As home values continue to drop across the country, a growing number of homeowners are finding themselves upside down with negative equity in their homes, meaning they owe more than their property can be sold for. If you are one of these homeowners and have an affordable mortgage, a secure job and no plans to sell in the immediate future there is little need to worry. Given enough time, values will more than likely rise. However, if a job loss, relocation, divorce or rising mortgage payment is forcing you to sell now, you could be in a tough situation.
Some homeowners are surprised to learn that lenders might be willing to accept less than the full amount due if the property is sold. Referred to as a “short sale,” this simply means the seller’s lender is accepting a discounted payoff to release an exiting mortgagee, which then allows the homeowner to sell the house.
From the lender’s point of view, a short sale saves many of the costs associated with the foreclosure process including attorney fees, damage to the property, the eviction process and the costs associated with the resale. With a short sale the lender gets the property back faster, so it is able to cut its losses. Therefore you would think lenders would be more than willing to work with sellers trying to sell this property. But this is rarely the case. In fact, only 30 to 35 percent of short sale offers get approved – due primarily to the lender not accepting the offer price. And of those that are approved, about 60 percent fall apart before closing, usually because the buyer has given up or can not obtain financing.
Most sellers, buyers or real estate agents who have been involved with short sales have nightmare stories of lengthy delays, broken commitments, cancelled contracts, etc. Many real estate agents simply refuse to work with buyers or sellers attempting a short sale. “Not worth the brain damage,” one local agent told me recently when I asked if he has handled any short sales. And to top it off, many lenders will often reduce the commission paid to the real estate agents who have worked so hard and long to close the deal.
But for many homeowners that could all be changing soon. It seems the Obama administration would like to see more short sales taking place to stimulate the housing market. After all, according to the experts, it was the housing market and lax lending standards that got us into the economic fiasco we now face.
Incentive Programs
On May 14, the Treasury Department announced a plan to provide incentives for lenders and borrowers to pursue short sales in cases where the borrower is generally eligible for a modification under the federal government’s Making Home Affordable plan, but either can’t qualify or gets the modification but then can’t keep up the payments.
In these cases, the government will pay a lender or loan servicer $1,000 for completing a successful short sale, it will pay the borrower $1,500 to assist with relocation expenses, and it will pay second-lien holders up to $1,000 if they release their claims. In many cases it is the second mortgage or the equity line on the property that stops the short sale from closing. Many second-lien holders have been reluctant to release their liens even though the properties value has declined so far they have little hope of recouping their investment.
Taking the government’s lead, some large banks such as Bank of America and Wells Fargo have announced programs to streamline and shorten the short sale process for their customers. These lenders have announced plans to increase staffing, update training and provide dedicated short sale call centers. These lenders also recommend that customers who are considering a short sale contact them prior to signing the listing agreement with their real estate agent to start the approval process. Time will tell if these lenders follow through with these promises or simply use short sale programs as a PR stunt to give the appearance of helping the struggling homeowners.
Potential Downside
Anyone considering a short sale should consult an attorney, CPA or other well versed expert to fully understand what they are getting into. This is critical. If the lender is forgiving some of your debt you could be in for an unpleasant surprise. In certain situations, for instance, you could be liable for income tax on the amount the lender has written off.
With most short sales the lender may require the seller to sign a document giving them the right to come after you personally for the amount they have written off. Whether they exercise this option will depend on whether they believe the homeowner has the resources to make up the difference. This document alone has resulted in many homeowners cancelling the sale.
And in California, if the debt being forgiven is the original mortgage you obtained when you purchased your property you might be better off going into foreclosure. The non-refinanced loan used to purchase a primary residence is a non-recourse loan. That means the lender cannot come after your other assets for the unpaid balance. If the debt being written off is part of a refinanced mortgage or second mortgage placed on the property after the purchase, it is now considered a recourse loan and the lender can come after other assets for the unpaid balance.
While a short sale may seem like the perfect exit strategy for homeowners upside down with their mortgage, they must do their homework and know exactly what they are getting into early in the process.
Ron Pfleger is a licensed California Real Estate Broker (#00986777) with over 20 years experience in real estate and finance. He co-hosts a real estate radio show on KSVY 91.3 Sonoma called The Resource Network.
