If real estate were a three-ring circus – and let’s face it, most of the time it is – short sales would be the main attraction. And what is a short sale? That is a question that I get asked often by buyers who see the bold “SHORT SALE” words in all caps in the remarks section of a property description.
The reason for my hiatus from blogging is due almost exclusively to a nightmarish short sale that I just closed…and bringing it to a close was quite the feat. There were many times I nearly threw in the towel as many others before me already had. Before I got the listing, three other deals died. Fortunately for my sellers, I am relentless.
So what is a short sale? In essence, a short sale happens when the bank(s) permits a seller to sell their home for less than what is owed on their mortgage. This only occurs in situations in which the home owner must sell, is underwater and under financial duress. Basically, the homeowner has fallen on hard times and owes more to the bank than what the property is worth. Short sales saw their heyday after the market crashed in 2008 and homes lost tremendous value overnight. Over the next decade, people who purchased during the height of the bubble were forced to sell for various reasons – either job loss or negligent lending/borrowing practices that resulted in people taking out mortgages for which they were under-qualified. In the latter scenario, banks were offering loans and refinancing options that were intended for investors only, loans that would result in a massive principal payoff after a short period of time and would only be beneficial in short term ownership situations. The long and the short of it is (pun intended) that many people bought too high and were forced to sell low. Banks, needing to take some accountability in these situations, were forced to take a hit by allowing homeowners to sell for less than what they owed on their mortgages. But they didn’t make it easy by any means…. I could honestly write thousands of pages on my adventures in navigating what one bank attorney described as the worst short sale she’s ever dealt with, but for your sake and mine I will channel my hard knocks and lessons learned into a top 10 rules of short sales list.
Rule #1 Be Patient
If you need to close in a couple of months, or even three months, DO NOT consider a short sale. Be prepared to tie your deposit up for several months waiting to close. If you are not a patient person, you will not survive the process. When representing buyers interested in purchasing a short sale, the first question I ask is whether or not they are ok waiting six months or more to close. While short sales have tightened up their turnaround time frame in recent years – I closed my last one in just three and a half months – there are still going to be quite a few delays and cortisol raising moments along the way.
Rule #2 Be Realistic
This is a short sale. The seller is seeing no proceeds from the sale and is a hair shy of being destitute. The only reason they are short selling rather than forfeiting the property or filing for bankruptcy is to save their credit. Be prepared to take the property in “as is” condition. The seller cannot afford to make repairs. If you are not prepared to take the property as it is, I would walk away. Having said that, in some special cases, depending on the nature of the repair, you can request a seller concession, which means your offer price is higher than what the short sale bank will net. Those extra funds get wrapped into your mortgage and applied to your closing costs, thus freeing up your liquid cash to cover repairs. However, getting this approved by the short sale lender is tricky and depends upon the nature of the repair. Having a major defect that is a health/safety/environmental concern that must be addressed such as a failed buried oil tank or septic system is normally justified and easier to get approved. A broken faucet or appliance? Not so much.
Rule #3 Find Out How Many Banks are Involved
In many instances, home owners took out one or more home equity lines with different banks over the years, in which case they may be indebted to more parties than just the bank that is the primary lien holder. The fewer banks you have to deal with the better! Each bank is a decision maker in the approval process of a short sale, and depending on the size and quality of the banks, they can greatly hold up the process of getting the short sale approved. To put it in perspective, I dealt with two banks on my most recent short sale and it was the most painful experience of my life (up there with child birth).
Rule #4 Ask if the Short Sale is Approved
In 99% of the cases I’ve seen, unless a property fell out of contract with another buyer, most short sales that you see on the market are not yet approved. The reason is that they cannot be submitted for approval until a contract is signed with a prospective buyer. This is what triggers the BPO (Broker Price Opinion) to be ordered. The BPO is the internal appraisal commissioned by the bank to determine the property’s value. They need a contract fully executed by buyer and seller in order to order this. And the appraised value is the main criteria in determining whether to accept or counter the offer presented. So in essence, the short sale cannot get approved without a buyer first making an offer, and that first offer is basically the guinea pig.
Having said that, the seller himself also must be approved for the short sale. He must prove financial hardship before the bank will entertain his request for a short sale. And this can and should be done prior to marketing the property. As a prospective buyer, I would inquire as to whether the seller has been vetted by the bank and determined eligible for a short sale. Additionally, The Mortgage Forgiveness Debt Relief Act ended in December of 2017. As of 2018, unless sellers can prove total insolvency, they will receive a 1099-C and are on the hook to pay taxes on the gap between what the bank nets and what is owed to them after a short sale. Short sale sellers that are unaware of this tax law change may later decide to pull the plug on the short sale altogether and file bankruptcy (I’ve had this happen), resulting in the loss of money invested in the short sale by the buyer (inspections, appraisal, etc). I would make certain the seller is both pre-qualified for the short sale, and is properly advised on his post closing financial obligations.
Rule #5 Get an Appraisal, Inspection & Contractor Estimate
I always advise my short sale buyers to get an independent appraisal of value done on the property to justify your offer price. It costs about $400 or so, and if you are getting a mortgage it has to be done anyway. Even if you are paying cash, I would consider it another buyer due diligence cost a la the home inspection. Having one on hand is very useful in combating a BPO that comes in higher than your offer price. To this effect, I would also be prepared to submit your inspection report to the bank. It is often the case that short sale properties need TLC that may or may not be reflected in the appraised value, as appraisers are limited as to the condition adjustments they are able to make. Such repairs will be evident in the inspection report. A good rule of thumb is to get a licensed local contractor to give you an estimate of repairs that are in the inspection report. Your realtor should be able to recommend one, and they usually will provide a written estimate pro bono for you in the hopes that you will engage their services in the future. If the short sale lender counters your offer because their BPO comes in much higher, you will be armed with excellent negotiating ammunition if you have your appraisal, inspection report and contractor estimate handy to justify your offer.
Rule #6 Choose Your Team Wisely
Neither agents nor attorneys need special training, experience or licensing to represent buyers and sellers in short sales, BUT THEY SHOULD. It takes an inordinate amount of patience, common sense and skill to successfully negotiate a short sale transaction, and can easily become a full time job! If you get an inexperienced buyer or seller to represent you, you are in for a heap of trouble. My first short sale literally fell into my lap. I wanted no part of it, until I spoke to the homeowners who cried poverty and pulled at my heart strings. No one else would take them on, so I bit the bullet. However, I was wise enough to bring on board a seasoned negotiator and attorneys who had experience in short sales. Agents do the lion’s share of the work as they are the ones negotiating directly with the banks, so it’s important that they know what they are doing. For example, they need to understand how to fill out a HUD-1 form which details the exact costs that need to be approved. If that form is even slightly incorrect at the onset, it can hold up the process for a very long time. They also need to have the persistence necessary to get to the finish line, excellent communication skills and the ability to stand firm with banks who will attempt to push them around.
Rule #7 Put as Little Down at Contract Signing as Possible
In NY, the standard Earnest Money Deposit is 10% at contract signing, or the entire down payment if it is less than 10%. The trouble with a short sale is that it is the only case where the contract is signed prior to an offer being accepted. When you sign a contract on a short sale, you enter into a period of uncertainty as to whether or not the deal will materialize for what could be a period of several months. That is way too long to tie up tens of thousands of dollars. Consult with your real estate attorney (who is hopefully seasoned in short sale transactions) on putting the lowest possible amount down at contract. I would say 3% would be ideal, though some sellers’ attorneys will insist upon at least 5%.
Rule #8 Get the HUD Right the First Time!
As previously mentioned, the HUD-1 is very important. It is the nucleus of the transaction, and crucial in determining not just the net proceeds, but the closing fees that will be approved. It is crucial that only one correct version is sent to the short sale bank because they will not keep track of draft revisions, and cannot be relied upon to approve the most updated version for approval. It is highly recommended that the HUD be drafted by one of the attorneys to ensure it is as accurate as possible. Unfortunately, attorneys don’t feel they get paid enough on a short sale warrant the extra leg work required (true), and it often falls on the agent to put together the HUD. Why is this a problem? Let my most recent experience serve as a cautionary tale. On my short sale, both buyer and seller attorneys were largely checked out so I engaged a third party short sale negotiator to put together and submit the HUD, and basically deal with both banks. I am not a numbers person, so for me, just having the HUD prepared was worth his entire fee. However, when the HUD was initially submitted, it was missing a $5,000 seller concession. This was not the negotiator’s fault. The $5,000 was negotiated after contracts were signed and the offer was submitted to the bank. A revised HUD was promptly re-sent, and we were assured it was submitted for approval. After two months, we were initially elated to receive the approval letter, and then gutted to discover that the file had to be resubmitted for approval because it was missing the seller concession. The asset manager at the bank submitted the wrong HUD for approval! After another two weeks elapsed, we finally received approval on the seller concession, but our happy dance was once again cut short when the approval was sent to the seller’s attorney. Ever the Monday morning quarterback, he pointed out that there was an additional 1% city tax that was not accounted for in the approval. Perhaps if he had prepared the HUD himself to begin with as he should have, we wouldn’t have this issue at the 11th hour…but I digress. The negotiator that I hired was from Queens and had no experience in the city in which the property was located, and was unaware of the additional tax. This resulted in another delay as the file had to yet again be resubmitted for approval.
It cannot be underestimated how much time can be saved simply by getting the HUD correct at the onset. Sellers, I would advise urging your attorney to draft the HUD, or at least review the one that is prepared by an agent or negotiator prior to submission to the short sale bank. Buyers, before signing contracts, have your attorney look over the numbers on the HUD. It’s so important, I cannot say it enough. I firmly believe that it should be common practice for the seller’s attorney to draft a HUD and include it along with the contract of sale in short sale transactions, but we do not live in a perfect world.
Rule # 9 Know thy Investor
Depending on the type of mortgage the seller obtained when he purchased, you may not be dealing with the investor directly. If the primary mortgagee is either Fannie Mae or Freddie Mac, for example, that means you will be negotiating the short sale with a third party mortgage servicer rather than the investor themselves. A mortgage servicer is a company hired by the investor to service the loan (collect monthly payments, etc.). Each asset manager within a servicing company has at least 100 files that are assigned to them at any given time, and they can be very disorganized and haphazard in the materials they pass along to the investor. From what I’ve observed, there is very little incentive on their part to see the file close because the servicer gets paid by the investor to service the loan for as long as they hold it. The investor trusts them to make decisions on their behalf, and I’ve found that, often times, those decisions are neither logical, nor in the investor’s best interest. In the case of this last short sale, things got so bad that I had to ask for a non-delegated review of the file – that is, to deal directly with the investor without the middle man – thus ensuring that all materials went directly to the investor for review. The investors tend to be much more amenable and invested in seeing the deal close successfully. They are also much nicer and easier to get on the phone. The last thing they want to do is foreclose on a property, which ends up being much more costly to them than short selling it. Your interests are more closely aligned with theirs, so don’t be shy about calling them directly and blowing the whistle on the servicer.
Rule #10 Do Not Lock too Soon
If you are mortgaging your purchase, do not lock your interest rate until you have an official approval from the short sale bank(s). As I mentioned, short sales can take several months, and anything longer than a 60 day rate lock is extremely expensive. If you opt for the 60 day lock prior to getting approval, you could end up paying hefty extension fees. So I would highly advise, unless rates bottom out to a ridiculously unprecedented low and you know you are close to the finish line, do not lock in your rate until you get short sale approval. Once a short sale is approved by all lien holders, it can take 30-60 days to actually close, with additional delays possible. So consider that when locking in!
I hope this was a helpful overview. Feel free to leave a comment or send a message if you have any specific questions about the short sale process or need guidance.