What is it? - The slowing real estate market has placed many homeowners and real estate investors in a position with their property that is called “upside down”. They owe more than the property is worth. Usually this will not matter to a homeowner that is living in the property or renting it and the cash flows from the property income along with other income sources are sufficient to service the mortgages, pay the real estate taxes and the other costs of the property ownership. But what if there is not sufficient money to pay these bills?
The typical solution is to sell the property. However, in today’s real estate market, the market value of the property is often less than the total due on the mortgages. Unless the property owner can use its own funds to pay the shortfall, the mortgages cannot be satisfied at a sale and therefore the property cannot be sold. The short sale is where the lender takes less than the amount it is owed.
Most important of all, we represent the property owner in a legal relationship of attorney and client. We do not represent the buyer. We do not represent the real estate broker. We do not represent the lender. We only represent the property owner. We only get paid by our client. We receive no commission from the real estate brokers.
Lenders have since at least 1994 utilized a method of addressing these situations through either reducing the mortgage payments or allowing the sale to occur and accepting a payoff of the mortgage that is less, sometimes considerably less, than the amount that was borrowed.
The short sale is a voluntary program of the lender. A short sale, sometimes called a pre-foreclosure sale (PFS), utilizes a procedure by the lender to analyze the situation of the property and the borrower. This analysis is done using property inspection, reports of realtors, reviewing the borrower financial situation today, and determining what the result might be if the property were to be sold in foreclosure. Generally, the lender wants to see which route will provide the lender with the most money in the shortest time. Not foreclosing on the property can be valuable as a time saver to the lender, and that convenience has a value to the lender, which shows up as a discount on the payoff of the mortgage.
There are alternative dispositions to the Short Sale. Some situations are best suited to a modification of the existing mortgage terms. This can include an adjustment to interest rate or term of the loan, but usually the desired result is a significant reduction in the amount of the monthly payment, while not increasing the amount of the total indebtedness. Modification scenarios require a balancing of financial ability and house value and can include factors such as income derived from the property.
Deed in lieu of foreclosure is a popular subject and can sometimes be accomplished if there is just no way to sell the house and there is no possible rehabilitation of the borrower. Deed in lieu of foreclosure is easier to accomplish if there are no other unpaid liens against the property and there are no judgments against the borrower that will prevent “clean title” from being passed to the lender. The problem with deed in lieu, from a lender’s perspective, is that they end up having to carry the property on their books, and have the liability of the cost of sale, real estate taxes, insurance and maintenance on the house.
There are many obstacles to achieving a successful negotiation with the lenders. If there is a junior (second, or home equity loan) mortgage, that lender usually will be asked to take almost no money and give up the house. Second mortgage lenders sometimes ask in return for a promissory note for repayment of the balance of the loan, or they will keep the existing promissory note and ask to continue to receive payments, even though you do not own the house anymore. However, the borrower would usually be in that same position even if the first mortgage was foreclosed.
Not all of our clients that look for a short sale or deed in lieu process are in a financial hardship. If you have assets to pay the shortfall or continue to make payments on the mortgage, but you have “just had enough”, these alternatives are still available to you with a caveat – you cannot expect to walk away from the property without paying the short fall. But you may be able to pay the shortfall under negotiated terms that are more attractive than immediately liquidating other properties to raise the needed cash. What gets done is essentially a modification of the mortgage(s) with a promise to pay the difference. Sometimes the shortfall will need to be secured with a second or third mortgage on some of your other real estate. The good news is that there are solutions to stop the monthly bleeding on the upside down property.
Another issue can be other liens on the property. For example these liens could be for non-payment of real estate taxes or assessments, mechanic liens, code enforcement liens and federal income taxes. All of these liens, as well as other matters could affect the decision of the lender to permit the short sale. If these liens prevent a short sale, other alternatives, such as a deed in lieu of foreclosure, may provide similar relief to the borrower, but will not allow an arms length sale of the property.
To achieve a successful short sale, you should have an attorney advising you and negotiating with the lenders, an experienced real estate broker that will list and advertise your property, and a title company to assist in the final closing and the provision of title insurance. Only an attorney has the ethical obligation to represent only your best interest.
Property owners should beware of “stop foreclosure” schemes and “avoid foreclosure” programs. These programs always involve an investor seeking to get your property for a lot less under current market value than an arms length negotiated sale will provide. Remember – for the investor to make money the investor must buy under the current market. That means it will be harder to get the lender(s) to accept the short sale and it will probably leave the borrower ultimately owing more money.
An often overlooked consequence of a foreclosure or short sale is that to the extent the borrower is relieved of paying any money due the lenders, that money is actually income to the borrower and income tax could become due on that income. That means the less the home sells for, the greater the potential income tax liability to the borrower. There are special exemptions that went into effect for deed in lieu and short sales that occur for the three year period beginning January 1, 2008. These exemptions only apply to a primary residence (a home you lived in for at least 2 years prior to the sale) and only to the extent of the original loan amounts used to purchase the home.
When you do not pay your mortgage for more than 30 days, a late payment will show up on your credit report. When you allow your mortgage to go into foreclosure, your credit report will show there has been a foreclosure. If you have a short sale, the arrangement with the lender should be recorded as a “settled debt”. Each of these events has a different effect on your credit score and your credit report, and how you obtain credit in the future. Each event stays on your credit report for 7 years.
The following articles have been written by Mr. Zaretsky and are published on the Internet. We encourage you to read them and other available source material on the Pre-Foreclosure process. You can look for recent articles by clicking on this My Blog Articles.