I am asked, “How does a short sale work?” nearly every day. As a real estate investor who specializes in buying distressed properties, I encourage borrowers facing foreclosure to discuss this special selling option with their lender. However, it must be stressed to promptly contact lenders because short sales are not an option once a house enters into foreclosure.
The answer to how does a short sale work depends on the state where the property is located, as well as the policies of the servicing lender. While banks follow similar protocols, the exact process will deviate.
The process begins by contacting the bank’s loss mitigation department. Once borrowers become delinquent with home loan payments their account is assigned to a loss mitigator. This bank employee works with borrowers to develop a payment plan or determine if the property qualifies for short selling.
Lenders usually attempt to help borrowers devise a plan which allows them to retain their property. These options can include deferred loan payments, loan modification, or mortgage forbearance. Short selling is generally the last option offered because banks take a financial loss on the property.
Real estate short sales literally mean the property is sold ‘short’ of the balance owed. Most banks require borrowers to pay any deficiency between the purchase price and loan balance, but some accept the purchase as payment in full. It is important to obtain a ‘Payment in Full’ agreement in order to benefit from the transaction. In most cases, borrowers retain the services of a real estate attorney to negotiate contracts.
If borrowers are held responsible for deficiency amounts and unable to pay the balance in full, banks can obtain court ordered judgments. Deficiency judgments are reflected on credit reports for up to 7 years after the balance is fully paid and can result in a FICO score reduction of 100 points or more.
In order to qualify for short selling, mortgagors must provide financial records to prove they are financially insolvent. Most banks require borrowers to submit wage earnings, tax returns, list of income and expenses, and a letter of hardship.
The hardship letter is a crucial element and can make or break the deal. Therefore, mortgagors should take time to compose a concise and well-written letter which outlines the circumstances that caused financial distress.
Banks are generally more willing to work with borrowers who have taken measures to rectify their financial problems. Therefore, it is important to include details of any action taken within the letter of hardship. This might include selling a second car; taking a second job; eliminating cable or cell phone; or engaging in car pooling.
Once short sale approval is granted, the property must be sold quickly. Most banks require borrowers to locate a qualified buyer prior to entering into a short sale agreement. Others let borrowers list their home through a realtor. Unless buyers are prepared to make a cash offer, they must first obtain preapproved financing.
The short sale process usually requires 4 to 6 months to complete. Short sales are usually reported to credit bureaus and borrowers should plan on engaging in credit repair strategies to improve FICO scores as quickly as possible. In most cases, mortgagors find it takes two or more years to qualify for another home loan after entering into a short sale contract.