Short Sale, If Allowed, Could Avoid Foreclosure

Short Sale, If Allowed, Could Avoid Foreclosure

By Benny L. Kass
Saturday, August 18, 2007; Page F12

Q: We are in financial trouble. Our house will not sell for enough money to pay off the mortgage, let alone a real estate commission. Our real estate agent suggested that we do a "short sale." What is this?

A: A short sale is an arrangement with your lender in which it allows you to sell the property for less than you owe. This is a method of disposing of your home without having the lender foreclose on you.

Why would a lender permit this? First, you should understand that not all lenders do. The decision depends on a number of factors: Where is your house? How much loss will the lender suffer? What is the possibility that an investor would buy the property at a foreclosure sale? Each lender has its own requirements, so I can provide only general information. You will have to consult your lender to determine what it needs to move forward with a short sale.

Let's take this example: You bought the house last year for $500,000, foolishly taking advantage of the mortgage broker's sales pitch and obtaining a 100 percent loan. You lost your job and cannot afford to continue with the monthly mortgage payments. The house will probably sell for only $475,000. You are, unfortunately, what lenders call "upside down."

Your first calls should be to your financial and legal advisers -- not the lender. You don't want to contact the lender until you fully understand the risks involved and are sure you want to do this.

Under federal law, when a debt is forgiven, it can be treated as ordinary income on which tax must be paid. Thus, if your lender allows you to sell the property for $475,000, less a 2 percent commission, you will have a deficit of $34,500. According to many tax professionals, you will have to pay income tax on this amount of forgiven debt, even though you did not receive the money.

Furthermore, make sure that, even should the lender approve the short sale, you will not be obligated to make up this difference, which is called a deficiency. Unfortunately, most lenders will not put their agreement in writing, so your legal advisers will have to satisfy themselves -- and you -- on this matter. In fact, many lenders have been known to use this "forgiveness of debt" issue to dissuade their borrowers from pursuing a short sale.

After you are satisfied that you understand the concept and are prepared to move forward, then you should contact your lender. Ask to speak to the manager of the short-sale department. Typically, a lender has a "loss remediation" department that handles these matters.

Your lender will need a letter of authorization for a lawyer or real estate agent to work on your behalf. Privacy laws prohibit lenders from discussing personal and financial information with a third party without such written permission. This letter will include your name, property address and loan number.

You, or your agent, should then prepare a comprehensive letter explaining why you are requesting the short sale. Emphasize your hardship, without turning it into a sob story. A market analysis showing what houses in your area are selling for will also help. Finally, spell out your request in detail: the price you are asking the lender to approve, the commission the real estate agent can accept and the closing costs associated with the settlement. Keep in mind that in many jurisdictions, there is a recordation and transfer tax, which is typically split between buyer and seller.

Your proposal should be as specific as possible. You don't want to learn at settlement that you still have to come up with a lot of cash because your lender did not authorize certain out-of-pocket expenses.

You should also request from your lender your outstanding mortgage balance. The lender has a legal obligation to provide this on request; the burden is on the lender to provide an accurate accounting. Review this carefully to make sure that no charges have been erroneously added. If you have missed some payments, you will be assessed late fees. When you present your proposal to the lender, try to get these charges deleted from the outstanding mortgage balance.
Your proposal should also include your financial situation. If you lost your job, include proof with the letter.

The more documentation you can provide the lender, the faster the decision will be. However, lenders are swamped with these requests; you are not the only one facing a possible foreclosure. The earlier you can start the process, the better chance you have of getting the short sale approved.

But the lender's approval to proceed with a short sale does not end the process. When you or your real estate agent find a prospective buyer, the contract must state that it is contingent on lender's approval. You have to send the contract to the lender; it would help to include an accounting of all expenses that you will have to pay at settlement, as well as the final number that the lender would receive at settlement.

A HUD-1 settlement statement would expedite the process. Your lender will then review the documentation and may reject certain expenses. For example, if the contract provides that you will give your buyer money toward closing costs, or that you will pay some items that are traditionally the buyer's obligation, such as title search and survey, the lender may not allow such payments.

You want to go to settlement knowing all of the terms and conditions on which your lender will accept the short sale, including whether you will have to come up with money at the settlement table.

You are in financial trouble. If you have missed some payments, your lender may already have notified the credit-reporting companies. You can try to persuade the lender not to report any more delinquencies, but that is at the lender's discretion.

The short-sale process works but is complicated, time-consuming and uncertain. If you can start now, before you are in default, you will be ahead of the game.