Short Sale 101

It has been years since the term "short sale" has been used in our real estate market. When a homeowner’s financing (loan) exceeds the market value of their home (what the home is worth) it is considered "up-side down." If the homeowner decides to sell their property and chooses not to pay the lender the shortage, that is referred to as a short sale. However, the transaction is subject to the lender’s approval of a short sale (or short payoff).

The lender’s position is that the borrower owes the remaining balance on the loan. Lenders do not share in the equity of a home in a growing market, so why would they share a loss in a down market? Lenders are not guarantying that home values will go up when they approve a loan. For obvious reasons, lenders are very reluctant to enter into any discussion regarding a short payoff. So why do lenders have a short sale payoff division?

In California, conventional home loan lenders have no recourse but to go after a borrower’s personal assets in a defaulted loan. If a borrower stops making payments and the lender forecloses on the property, the lender gets the property. The lender will do their best to sell the property and cover their loss, but with the loss of time, legal fees, lost-payments, real estate sale fees etc., the loss will be more than what they gain in the sale. On the borrower’s side, all that may happen is a foreclosure "ding" on their credit. But what happens if an up-side down homeowner wants out of their loan and their lender wants to be paid in full? Why would a lender discuss the possibility of a short payoff? Generally, lenders won’t; they won’t unless the borrower forces the situation.

For example, Joe the Homeowner obtains a home loan for $500,000 to buy a home for $600,000. Joe has good credit and cash reserves, and he keeps up to date on the monthly payments. A few years later Joe decides to move out of the area and needs to sell his home. Joe discovers his home has declined in value to $450,000. Joe gives his mortgage company a call and informs them, "I am selling my home. Will you accept the net proceeds (approximately $430,000) as payment in full?" The lender’s response is, "When our company loaned you the money to buy your home, you assured us (via a signed contract) that you would pay off the loan in full. If you must sell your home, we expect you to pay the shortage from your cash reserves, or keep the home and make your payments as agreed."

A few months later, Joe calls the lender back.

"I stopped paying the monthly payment, and you have started the foreclosure process. I have put the home for sale and have received an offer for $450,000. I will not put any funds into escrow to close (and you can’t force me to). Will you accept the net proceeds as your payment in full?"

The lender has several options:

·         Foreclose on the home losing time and money, hope the market does not decline further and put it back for sale

·         Keep the home after foreclosure (lenders do not want to keep homes), or

·         Accept the short payoff and attempt to negotiate with the buyer of the home a higher sales price

Lenders usually consider the homeowner’s hardship when they decide whether or not to accept a short payoff.

If the lender negotiates a short payoff and closes escrow, the borrower will possibly have a record of the event on their credit (a foreclosure will appear on their credit report whenever it is pulled). The IRS taxes the forgiven amount of the loan (the short pay amount) as taxable income to the homeowner (or now, "seller"). Currently the taxable aspect is being debated in Washington D.C.

With lenders folding or some being merged with other banks, it can take months for a lender to act. Sometimes, lenders foreclose on a property because the department negating the short sale does not communicate with the new foreclosure department. Other times, the buyer of the short sale property can be in contract (subject to the lender’s approval) with the seller and at the last minute discover that the lender will not cooperate or firmly lower the short sale amount, which raises the sales price. Sellers may opt to add extra funds to make the deal work but this can be a "big stress" for the buyer at the close of escrow.

There are different types of home financing in California. The type of financing may have an effect on the tax or legal consequence to the seller. This article deals with owner-occupied homes. Other property types (second homes, incomer/commercial property, etc.) may be short sale negotiable, but with different tax/legal consequences.

It is vital for a seller/borrower to get professional legal and tax consequence advice. I have worked with many sellers in a short sale position, listed their home, and successfully negotiated high value transactions.

You may can contact me at 310-372-8378 or call me on my cell phone at 310-613-2808 for more information.

Chuck Wilson

Broker Owner

Real Estate of South Bay