
So what are the risks of using a short sale to avoid foreclosure? Well, the first is that no matter what - your credit score will be negatively affected. The second is that it is possible you may have to pay a deficiency judgment. The sale price will be lower than what is owed on the home, and the difference in the two prices is called "deficiency". The sales price doesn't fully satisfy the debt, so the lender can sue you to recover that cost.
Sellers have an excellent opportunity to work through a short sale with their banks but also have great opportunities to get their loans renegotiated to better terms even on investment properties. While all banks are different, there are solutions for both buyers and sellers right now.