A “short” sale is where a lender takes less money than what is owed on the loan. This is done by the lender instead of foreclosing on the property, when the borrower is having trouble making the payments. If the property can be sold, but sold for less than what is owed, the lender may prefer to take whatever money remains after paying for the cost of the sale instead of going through the foreclosure process which may result in the lender getting the home after foreclosure.
The security of a loan depends on whether its lien, normally a deed of trust, is recorded in first position, second position or any position after that. In other words, the loan that was put on first is recorded in first position, the one that is put on second is in second position, and so on. If there is only one loan, the homeowners and their Realtor need to try to persuade that lender to take less than what is owed. If there is more than one loan, the loan in first position will rarely give up anything, as they have better security. The reason is that in most states when the first loan forecloses, the second and all subsequent loans, have no security interest in the property i.e. they get nothing out of the sale of the property unless the foreclosure sale at the courthouse results in a bid that is higher than the amount owed on the first loan. Since the ability of the second lender to collect from the sale of the home is much worse, that lender is the one to talk to about taking less than what is owed.
As you might imagine, lenders will not take less than what they are entitled to unless they have no better choice. So, the borrower has to show that they do not have the ability to pay the rest of what is owned on the loan. If you are starting the sale of a home where you expect to go “short”, you will need to gather information that shows that the borrower cannot pay the balance due. Start with a “letter of woe”, i.e. a letter that describes the difficult financial situation that the borrower is in. Then, gather tax returns and at least two recent pay stubs. Information on bank accounts and other debts can be helpful. You might also get the form that the lender will require in order to fill it out before an offer comes in so that you can be ready to present it to the lender.
When an offer comes in to sell the property, be sure you put a contingency in the contract for the approval of this sale by the lender (s) that will need to accept the short proceeds. Something like “This contract is contingent upon the approval of this sale, and the net proceeds of this sale, by (insert name of Lender(s)). In the event that (name of Lender(s)) does not approve, this contract may be terminated by Seller”. If you do not have that contingency in the contract, the Seller is signing an agreement to sell the property at a price where the Seller will have to come up with the extra money to pay off the balance owed to the bank. If the Seller does not have that money, you will have created a serious problem.
There may be other issues for the seller in selling “short”. The amount of the principal portion of the debt that is not paid back to the lender may be taxed as ordinary income. So, if the lender does not get $50,000 of the principal on the loan, the seller may be taxed as though he/she made income of $50,000. This depends on whether the loan is Recourse or Non-Recourse. We do not have space here for a full discussion of the Recourse concept, but the short version is if the bank cannot go after the borrower for any balance of the loan that they do not get at the foreclosure sale, it is probably non-recourse. These laws vary from state to state. A good example is that in California, a “purchase money” loan to buy an owner occupied home (1 to 4 units) is non-recourse, as the lender can only foreclose. If that loan has been refinanced, it may be a recourse loan where the lender can go after the borrower if they do not get enough at the foreclosure sale. The IRS is not particularly kind in their interpretation of this concept. For example, in California if a lender forecloses using the Power of Sale in the Deed of Trust, instead of going to court to foreclose, the lender cannot go after the borrower after the foreclosure sale. But, the IRS says that if the lender could have gone after the borrower if they had not foreclosed using the Power of Sale, the loan is recourse and the “short” amount is taxable. There is a bill that has passed the U.S. House of Representatives that would change this for people who do not have high incomes. This bill has not become law, as it still has a long way to go.
The other problem with selling short may arise if the borrower did a stated income loan. If the borrower told the bank at the time of applying for the loan that his/her income was huge, then submits tax returns and other documentation to show that it was nowhere near that amount, the lender may have proof that there may have been loan fraud.
The advantages of this process for the buyer is that they get a home at a great price, below the value of the mortgage balance. However, the buyer gets a bumpy ride. It will take the lender some time to review and approve or disapprove the short sale. Until that is done, the buyer does not know if he/she has bought a house or not. There may also be other requirements that the lender will put into the transaction as a condition of approving the sale. Also, if the seller does not have any money to pay the balance on the loan, he/she probably has no money to do any repairs, so the buyer is probably taking the house “as is”.
The short sale will allow the seller to have less of a problem with his/her credit than a foreclosure, although the short sale normally shows as a blemish on the credit reports. Some lenders will be kinder than others on how they report it. The sale also allows Realtors to accomplish a sale that would not otherwise happen, although the lender who is going short frequently tries to negotiate the commission down. Finally, the short sale allows the buyer to get a home at a good price and one that has not gone through the distress of a foreclosure process.
If you would like to learn everything about short sales, go to www.ShortSalesR.us because it goes through nearly all the issues. Look at the search box in the upper right of the splash page, put in what you are looking for, and it will give you the posts on that subject.
If you have any questions about this, please call Tim Burrell at 919-812-5111 or send an email.
Selling a Home In Foreclosure
If you are selling a home that is facing a foreclosure some steps you should take are to:
- Contact the lender to see if you can get more time. Most lenders do not want to foreclose, and the earlier you can contact them the better. If the payments on the loan have been made, but the foreclosure process has not started, it may be handled by the a department with a name like Loss Mitigation, where they have certain flexibility. If it goes into the foreclosure process, it normally changes to another department, and that department normally has less flexibility.
- If the foreclosure has started, consider going to whatever hearing there may be to set the date of the sale. You may be able to get more time or flexibility.
- Put a great price on the property, where it will jump off the page when the buyer sees it. You need to sell fast, so you cannot start high, then lower the price. Get it under contract, and the lenders will work with you more.
- Consider giving the lender a Deed in Lieu of Foreclosure. If you negotiate with the lender and they take the property in full settlement of all of the debt, it may be the best result for the borrower. However, the lenders will not do this if there are any other liens on the property.
- If you get a contract to sell the property, work with the lender to be sure they do not foreclose, and be sure you get the loan paid off quickly after the sale so that the foreclosure sale cannot take place.
Where to Buy a Property in Foreclosure
You can buy a property in foreclosure:
- At the foreclosure sale, typically on the courthouse steps. Be sure you know the procedure and requirements, and be aware of state laws concerning Upset Bids and other things that may happen after the foreclosure sale.
- Realty Track
- Individual Lender’s websites
- Contact Realtors who frequently list foreclosed properties
Representing Lenders on REO Propeties
If you are a Realtor who wants to represent lenders selling REO properties:
- Do Broker Price Opinions to try to get the lender’s attention.
- Register on websites for lenders and property managers looking for local Realtors, such as
- Go to national meetings of lenders and property managers organizations such as the Five Star Conferences or the REOMAC meetings. Be warned, these conferences are overflowing with agents “vomiting business cards” on the asset managers.
- Join Organizations that will put you in contact with asset managers, such as NRBA, www.ReoBroker.com, REOConnection
It is extremely hard to get started handling REO properties, as the Asset Managers are overworked and do not want to train anyone new in their system. So, if they can go with the current agents who are experienced in how to handle all their administrative requirements, they will not start fresh with you. The biggest trick is to get started, handle your first assignments perfectly, and have the Asset Manager recommend you to others in their group.
If you want to learn more about short sales and representing REOs, click here and join in the discussion of how to succeed in distressed properties.