SHORT SALES. Where? Wherever There Are Foreclosures, There Are Short Sales. Page 1 of 7

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1 SHORT SALES What is It? A short sale occurs any time a lienholder agrees to release its lien for LESS than what it is owed in connection with the sale of the property. While a short sale theoretically can involve the short payment of any lien, it is generally the mortgage holder that is taking less money. Why? The lender normally has two major motivations to enter into a short sale: Actual or expected default on the mortgage Save money There may be additional reasons: Lender s agreements with investors or the government Need to reduce non-performing assets or increase liquidity Lender may also need to comply with federal laws requiring them to work out a short sale. Put yourself in the lender s position: Does seller have the ability to pay the debt? If we foreclose and resell the property, how much will we recover, AFTER subtracting costs of foreclosure? Lender saves: Foreclosure expense. Costs of rehabilitating the property. Cost of capital. Days on market multiplied by per diem interest on property value. Cost of maintenance. Property taxes HOA dues Utilities Security Lawn care Real estate commissions on resale. Seller s motivations Can t sell property for what is owed. Financial hardship prevents paying or renegotiating mortgage. Desire to avoid further damage to credit. Realtor s motivations Insufficient business in a tough market. Many properties cannot be sold for what is owed on them. Saving a sale that otherwise might not go through. Listing agent is often in a good position to identify property suitable for a short sale. Where? Wherever There Are Foreclosures, There Are Short Sales Page 1 of 7

2 Where? Foreclosure Rates Foreclosure Rates First Half of 2010: 1. Nevada 1:17 2. Arizona 1:30 3. Florida 1:32 4. California 1: New Jersey 1: Texas 1: Vermont 1:4008 Source: Atlanta Journal and Constitution Who Are the Candidates? Property Value is less than what is owed. Junior lienholders are willing to cooperate. Someone wants it at some price. Sellers Financial hardship Unable, not just unwilling, to bring shortage to closing Documentation - Financial statements Family budget Paycheck stubs Tax returns Financial affidavit The Disqualification Process Typically, the lender will want to know about: Seller s assets & liabilities. Usually a financial affidavit. Often very intrusive. Income. Tax returns Paycheck Stubs Monthly expenses. Short Sale Negotiators There are now businesses that specialize in negotiating short sales with lenders. Tax Consequences Seller should seek legal and financial counsel. Real estate or title agents are not qualified to render advice. Phantom income when someone forgives a debt, it is income to the person forgiven, just as wages are income. For example, if a lender forgives $10,000 in debt, that $10,000 is treated as taxable income to the borrowers. The lender reports the debt forgiveness to the IRS on a Form Page 2 of 7

3 If the borrowers are in the 25 percent tax bracket, the borrower s tax liability is increased by $2,500. Of course, the borrowers probably don t have $2,500 lying around. (If they did, the lender probably would have required a higher payoff.) Mortgage Forgiveness Debt Relief Act of 2007 H. R. Bill 3648 forgives taxes on phantom income from short sales. Applicable tax years are Property must be principal residence. Does not apply to investors or second homes. Debt forgiven must be either original or refinance of: Acquisition indebtedness. Home improvement loan. Does not apply to home equity loans. Limit $2 million if married, $1 million if filing separately. No income limitation. Credit Consequences In most circumstances, a short sale will hurt seller s credit. Exception may apply when lender is fully repaid through a promissory note. Credit score consequences are from the rumor mill, as credit reporting agencies keep their calculation methods secret. Different lenders have different ways of reporting the short sale to the credit bureau. How the short sale is reported, and the consequences, should be addressed by the seller when negotiating a short sale with the lender. Contract Issues Short Sale Addendum adds terms: Seller s net proceeds will be insufficient to pay the balance of Seller s mortgage loan Contract expressly contingent on the consent of seller s lender Defines Seller s net proceeds as, the Sales Price less Seller s expenses... and Seller s obligation to pay any brokerage fees. [settlement expense] Automatic termination of contract if seller cannot provide lender s consent within a date set in the contract Implies lender can withdraw its consent any time prior to closing Provides for return of earnest money if lender kills the deal Seller authorizes lender to give information to buyer or buyer s agent on the status of lender s consent. Addendum applies to EACH lienholder Communicate With the Lender As with any other loan being paid, you will need a payoff from the lender. The payoff is likely to be in the form of a letter. Page 3 of 7

4 If you are not dealing with the lienholder of record, require proof that the party providing the payoff has authority to bind the lienholder. Who do you talk to at the lender? Likely department names: Loss mitigation Pre-foreclosure Loan workout Short sale department In many cases, the seller and listing agent have identified the appropriate people who can provide the payoff by the time you receive the contract. Seller decides who gets to talk with the lender. Cannot talk with lender about seller s lien without written authorization from the seller. Lender is bound on this issue by the federal Gramm-Leach-Bliley Privacy Act, among other laws. But Don t Talk Too Much! Remember, unless the settlement agent is also an attorney who is representing the borrower, communications with the lender should not include negotiating the substantive terms of the short sale. The settlement agent s role is to obtain the short payoff letter and follow the instructions therein. The Short Payoff Letter Each lender has its own form of short sale approval letter. The letter will contain standard conditions and requirements, as well as provisions applicable to the specific transaction. The employee who sends the letter usually does not have the authority to change any of standard terms. - Addressee some lenders address the letter to the settlement agent. Others will address it only to the borrower. - Identification of lender - Identification of property - Names of buyer and seller - Loan number - Payoff amount this is often stated as the minimum the lender will accept. - Expiration date - Lender approval of settlement statement - Unsecured promissory note? Approved Closing Costs: - Realtor commissions - Title insurance - Escrow costs and fees - Homeowner association dues - Tax proration - Seller contribution to buyer closing costs - Seller incentive? Page 4 of 7

5 - Junior lienholder payment? - Third party negotiator fees? Junior Lienholders If there are any junior lienholders, they also will have to agree to accept a short payoff. So, you also will need a short payoff letter from any junior lienholders. Why should the first lienholder allow any junior lienholders to receive anything? A junior lienholder who gets nothing has the power to blow up the whole deal. How? The Short Payoff Letter Common Standard Terms and Conditions: - No substitution of buyer - No cash back to seller or buyer - Escrow account retained by lender - Any refunds go to lender - No title transfer prior to payoff - Lender will report short sale to credit bureaus. FLIPS The short sale approval letter often contains restrictions against flips. The language used varies. One lender prohibited resales within a certain period after closing. This is usually not acceptable, as the settlement agent has no control over what happens after closing. One common restriction is that the settlement agent has no knowledge of any pending sale of the property by the buyer. TRGC s general policy is not to insure a resale of property that was acquired at a short sale until the release or satisfaction of the mortgage has been recorded. This policy applies even if the short sale letter does not expressly prohibit flips. Exception: if the flip has been fully disclosed to and approved by all parties, including the payoff lender. The approval of all parties must be in writing. Signatures in blood are preferred, but not required. The Short Payoff Letter Our ultimate objective is to be sure that the payoff lender is contractually obligated to record a release or satisfaction of the mortgage! The Settlement Statement The final settlement statement MUST be approved by the payoff lender prior to closing. Be sure the figures on the settlement statement match the figures on the approval letter. Page 5 of 7

6 HAFA Background In early 2009, the Obama administration introduced the Home Affordable Modification Program (HAMP). HAMP is a program where the government provides incentives to the lender to accept a short payoff on the mortgage and refinance the balance with a longer amortization. Some people don t have the income to qualify for HAMP. Many HAMP borrowers defaulted under their restructured loans. HAFA appears to anticipate the lender may automatically send people who have qualified for the HAMP program short sale guidelines. HAFA Effective April 13, 2010 In response, the Treasury Department established a new short sale program known as the Home Affordable Foreclosure Alternative Program (HAFA). Borrowers who did not qualify for, or washed out under, HAMP are referred to HAFA. The purpose of HAFA is to streamline the short sale process for homeowners who have no realistic chance of avoiding foreclosure otherwise. HOME AFFORDABLE FORECLOSURE ALTERNATIVES (HAFA) Does NOT apply to: FHA loans. VA loans. Designed for conventional loans held by lenders who took Toxic Asset Relief Program (TARP) money. Qualifications: Must be borrower s (seller s) principal residence. Lien being paid off must be a first lien mortgage originated prior to January 1, The mortgage must be delinquent or it is reasonably foreseeable it will go into default. Unpaid principal balance must be $729,750 or less. The current monthly payment must exceed 31 percent of borrower s (seller s) gross income. Procedures: Within three (3) business days of getting a contract offer, submit to lender a Request for Approval of Short Sale (RASS). Lender must respond within ten (10) business days, by either of the following: Accepting and providing a Short Sale Agreement outlining terms. Providing information on what terms the lender would accept a short sale. Other terms: Provides for subordinate liens to be paid at a rate of six (6) percent of balance up to maximum of $6,000. On a HAFA short sale, the lender may not require Realtor commissions be reduced below six (6) percent. Seller may keep up to $3,000 in relocation costs from sale. Page 6 of 7

7 Foreclosure Issues Many short sale candidates are in foreclosure. This can put you on very tight timelines to get the deal done. Some lenders may withdraw the property from foreclosure to accommodate the short sale, but you need that in writing. Once you have it in writing, make sure the foreclosing attorneys are aware it is supposed to be withdrawn from foreclosure. If the property is in the foreclosure process, it is a TRGC requirement that the sale closes and funds at least two (2) business days prior to the scheduled foreclosure date. Overview of the Process Unless HAFA applies, there is no fixed set of rules. Each lender is different and has its own criteria. Some lenders will only communicate with the owner. Some will only consider a short sale after seller is in default. What Can the Seller Expect? Demonstrate value less than mortgage Find a buyer. Submit offer to purchase. Prove financial hardship. Approve final terms. What Can the Buyer Expect? Purchase AS-IS. May have inspection right. Potential lengthy process. No guarantee of approval. Don t expect to flip. Don t get emotionally invested in property. Always have a Plan B. Page 7 of 7

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