When you sell your home for less than the balance you owe on your mortgage(s), it is called a short sale or sometimes a short payoff. Many lenders are willing to accept a short payoff (less than they are owed) when the owner cannot make the mortgage payments.
The reason a lender will forgive all or a large portion of the unpaid amount of the loan is that a short sale saves it time and money by avoiding a more costly foreclosure procedure.
For example; you bought your property for $400,000, putting very little down; hence you borrowed approximately $400,000. But, the collapse of the real estate market means that the value of your home has plunged. Today it’s worth only $350,000. That means that you’re upside down (under water) to the tune of $50,000. That’s how much more you owe on your mortgage than the value of your home.
Now a triggering event occurs.
For example; your mortgage resets to a much higher interest rate and monthly payment, which you cannot afford. Because you owe $400,000 and your house is worth only $350,000, you have negative equity.
This precludes you from being able to refinance (no lender will offer you a mortgage when you owe so much more than your property’s value), and you can’t sell in the traditional manner (unless you come up with $50,000 out of your own pocket—something I’ve yet to see a seller willing and able to do!).
What Happens If I Stop Making Payments?
You stop making payments, and you face foreclosure. You can’t refi, and you can’t sell (in the usual way). What can you do?
One good alternative is to get the lender to accept less than you owe; in the example above, instead of $400,000, only $350,000. If you can get your lender to accept $50,000 less (plus transaction costs), you can still sell your home—and without spending a dime of your money.
That’s the big trick, of course. Getting the lender to take less. When you’re successful, it’s called a short sale.
What If I Have More Than One Mortgage?
Frequently people who are facing foreclosure have more than one mortgage on their property. They may have taken out a home equity loan, which is in the form of a second mortgage. And they may have taken out another loan in order to consolidate some credit card debt, which may be in the form of a third mortgage. And so on.
Additionally, they may have liens against the property. An auto loan was not paid, and the lender went to court and secured a judgment, which is now a lien against the property. There may be tax liens from the federal (IRS) and state governments. And so on.
Junior mortgage holders and lien holders can each put in their request for payment as part of the closing costs. But it’s at the discretion of the lender of the first mortgage as to whether or not to allow it. Very frequently the first lender will simply shut out the others, refusing to pay almost anything. Thus lenders in junior positions (second, third, and so forth as well as many lien holders) will be wiped out and will get nothing or just a token payment.
Here’s one exception- tax liens. The exception is if the lien holder is a state taxing body (such as one that collects property taxes). Their liens generally supersede any mort- gage. Hence, the lender on the first mortgage must usually pay these in order to be able to get clear title back whether it’s a short sale or a foreclosure.
It’s Not How Much You Owe, It’s How Much the Lender Will Forgive
Don’t be intimidated by the amount of money by which you’re under water. It really doesn’t matter if it’s $10,000 or $100,000 or $500,000. Regardless, if you need a short sale to sell, you may very well get it. Remember, you’re not getting any cash out of a short sale. You’re salvaging your credit. Thus the absolute amounts shouldn’t matter to you.
Of course, they matter to a lender. But the lender is only concerned with mitigating loss.
You need to show a reasonable lender that it can lose less by doing a short sale than by going through foreclosure in order to get your deal. The rub, of course, is that some lenders just aren’t reasonable and don’t always do what’s in their own best interests.
What a Short Sale Can Do for a Seller
In a difficult real estate market, short sales can be a positive force, especially when you’re facing foreclosure.
Here’s what a short sale can do for a seller:
- Allow you to sell when you’re “under water.” (In some areas as many as a quarter of all homeowners owe more than their homes are worth.)
- Avoid or stop foreclosure. (It’s a short sale—the foreclosure process ends the moment you no longer own the property.)
- Preserve your credit. (There’s almost nothing worse on a credit report than a foreclosure. The short sale prevents it.)
- Safeguard your finances. (This will stop you drawing down your reserves by making payments you can’t afford.)
- Many millions of homeowners are facing foreclosure as this is written, and many more are likely to join their ranks.
Seven Steps to a Short Sale
There are seven steps you should follow to complete a short sale. These include:
- Use a preliminary net sheet (PNS) to see if you really are under water.
- Find a good real estate agent that specializes in short sales, or sell the property yourself.
- Prepare your property to be sold, and prepare yourself to move.
- Find a buyer for your home at market price.
- Write and sign an authorization letter so your agent and others can contact and deal with your lender.
- With your agent, prepare a short sale package to be sent to your lender which includes documentation of your financial condition as well as a hardship letter.
- Sign the papers and get out from under!
Get Short Sale Assistance
For assistance with selling or buying a Maryland or Washington, DC short sale? Contact us.