In the early and mid 2000’s, home values throughout the United
States appreciated at an unprecedented pace. During this time,
buyers commonly borrowed in excess of 90% of the cost of their
new home purchase, and many homeowners refinanced their
existing mortgages in order to cash out newfound equity. When the
real estate bubble finally burst and home values began to decline,
thousands of Massachusetts homeowners found themselves “under
water” – a phrase that has come to describe the situation where an
individual owes more on their mortgage than their home is worth.
For those wishing to sell, this presents the problem of bringing
thousands of dollars to the closing table.
As a result, many would-be sellers are simply staying put, hoping
for the real estate market to rebound. Unfortunately, the collapse
of the real estate market also hastened further economic turmoil,
resulting in, among other things, reduced wages and increased
unemployment. For those now without adequate means to make
their monthly mortgage payments and lacking available cash to
sell the home and pay off resulting deficiency balances, foreclosure
seems an inevitable conclusion. However, with increasing
frequency the short sale is providing struggling homeowners with
the ability to avoid foreclosure, extricate themselves from the
underlying debt, and move on with their lives.
So, what exactly is a short sale? In its simplest form, a short sale
is a real estate transaction wherein a homeowner owes more on
their mortgage than the property is worth, but the lender agrees to
release the mortgage for a partial payment so that the property can
be sold to a third party. Although a mortgage holder could attempt
to recover what is owed through the foreclosure process, the fact of
the matter is that foreclosure is expensive to pursue and typically
yields greater losses in the end. Therefore, most lenders will try
to work out a short sale with their borrowers if the circumstances
warrant.
In order to be considered for a short sale, the lender will first
require evidence that the borrower is experiencing a personal
hardship which requires them to sell their home. A “hardship” can
be anything from job loss or income reduction, to illness, marital
difficulties, or work-related relocation. The lender will also request
evidence of the borrower’s personal financial situation, including
the disclosure of tax returns, bank statements, current paystubs
and statements detailing monthly income and expenses. Although
somewhat counterintuitive, the borrower does not necessarily
need to be behind on payments or in imminent risk of foreclosure
to qualify, and in my experience there is little if any correlation
between the amount of a borrower’s arrears and the speed or
willingness of a lender to consider a short sale request. In fact, from
the standpoint of preserving credit, borrowers are well advised to
continue making mortgage payments to the extent that they are
able. However, a borrower in a relatively strong financial situation
may find that their lender is only willing to approve the sale and/
or waive any remaining unpaid balance on the loan if the borrower
contributes some out of pocket funds at the closing.
A final consideration worth noting involves the negotiated sale
price for the property, relative to actual market value. Short sale
buyers are often looking for a bargain, and are well aware that
sellers are generally anxious to part ways with the property. As
such, offers can be well below market value, and sellers should
exercise caution when determining how to proceed. In addition
to evaluating their borrower’s financial circumstances, lenders
will also undertake an investigation as to the current market
value of the property, typically through the written opinion of a
disinterested real estate broker, and occasionally through a formal
appraisal. If the lender determines that the offer price is too far
below its appraised value, this will likely lead to the lender rejecting
the short sale. As such, sellers and their real estate brokers should
look closely at comparable properties on the market for sale when
evaluating a given offer, as well as recently sold properties, as these
will surely be on the lender’s radar as well during the short sale
approval process.