Short Sales of Real Estate, aka Short Payoffs

A while ago I wrote an article called, "What Happens When You Can't Make Your Real Estate Loan Payment." This is kind of a continuation of that, as I got a search that asked, "What is necessary to persuade a bank to accept a short payoff on a mortgage"

Poverty. In a word, poverty. You have to persuade the bank that this is the best possible deal they are going to get. You can't make the payments, and if they foreclose they will get less money.

A "short sale" or short payoff is defined as a sale where the proceeds from the sale will not cover the secured obligations of the owner. The cash they will receive from the sale is "short" of the necessary amount. The house is no longer worth what they paid for it.

When I originally wrote this article, I was looking ahead. There were more and more of these happening, but the big wave had yet to hit. That wave has now mostly passed. There are always people that lost their good job and can't get a replacement nearly as good. But for a while, there were also people that were put into too much house, and approved for too much loan, suddenly discovering their situation was not sustainable because they suddenly couldn't make the payments. Unscrupulous agents that wanted a bigger commission, loan officers going along, and nobody acting like they were responsible for the consequences to their clients. My concern for lenders who do stated income and negative amortization loans (and a lot of loans that are both!) is kind of minimal. Okay, it's very minimal. Like nonexistent smallest violin in the world playing "My Heart Cries For Thee" level sympathy. I forecast years ago that many lenders were going to go through bad times, using a forecasting method that's about as mysterious as rocks that fall when you drop them.

On the other hand, for the people who were led into these transactions by agents with a fiduciary responsibility towards them, I have great heaping loads of sympathy and I'll do anything I can to help. Yes, they're theoretically responsible adults, but when the universe and everyone is telling them all the things that buyers were told these last couple of years, it's understandable. Sure there's a greed component in many cases but when they're told by both loan officers and the real estate agents that they "wouldn't have qualified for the loan if you couldn't afford it," they are being betrayed by the same people who are supposed to be professionals looking out for their interests. I really do suggest finding a good lawyer to these folks, as those agents who did this to them (and their brokerages) better have had insurance which said lawyer can sue to recover money they never should have been out.

I'm going to sketch it out in broad terms, but there are a lot of tricks to the trade. Short sales are not something to try "For Sale By Owner," or even with a discount agent.

First off, you need to draw a coherent picture of the loan payment being unaffordable. If you were on a negative amortization approaching recast, or hybrid ARM (usually interest only for the fixed period) that is now ready to adjust, you're facing a much higher payments. Even if you were able to afford the minimum payment before, now you can't and you've decided to sell for what you can get before it bankrupts you to no good purpose because you're going to lose the house anyway. You're going to have to prove you can't afford your loan. The bank isn't just going to accept your word, but several late payments or a rolling sixty day late that looks headed for ninety have been known to be persuasive. If you can afford the payments but have merely convinced yourself you don't want to, please read Why You Should Not Walk Away From Upside-Down Real Estate. Nonetheless, there are a lot of tacks that you don't want to take. Remember, lenders want to be repaid and they've got a couple of pretty powerful sticks to shake at you. They are not going to agree to sacrifice money merely because to make the payments would be uncomfortable for you. You're going to have to persuade them it's impossible.

Second, you're going to have to persuade the lender that this is the best possible price that you are going to get, and that even if they think they'll get more by going through foreclosure, it will be more than offset by what they'll lose through the expenses involved. Not to mention that they might end up owning the property, which they don't want to do because then they have to spend more money selling it.

Third, you've got to be on the ball about the transaction itself. All the ducks have to be in the row from the start, which is when you approach the lender with a provisional transaction. If they're not, the lender is just not going to go through the process of approving a short sale until they are. Since this takes time, it has the effect of dragging out the transaction. Every missed deadline means the lender will look at the whole thing again, possibly changing their mind about approving the short sale. You need a qualified buyer. Furthermore, most short sale buyers end up bailing out of the transaction at some point, most often because they don't think it's going to get approved on terms that are acceptable to them. You need a full service listing agent who knows what they're doing to prevent this from happening.

Fourth, just be prepared for the fact that the lender is not only not going to approve the transaction if you get any money, but that they're also going to send you a form 1099 after it is all done. This form 1099 will report income for you from forgiveness of debt. This is taxable income! Many agents eager to make a sale will not tell the sellers this, and when you get right down to it, there is no legal requirement to do so, but I've always thought this was one of the ways to tell a good agent from a not-so-good one. It does seem like something you should be told about before you've got the 1099 form in your mailbox, right? At that point, you are stuck with all of the consequences, where if you had known before, you might not have been so complacent. It is to be noted I've been made aware of ways to circumvent the "no money to the owner" requirement, but they are FRAUD, as in go to jail for a while and be a convicted felon for the rest of your life FRAUD. It can be tempting, but committing fraud is one of the most effective ways I know to make a bad situation worse.

For the buyer, short sales can seem attractive for any number of reasons. Typically the seller is in a situation where they have to sell, and everyone knows it. The option of waiting for a better offer really isn't on the table if what you're offering is anything like reasonable. They can't bluff you, they should know that bluffing you is a waste of effort, and somebody should have explained to them that they really just want out now (and why this is so) before it gets worse. What's not to like? The answer is the fact that there's a third party with veto power over the transaction. The sellers don't have must motivation to bargain hard because they're not getting any money anyway, but many lenders are stuck in the land of Denial.

Your competition will also make things difficult. Because people think there's fast money to be made, these folks are the target of "flippers" everywhere. The large city, highly inflated markets more so than most. A couple weeks before I originally wrote this, we put one on the market and got three ugly low-ball offers within 48 hours, and this is part of why you need an agent to sell one. Remember, the seller isn't getting any money, but they are going to get a 1099 form that says they have to pay taxes. Don't you think most folks would rather it was for less money, and therefore, less taxes, instead of more? The more money the lender loses, the higher your liability. Had any one of the three made a better offer in the first place, they would have gotten the property at a price to make a profit, but they had to prove how rapacious they were, or something. As it was, we jawboned the first three vultures and two other, later entries, into a quasi-decent price, with minimal later tax obligation to our seller, and (eventually) got the lender involved to see reason.

In summation, "short sales" are a way to cut your losses for sellers, and a way to maybe get a good price for buyers, but you have to know how to convince the lenders to accept them, and how not to overplay your bargaining position, lest you get left out in the cold.

However, lenders are basically in denial for a variety of reasons, and they do not want to admit that their underwriting was at fault for lending more than the property was likely to be worth, and more than the borrower could really afford. For that reason, short sales are a long hard slog, and many times lenders are rejecting the transaction no matter how much sense it makes. So be advised before you even start that this is an uphill battle, and if the listing agent is not on top of the game, you may be wasting your time making an offer. Quite often, the lender simply says no - that they're not going to accept this transaction unless someone comes up with more money to make them happy.

Caveat Emptor

Original here

UPDATE: You may also want to read my new article on Mortgage Loan Modification