Louisville realtors, investors and debtors facing foreclosure ask me now and then how short sales work. Consider this a primer.
I recently brokered the sale of a house for $85,000 to an investor. The house appraised for $120,000, giving the investor substantial immediate equity. The lender took a $60,000 loss. The owner/seller was forced to sell his house, for which he received not one red cent, and had to move into rental. How is it that all parties walked away from the closing table satisfied?!
In the beginning…
When a home owner owes his lender more than he has borrowed, he’s said to be “upside down on his mortgage”. This can come about in many ways, the principal amongst them occurring when he simply stops making mortgage payments, often because he is in serious financial difficulty. If his mortgage payment is $1,000 per month, and he stops paying, or pays intermittently, the fines, interest and rule can rack up pretty quickly. And if the owner can’t pay the mortgage, chances are he hasn’t been able to make necessary repairs to his home. This situation is almost always accompanied by despondency, which again leads to neglect of the house.
Stir into the mix bankruptcy, and perhaps divorce, and you’ll understand it’s not surprising to find the homes of these owner/debtors are often seriously degradated. That leaky roof is probably the last of the owner’s problems.
The “F” information
Foreclosure. It’s not a happy prospect for the lender or the borrower. Lenders have different tolerances for late payments. However by the time the debtor is late for the fourth consecutive month the great majority of lenders begin foreclosure proceedings. In Kentucky the foreclosure sale of the home by public auction takes generally anywhere from 6 months to a year from the time the foreclosure procedures began. It can take longer – I saw one artful debtor drag on the foreclosure proceedings for more that 20 months! Her mortgage payment was $1,300 a month. After 20 months that became a meaningful debt compounded by late fees, interest, legal costs, and the possible cost of selling the character at a public foreclosure sale. To say nothing of the continuing, moment by moment decline of the character. By the time she moved out the bank had written off in excess of $80,000.
The lender’s and borrower’s conflicting interests
Capitalism is a wonderfully contrived system. It hands not only the strength-barons a potent range of weapons with which to fight, but also the poor and destitute. Though the battlefield is nowhere near already, double digit interest thrust too deeply down an indigent debtor’s throat may precipitate his “nuclear” retaliatory option – Chapter 7 bankruptcy. And so these two, symbiotically entwined, are locked in an elegant dance, teetering between dividends and disaster, profit and poverty. One serious mis-step, and the band stops playing.
consequently, from years of bitter experience, lenders have learned that it’s often better (cheaper) to attempt to gain the cooperation of the owner and have him agree to voluntarily sell and vacate his home, instead of evict him under foreclosure. Lenders also understand that the chance of ever recovering the money owed to them by the debtor is slim. But many debtors choose not to sell because, around the time they realize they will never catch up on their payments, they often have another “Ah Ha!” flash of insight: that if they stop paying their mortgage and just wait for the foreclosure axe to fall (or better however, include in a hatfull of tricks to keep that axe under control) they can live “rent free” for at the minimum 6 months. So now the debtor turns from borrower to squatter, perceiving it to be in his best interest to prevent the foreclosure for as long as possible. And if the house, the lender’s “security”, should fall apart in the meantime, so be it.
The lender is in a position to offer the borrower a very important concession for his cooperation: to write off the complete debt if the borrower finds a buyer to buy the house at a price and terms permissible to the lender, within the time stipulated by the lender. This is the essence of a short sale. Lenders set their own guidelines for what they will accept. They may say they need to get fair market price, but will in fact often be prepared to sell for much less. They do not want to chance selling this house at auction and risk receiving a very low price. Or worse however, receive a bid so low that the character does not meet their save price, and they end up owning the character. In this case the character is administered by the lender’s REO (real estate owned) department, which will then list the character with a realtor. And the cycle begins again……
The Lender initially said The Willows house was worth $120,000, and wanted it sold at about that price. It got the $120,000 figure from someone it had hired to do a BPO. BPO is short for “Broker’s Price Opinion.” It is similar to a CMA (Comparative Market examination) and serves the same purpose: to arrive at a fair market value for a character. Most are done as a “excursion-by,” meaning that the “driver” (usually a realtor, maybe an appraiser) drives by the outside of the character, takes one to three photos and leaves. He then completes the lender’s BPO form on-line and e-mails it with the picture. Sometimes an “internal” is requested, in which case the realtor goes into the character, takes about 3 internal and 3 external photos and sends these by to the lender with the completed BPO form.
When the debtor had realized he would not be able to save his house in The Willows, he contacted me to see if I could help. He did not want a foreclosure on his credit report, which would have prevented him from getting a traditional mortgage for three years. already with a Chapter 7 bankruptcy, the wait period is only 2 years from dismissal. He also wanted to have his debt forgiven. I was able to accomplish both these goals, saving him about sixty thousand dollars.
The short sale course of action
As a Realtor, the first thing I did was explain to my client all his theoretical options, including deed in-lieu of foreclosure, loan renegotiation and others. He settled on short sale. I listed The Willows character, and had him sign an authorization for me to contact the lender to see if it would agree to a short sale. Remember, when I list the character, the owner/debtor is my client (not customer). This method I must always act in his best interest. The lender is not my client and I owe it no such duty. In a normal sale the seller and buyer have greatly divergent interests: the seller wants to sell at the highest possible price, and the buyer wants to buy at the lowest. In a short sale there is no such contest between the parties: the seller wants to sell at any price the lender will accept, and will generally agree to any price offered, contingent upon the lender’s acceptance. So in a short sale, the lender takes on the mantle of “seller” vis-a-vi the buyer and these are really the parties who negotiate the contract. Now get your head around this one: as listing agent in a short sale I am often in the disinctive position of actively attempting to negotiate for the sale at the lowest possible price permissible to the buyer! (But always with the caveat that this is in the seller’s best interest, and does not threaten the sale). This anomaly has many ramifications for the way I conduct and negotiate these transactions.
Price, Terms and Timing
Price: So how much will the lender lop off that price? I’ve generally found that as the day of auction approaches, lenders become more malleable. Pretty inefficient, because they loose a lot of time and money that way. I supplied the lender of The Willows character with objective material suggesting that the excursion-by BPO was inaccurate, given the condition of the house. The lender then had an internal BPO done. That was meaningful to getting this particular deal done. I also sent off photos and comps of my own. In some situations I’ve sent the lenders well over 100 photos. Pictures speak louder than words, and it’s basic, when the character is damaged, that the lender understand the shape it’s in. Remember – the BPO realtor may be doing up to 50 BPOs a week – he could care less about this one deal. But as listing agent I need to keep the lender informed of all issues that coincide with my client’s best interests. The second Willows BPO came back at $100,000, and the lender initially tried to acquire that figure. Ultimately, with the foreclosure sale due to occur the next day, it reduced that amount to 80% of the $100,000 plus $5,000 to pay off non-mortgage related liens. At 4.50 pm the lender agreed to stop the foreclosure sale scheduled for 11.00 am next morning.
But hey, it ain’t over ’til the fat lady sings! Because the loss on this loan was $60,000, and because the lender had authority to settle up to $30,000 only, we had to wait for final information from the mortgage insurance company, which we ultimately obtained, but not without many hours additional work.
As you see, the price of The Willows character was determined by the lender looking at the bottom line – how much net it would receive. And in order to get this number, all lenders in short sales request a “fake HUD-1” or a “net sheet” submitted simultaneously with the offer. In a normal real estate transaction the HUD-1 is drawn up at the end of the transaction, after agreement is reached. – in a short sale the title search is performed closest upon listing, already before there’s an offer, so that the figures can be applied to the net sheet as soon as needed.
Terms: The most shared terms distinguishing these deals are that the lender often requires terms such as “sold as is” and “proof of finance or funds required with offer”, and to protect the seller, the realtor should insert terminology suggesting seller’s acceptance is unprotected to release from all liability for debt. None of this is carved in stone, and I’ve negotiated repairs and other concessions from lenders. Each case is rare. Paper will suffer any indignity – write the offer!
Timing: The REO, Foreclosure and Bankruptcy departments often appear to be understaffed and overwhelmed, so don’t expect moment responses. Some will take weeks to reply. Make sure the buyer and seller understand this. But once a deal is hit, the lender will often expect an unreasonably quick closing, and will attempt to penalize you with days interest for closing after a certain date. This all goes back to the net sheet calculations; because you have informed the lender how much it will receive by a certain date, it then attempts to keep up the line at that date, already though they are generally very slow to respond. The Willows lender, after having not responded to multiple contacts, gave us just 2 days within which to close! Fortunately we well prepared, but it was very close.
The tax consequences of short sales fall outside the scope of this article. If you want info on how to manager competing offers, dual limited agency within this ecosystem, or need a copy of the net sheet I use, you may contact me.
Here’s a new twist. A associate of weeks ago I submitted a $235,000 offer to a lender on a short sale, (Seller owes about $275,000) which the lender ultimately accepted. However, in it’s acceptance letter, at the very bottom of the sheet, the lender stipulated that it retained its right of recourse against the seller/borrower (my client)! And this despite seemingly contrary language in the main body of the letter. I explained to the lender that the ONLY reason my client had agreed to the short sale (and not to jerk the lender around in the bankruptcy proceedings) was because he expected to acquire a complete release from all liability at closing. After a weeks or so of wrangling, attorneys etc, the lender “saw the light” and agreed to the release.
Though the information provided is considered reliable, it is not complete, nor warranted accurate. Always consult your broker or an attorney.