The Short Sale Process for Homeowners
IF YOU ARE UNDERWATER ON YOUR MORTGAGE, YOU NEED TO KEEP READING
If you are a homeowner who is behind on your mortgage payments, or will soon be behind on your payments, this article is written for you. Even if you aren’t, it always makes sense to be prepared for life’s unexpected events. The purpose of the owner’s section of this article is to analyze the situation you are in and then explain your options in detail.
If you have any other questions that are not addressed in this article, feel free to reach out to us.
You Can’t Pay Your Mortgage
If you are late on your mortgage payments, then the bank is coming for you.
After 120 days or about 4 months of delinquency, the bank will begin the foreclosure process. Foreclosure is a massive problem, especially for somebody already in a bad place financially. Not only can the process drag on for months, but the owner also faces several large consequences after going through foreclosure.
Hardships of Foreclosure:
- -The owner now has no place to live;
- -The owner is losing the largest investment they have ever owned;
- -The owner will not be able to receive another Fannie Mae loan, which applies to most common loans, on another property for at least 7 years due to stipulations in Fannie Mae guidelines;
- -The owner’s credit score drops anywhere from 100-160 points.
These are all major reasons why most homeowners choose to avoid foreclosure. With that in mind, let’s take a look at your options.
The chart above displays 3 straight weeks of increasing 30-year mortgage rates and the first decline in these rates of 2018. This chart, along with the other weeks of inclining mortgage rates, suggests that the number of underwater mortgages in Pennsylvania, but more so New Jersey, will increase.
According to CoreLogic, central Pennsylvania underwater mortgage rates appeared to drop by more than 10% at the end of 2016. On the other hand, there are over 30 towns in New Jersey alone that exceed the national average of 9% for underwater mortgages and Trenton is ranked as the #1 zip code for the highest number of underwater mortgages at over 74% of mortgages being seriously underwater according to USAToday’s article.
So let’s review what your options are.
Stay in Home Options
Now while this option can only be used by homeowners who haven’t missed a payment yet, it is definitely worth discussing. If you are a homeowner who has not missed a payment yet but fear that you will in the future, refinancing could be your solution.
What is refinancing?
Refinancing is when you replace an old loan with a new loan, usually one with a lower interest rate. The new loan pays off the old loan, so the borrower still must make payments on the new loan. Most times the new loan has better terms, like lower interest rates or extended loan periods, that allow the borrower to better stabilize their financial situation. I should also mention that refinancing has no effect on your credit score.
The process of refinancing is relatively simple and straightforward.
The first step is to find a better lender with better loan terms. This can easily be done by searching online, calling lenders, or even meeting with bank representatives in person. Typically, direct lenders offer a wider variety of better loan options when compared to popular banks (Usually by about 12 points!). However, the difference between these lender rates is a lot smaller.
Below is a list of some of the best online mortgage refinance rates in PA according to value penguin.
The next step, the borrower must apply for the new loan. If they are approved, the new loan will pay off the old loan and the borrower will begin making payments on the new loan. Some common reasons for a refinance application being denied are if the original loan is low-interest, if any payments have been missed, or if you have no equity in the home.
However, if you are a homeowner with no equity in the property or if you owe more on the loan than the property is worth, you might be eligible for the HARP program. This federal program enables borrowers with little or no equity to refinance into a more affordable loan without getting additional mortgage insurance. HARP is made for people whose mortgage is equal to or greater than 80% of the value of the property and who have missed a limited number of payments.
If you are an owner who is not in any immediate danger of missing a payment, try waiting a little while and reapplying. If your credit was too low you could always apply for an FHA loan (these loans are more expensive but are often approved for buyers with lower credit scores). But. if you are a homeowner who is in immediate danger of missing a payment and you are denied for a refinance, read on and find a better solution.
This is the best option for short-term financial issues. A forbearance is when the lender allows the borrower to either temporarily reduce monthly payments or temporarily suspend monthly payments altogether.
This works great for owners who are facing short-term financial issues. For example, what if you quit your job for a better job, but after you already left your old job you find out the new position will not start for 9 months. How in the world are you going to buy groceries, let alone pay mortgage payments?
In this situation, you would want to apply for a forbearance.
The first step in the forbearance process is contacting your lender to determine if you are eligible for a forbearance.
Reasons lenders grant forbearance:
- – Medical expenses
- – Unemployment
- – Change of Job
- – Death
After you have been approved for forbearance, you and the lender will need to agree on 3 things:
- Forbearance Period
- This is the length of time the mortgage payment will be reduced or suspended.
- Amount Reduced
- The amount the payment will be reduced by during the forbearance period if it is not entirely suspended altogether.
- Repayment Options
- Reinstatement Plan – A one-time payment of the total amount reduced or suspended.
- Repayment Plan – Allows the total amount reduced/suspended to be paid back in pieces on top of monthly mortgage payments.
If you would like to find out more about your specific forbearance options, reach out to your lender.
Best for long-term financial issues, modification of a loan is when the lender allows certain terms of the loan to be altered so that the payments can be easier for the borrower to manage.
This option is very similar to refinancing in that it results in easier to manage monthly mortgage payments. However, no new loan is needed. So if you were going to modify your current loan, you would need to reach out to your lender and come to an agreement to change the original terms of your mortgage.
Modification works by any/all of the following:
- – Extending the term of the loan,
- – Permanently or temporarily reducing the interest rate or
- – Even changing the loan type.
It all depends on your situation and your loan/lender. If you are curious about what your modification options are specifically, reach out to your lender.
A repayment plan is when an owner and lender agree upon a repayment plan that allows the borrower to repay missed payments on top of monthly payments. The owner and lender must agree upon the length of the repayment plan and the amount to be repaid on top of monthly payments.
While this was necessary to mention because it is an option, repayment plans only work well for owners who have missed 1 or 2 payments and are financially sturdy enough to pay them back quickly. Lender qualifications for repayment plans differ based on the borrower’s financial status and the type of loan. However, most repayment plans are income driven; meaning lenders allow/structure repayment plans based off of the borrower’s income as well as their income to debt ratio.
Leave the Home Options
Cash for Keys
Cash for keys is a term used when a lender offers a cash settlement to the owner of a property that is in pre-foreclosure to leave without a fight.
This is a good solution for homeowners who are being foreclosed on and are looking to drop the property as pain-free as possible. Keep in mind, the bank is not required to offer a cash for keys settlement, so think twice before you turn it down.
If the owner agrees to the terms, the lender will give them a cash settlement to vacate the property as well as to leave it clean and in good condition. This allows the owner of the property to not only get rid of their headache property but they make a little money in the process.
You might be asking why the bank would ever pay someone who already cannot pay their original debt to them?
The main reason is that it is the quickest and easiest option to avoid foreclosure. The foreclosure process is ugly and expensive and is as much a headache for the bank as it can be for the homeowner. The bank would much rather pay a small sum of money to the owner for them to leave the property quickly and painlessly.
Also commonly referred to as a deed-in-lieu of foreclosure, a mortgage release is when the owner of the property transfers or releases ownership of the home to the owner of the mortgage. In return, they are released from their loan and payments.
A mortgage release usually takes about 3 months to complete but can vary based on the owner’s situation. What happens next depends on which option the owner is qualified for. There are 3 options:
- – Immediately vacating the home
- – Staying in the home for 3 months
- – Leasing the home for a period of time longer than 3 months.
- – It is even possible for the owner to get money towards relocating somewhere else.
Mortgage release is a good option for homeowners that are facing long-term financial hardship and who cannot/will not sell their home.
Subject To compared to Mortgage Assumption
When you buy a property “subject to” an existing mortgage, you would take on the mortgage payments. However, the original borrower would still be liable if the payments were to become delinquent.
So for example, if you bought my property subject to my existing mortgage and began missing mortgage payments, I would be liable for the property and be the one involved in the foreclosure process.
This can be a good option for homeowners who have a financially-afloat buyer whom they trust to make the mortgage payments. The distressed seller will be able to get out of mortgage payments every month.
Buying a property by assuming a mortgage is different than buying a property “subject to” an existing mortgage. When a buyer assumes an existing mortgage, they are now liable for the mortgage from the previous borrower. So if you bought a property and assumed the mortgage for it and began missing payments; you would be the person involved in the foreclosure process.
This would seem like the best option for homeowners facing foreclosure, however, it requires the approval of a lender since the mortgage liability is transferring from one person to another. Mortgage assumptions have become rarer because lenders have strict qualifications that buyers must meet.
A short sale is when a lender approves the sale of a home for less than what is owed on the property’s mortgage payment.
For example, if you bought a $200,000 property and put $40,000 down, your loan would be for $160,000. Now, due to neglect or market changes the property is only worth $100,000. Then financial disaster strikes and you can no longer afford the mortgage payments. You now have a big problem and foreclosure is imminent. Then your luck changes and you read an article explaining what short sales are on moveinphilly.com. After learning about short sales and better understanding your situation, you get approved for a short sale and leave that headache property behind.
As a seller, there are certain criteria you will need to meet in order to qualify for a short sale. If any of the following do not apply to you and your property, then there is a chance you might not qualify for a short sale.
- – The market value of the property has dropped considerably from the time you purchased it. You will need solid comparables to show that the value has dropped and is worth less than what is owed on the loan. If you have an interested buyer, they should be able to provide you with these comparables.
- – The mortgage is either in default status or will be soon. This means that either you are late on your mortgage payments or are going to be soon. If the mortgage payments are not delinquent and not threatened to become delinquent, the lender has no reason to approve a short sale.
- – The seller is experiencing hardship. The seller must submit a letter of hardship explaining why they will not be able to pay the amount owed on the loan in full. Examples of hardship include; divorce, unemployment, bankruptcy, death, or medical emergencies.
- – The seller has no assets. The bank will review your tax returns and your financial statement. If they see that you have any assets, they likely won’t approve the short sale because the bank will feel that the seller could use the assets to pay the shorted difference.
Deficiency judgments are the lender’s rights to legally pursue the money left on the loan that wasn’t covered by the sale of the property. The difference between what the property sells for and what was owed on the loan is considered personal debt after closing.
To be clear, if these deficiency rights are not waived by the lender in the letter of approval, then the seller is liable for the personal debt and the lender can legally pursue it. The bank usually has at least 5 years to pursue the personal debt, so years later you could still be liable for the shorted difference. Depending on the seller’s financial situation, getting these rights waived can be relatively simple.
The lender will review the seller’s financial status when deciding to approve the short sale. If they approve it, it is most likely because the seller is distressed. If the seller has a bad financial status, the lender will simply waive the deficiency rights in the letter of approval. If you are going to sell your home through a short sale, be sure to negotiate for the underlying personal debt to be forgiven, and be sure the buyer (especially investors) are doing what they can to help get these rights waived as well. This way you are protected from future problems with the bank and are in no way liable for the property any longer.
Taxes and Tax Implications
Often times when asking why someone is interested in a short sale compared to foreclosure or other options, it is because the effect on their credit is far less drastic.
However, this isn’t necessarily true.
Fair Isaac released a report showing that in both foreclosure and short sale, the owner’s credit score dropped 100-160 points. It is said that if the owner of the property sold through a short sale while they were 60 days or more late on their payments, that the effect on their credit report would be the same as if they were foreclosed on. But, on average a former homeowner who went through a short sale is far more likely to decrease their debt than a former homeowner who was foreclosed on.
One major point to discuss in this section is that canceled debt can be taxed by the IRS as income.
Stupid, we know. Nonetheless, it is a possibility and one that you as the seller should definitely be aware of before engaging in a short sale. The cancellation of debt is the technical term for the bank waiving their deficiency rights, and forgiving the seller for the amount still owed on the loan.
When this happens, the bank fills out a 1099-C form and sends it to both to the seller and to the IRS. This basically alerts the IRS that the bank forgave the debt, but the IRS now sees this canceled debt as earned income. That income gained is taxable. However, the Mortgage Forgiveness Debt Relief Act of 2007, protects most owners in cases of foreclosure and short sale. This act does not relieve home equity loans or cash-out refinances though.
Short Sale Package
Most short sale lenders have a short sale package which contains the necessary forms to be filled out, as well as a list of all the other documents that will need to be submitted with the package. The list of documents usually consist of a letter of hardship from the seller, the seller’s financial statement, two most recent pay stubs, two most recent tax returns, two most recent bank statements, a copy of the agreement of sale (contract between the seller and the buyer), a copy of a HUD-1 (a proposed settlement statement), and a letter of authorization.
Letter of Hardship
The letter of hardship is written by the seller and must serve as an explanation as to why the seller is not able to afford the mortgage payments. Some commonly approved examples of hardship are divorce, job loss, medical emergencies, and death in the family.
This should be a copy of all the seller’s bank accounts, paper securities (stocks and bonds) and assets (real estate, corporations, etc.).
Sale of Agreement
The sale of agreement is simply the contract between the buyer and the seller. The buyer and seller must agree to all terms before both signing and submitting. Most lenders will not even look at short sale packages unless they have an interested buyer. This, along with the offering price, is why the contract is so important in the short sale package.
Also called a settlement statement, this document breaks down all the movement of funds, commissions, fees, expenses, and even missed payments. This is basically a preliminary detailed map of how much money is going to who throughout the short sale. The lender must be able to see that the seller is not profiting financially from the short sale.
Letter of Authorization
This is another letter, written by the seller, that grants the seller’s agent or lawyer the right to represent them and their wishes throughout the short sale process. Often times when the buyer of the property is an investor, the seller will grant them authority so long as the investor keeps the seller’s best interests in mind.
Getting into the Short Sale Process
To begin the process, a short sale package must be submitted to the lender for approval. It is possible for a seller to submit the necessary documents to a lender and be approved for sale without a buyer, but it is unlikely. In most cases, the lender will not review a short sale package until there is an offer on the property. Once the package has been submitted, it can take the mortgage company 2-3 months to approve the short sale. Once they deem a seller qualified to complete the transaction, they will assign a negotiator to the deal. The negotiator will then represent the lender throughout the length of the deal and at closing.
The buyer and the seller must both sign the contract; hereby agreeing to the terms. Then, the contract will be sent to the short sale lender as a part of the short sale package. The lender will approve the sale and submit a letter of approval. This letter of approval will need to be shown at closing because the bank is agreeing to accept less money than they are owed.
It is worth mentioning that after a seller submits a short sale package, so long as it contains a letter of authorization, he/she can be as involved in the process as they would like. Some homeowners would prefer to be involved in everything and know every step of the plan. Others want nothing to do with the short sale process and simply want to be rid of the property as quickly as possible.
The point is that the majority of the work in this process can be put on your agent or on the buyer/investor if you choose to.
Why Would Lenders Approve Short Sales?
J. Scott, author of “The Book on Flipping Houses”, gives a fantastic explanation of why a lender would ever let a short sale happen. After all, the lender is going to lose money and this is the biggest reason as to why most people think a bank/lender will not approve a short sale.
However, sometimes they might lose less money by approving the short sale than they would by foreclosing on the property.
The main reason being that foreclosure is an expensive process that requires lawyers, real estate agents, title companies, and many other entities. Foreclosure is also known to drag out. Even after all that, the lender might still not get as much for the property once it is foreclosed on compared to what they could have through a short sale.
Plus, the short sale causes less of a headache for the lender than foreclosing on the property would. Banks try to avoid foreclosures as much as the homeowners, and in most cases, banks work harder than the homeowners do to avoid it.
Long story short, a short sale can be in everyone’s best interest.
While we briefly covered some of the main reasons foreclosure is avoided by most homeowners, I will go further into detail on the foreclosure process now.
Foreclosure is when the bank swoops in and takes the house out of the possession of the homeowner because they weren’t paying their mortgage payments. This all starts with owners becoming delinquent on their loan payments.
After as little as 3 missed payments, the bank orders a trustee to record a Notice of Default (NOD). The NOD alerts the homeowner that foreclosure is imminent if they do not pay back the missed payments during the reinstatement period, which is typically around 3 months long. If the owner does not repay the missed payments within that time frame, a foreclosure date is established and a Notice of Sale (NOS) will be sent to the homeowner, posted on the property, recorded by the county clerk’s office, and usually posted in the newspaper.
On the date established in the issued NOS, a trustee sale will take place at the county courthouse. The property will be auctioned to the public and would need to be paid for in cash. Upon the completion of a trustee sale, the trustee’s deed to the property is passed to the winner of the auction; which is typically the bank.
The next step of the process is when the bank attempts to auction off the property. The bank then must set an opening bid for the auction which is usually the outstanding loan balance plus any accrued interest/fees that have piled up during the foreclosure process. If the property receives no bids higher than the opening bid, the bank’s attorney will purchase the property for the bank, in which case it is now referred to as a Real Estate Owned property, or REO.
Many foreclosures end in this fashion because usually the opening bid (A.K.A. the money owed to the bank) is usually more than the property is worth.
Drawbacks of Foreclosure
- Foreclosure is a drawn-out headache for both the owner and the bank;
- Foreclosure is expensive;
- Foreclosure significantly drops your credit score, usually at least 100 points;
- Foreclosure causes the owner to lose their home.
Benefits of Foreclosure
- One of the only benefits of foreclosure is being able to simply walk away from the property with no liability;
- Foreclosures take a while and legally the bank might have to allow the previous owner to live in the property until it is officially foreclosed on.