Homeowners who find themselves in the situation where they are having difficulty making the monthly payments for their home loans, and the loan(s) are either close to, or exceed the value of the home, making a refinance virtually impossible, should consider the alternative of the pre-foreclosure sale and short sale payoff to avoid a foreclosure. Mortgage companies will not approve a short sale if the homeowner is in bankruptcy because approving a short sale payoff is considered a collection activity.
The pre-foreclosure sale was recognized by HUD in 1994 and has helped thousands of borrowers in default avoid foreclosure and make a smooth transition to more affordable housing. According to HUD, short payoffs account for 50% of all workouts on conventional loans. However, the short sale negotiation process is a lengthy one. It may take several weeks or more likely several months to get an approval.
When this situation exists, and the lender and homeowner both believe a foreclosure is inevitable, a short sale is often a way to control losses for everyone concerned. The property is listed for sale with a real estate agent at, or slightly below, the property’s “as-is” current market value, with the lender agreeing, in concept, to take a reduced payoff on their outstanding loan amount. When an offer is submitted on the property, the lender will receive a package outlining the offer and agree, disagree or negotiate the sale price.
The benefit to both parties are that the homeowner doesn’t suffer the credit impacts and stigma of foreclosure and the lender can clear a non-performing loan without the associated costs of foreclosure, eviction and property rehabilitation. Short sales are much more difficult when there are loans with different lenders against the property requiring different lenders to agree on the amounts they will reduce their loans. Short sales are also greatly preferred by lenders over a common borrower decision to give the lender a deed-in-lieu of foreclosure.
Foreclosures become costly for both the lender, who must pay legal fees, possible eviction costs, real estate commissions, etc., and for the borrower, whose credit rating would be severely damaged, not to mention the emotional toll suffered. For definition purposes, property owners behind on their mortgage payments and in default of their loan are termed pre-foreclosure. Once a notice of default has been filed in the public records, the property is in foreclosure.
Not all lenders will agree to accept a discounted payoff and release the lien that is secured to a property for less money than is owed, especially if it is more profitable to foreclose. However, they may consider it if the seller has no equity in the property, is unable to repay the difference between the offered price and the existing loan and can show some sort of hardship as to how he got himself into such a financial bind.
The lender will determine which documents are needed in the short sale package. Each lender has different requirements. It is typical to require authorization to release information, hardship letter, financial statement, purchase and sales contract, settlement statement (HUD1), pay stubs, bank statements and tax returns. Some lenders may ask for more, so be prepared. Additional documents are needed on FHA loans. All lenders require a full appraisal of the property before making their final decision to accept or reject the short sale offer.
If you have equity in your home, you can sell it just as you would if you were not in foreclosure. The only difference is that you must order the loan payoff statement from the foreclosure attorney or trustee instead of getting it from your lender. Your only concern should be closing the sale and paying off the loan before the end of the redemption period.
For homes with no equity, you must apply for a short payoff if the sale of your house will not leave enough money to pay off all the mortgages, liens, back payments, and sales commissions on your property. If this is the case, call your lender immediately and get a financial package from them to make your request for a short payoff. The sooner you do this, the sooner the lender can complete its review of your short payoff request. Different lenders have a variety of packages for your individual loan workout options. Make sure that you request and receive the package for a short payoff. The purpose of the financial package is:
- To make certain the reason for the default was unavoidable, involuntary, or beyond your control
- To make certain that you have experienced financial hardship
- To make certain that you do not earn enough money now to pay the deficiency in installments over time
- To make certain that you do not have enough money to pay some or all of the deficiency in a lump sum.
HUD has clear guidelines for reviewing short-payoff requests. As long as you meet the criteria, your request will be approved. The basic guidelines for approval are as follows:
- You must live in the property
- The reason for the default on the mortgage must be unavoidable, involuntary, or beyond your control
- The house must appraise for at least 70% of the unpaid principal balance
- The contract price must be at least 95% of HUD’s appraised value
- The net amount to your lender, after all closing expenses are paid, must be at least 87% of HUD’s appraised value.
The lender must obtain a standard FHA appraisal from an appraiser who does not share any interest with the mortgagor or mortgagor’s agent. The appraisal must contain both “As Is” and “As Repaired” values for the property, and will be valid for six months. A copy of the appraisal must be shared with the homeowner or sales agent, if requested. After your lender receives all of the written documentation from you, they will have the house appraised. The appraisal fees are standard for the community.
Most lenders have a stringent hardship test that borrowers must pass in order to have the short payoff of their loan approved. In most cases, the borrower must be experiencing one or more of the following financial hardships:
- The borrower or an immediate member of the borrower’s family has experienced a catastrophic illness that has wreaked havoc on their personal finances.
- The borrower’s spouse has died or divorced and they have insufficient income to pay the loan payment.
- The borrower’s employer has transferred them out of the area and they’re unable to sell or rent the property.
- The borrower has been called away to active duty military service for an extended period and lacks the monthly income to pay their loan.
- The borrower has suffered a disabling injury that precludes them from ever working again.
- The borrower is unemployed and has no realistic expectations of finding employment in the foreseeable future, due to local economic conditions that are beyond their control.
- The borrower has become financially insolvent, and there’s no realistic expectation that their financial condition will improve within the foreseeable future.
- The borrower has been incarcerated and no longer has the income to pay the loan payment.
Here are some important points to remember about selling your house if a short-payoff is required:
The listing agreement that you sign with your realtor MUST provide that, “The seller’s obligation to perform on this contract is subject to the approval of the lien holders on the property. The seller may cancel this agreement prior to the ending date of the listing period without advance notice to the broker and without payment of a commission or other consideration, if the seller tenders a Deed-In-Lieu of foreclosure.”
It is very important for you to write this language on the listing agreement. If you do not, you may be liable to pay a realtor commission even if you do not sell your house! The contract that you sign to sell the property absolutely must provide that, “This contract is contingent upon acceptance by the seller’s lien holders”
If your lender does not approve the contract, this language will allow you to back out. If the contract does not have this language and your lender does not approve a short-payoff, you must either bring money to the closing to make up the shortage or your buyer can sue you for breach of contract! Your lender’s decision to approve or deny the short-payoff will depend upon many factors, as each case is different.
HUD allows a sales commission (usually 6% or less) and a consideration to be paid to the seller ($750 or $1,000).
The credit score of the seller will take a bigger hit by going through foreclosure or giving a deed-in-lieu of foreclosure than with a short sale. In fact, a short sale may result in a loss of about 100 points on the borrowers FICO score. A foreclosure or deed-in-lieu of foreclosure may result in a lost of 250 points of more.
If the bank chooses to take the loss as a tax write-off, there would be no deficiency judgment on the homeowner’s credit report; however, there is another implication. The deficiency that the homeowner did not have to pay would be considered by the IRS to be income. The lender will send a 1099 to the homeowner at the end of the year, and the homeowner will be required to pay taxes on that difference between sale and the mortgage balance at the time of the short sale.