 Personal Finance PowerPoint Presentation, Short Sale. Get ready to get financially fit by practicing personal finance. Most of this information can be found at Investopedia Short Sale Real Estate, which you can find online. Take a look at the references, resources, continue your research from there. This is by James Chen, updated August 20th, 2021. What is a short sale real estate? The term short sale in real estate refers to a sale that takes place when a financially distressed homeowner sells their property for less than the amount due on the mortgage. So you got the seller of the property, they're selling it for less than they owe on the loan on the mortgage. Normally you wouldn't expect this to happen under normal conditions, because when they took out the loan using the home as collateral, usually the bank wants a significant amount of down payment, like a 20% down payment, so that even if there's a decrease in the market, then you hopefully don't end up with a situation where the loan amount is higher than the home amount or what the home can be sold for. But if you have a situation where there's a significant decrease in the housing market and or there's a lesser down payment possibly because there's a government kind of program kind of thing incentivizing the banks to have less down payment or other incentives for banks to have or accept less down payments such as being able to sell it on the secondary market, for example, then you're more likely to end up with these situations where the home value is less than the loan value, which could of course lead to this kind of short sale situation. It leaves the bank in a bad situation because they can't really foreclose as easily. If there was a lack of payment, they might be able to foreclose, but even if they were to do so and they'd have to sell the home, they'd have to pay for the process of doing that and they still wouldn't get enough money typically that would be the problem to pay off the loan. So the buyer of the property is a third party, not the bank. So now we're talking about the buyer stepping in to purchase the property that's in this particular situation. So in all proceeds from the sale, go to the lender. So clearly the proceeds from the sale go into the lender because of this situation where the fact that the proceeds are not gonna be greater than the loan amount, they're less than the loan amount. So you're gonna take all the proceeds, you're gonna give it to the lender and you still have the fact that the lender's short on the amount that's still owed, which even though the home was collateral, the collateral no longer pays the loan. So you would expect then the person that took out the loan to still be responsible for the difference, but they might not be in a financial situation to be able to make up the difference. So the lender has two options available. They can forgive the remaining balance and go after the homeowner through a deficiency judgment which requires them to pay the lender all or part of the difference. So there's still that remaining balance that has to be thought about what's gonna be happening with it. So in some states, the difference must legally be forgiven in a short sale. So the difference might be forgiven as process of the short sale. Obviously the bank has some incentives to do that if they think the person who they lent the money to just doesn't have the money to pay the difference and they're just gonna settle it out, do the short sale and be done with it. Understanding a short sale, real estate, a short sale and real estate involves selling a home for less than the balance remaining on the mortgage. That of course puts pressure on the seller, especially if they're having financial problems and so on to pay the mortgage. So for example, a person may end up selling their house for 150,000 when there is still 175,000 remaining on the mortgage. Again, how could this happen? Because again, there'd probably be a decrease in the housing market, which does happen from time to time. And if you don't have a significant cushion on the down payment, that could happen. That could make people that are in the home feel, like they're not invested in the home at that point in time because that kind of reverse equity situation. In this example, the difference is 25,000, less any closing and other selling costs is considered the deficiency. Before the process can begin, the mortgage lender must sign off on the decision to execute the short sale, also known as the pre foreclosure sale. So the pre foreclosure sale, the lender typically a bank also needs documentation that explains why a short sale makes sense. After all, the lending institution could lose a lot of money in the process. No short sale may occur without lender approval. So the lender needs the approval because obviously they're short on this whole kind of process. So short sales tend to be lengthy and paperwork intensive transactions, sometimes taking up to a full year to process. So these are things that could have advantages due to the distressed nature for some people, but there are also things that are gonna be paperwork intensive and more involved process. So you're gonna have to be making sure that you understand what the process is if you're looking into that kind of thing. So however, short sales are not as detrimental to a homeowner's credit rating as a foreclosure. So if you're the homeowner and you're saying, okay, if I get a foreclosure happening, then that might, that will set me back in terms of my credit score possibly longer than if I could negotiate a short sale type of situation. A real estate short sale is unlike a short sale in investing. So don't get those two things confused. We're not talking about the same thing when you're talking investing stocks and bonds on a short sale. And investing short sale is a transaction in which an investor sells borrowed securities in anticipation of a price decline and is required to return an equal number of the shares at some point in the future. So you've got this kind of situation where they're gonna basically short the stock and then buy back the shares in the future at the lower price when they're gonna pay back. So they pay back with the shares in the future, which they think they're gonna be able to get at the lower price. So that's not what we're talking about here with the housing market. So special considerations, even though a short sale hurts a person's credit score less than a foreclosure, it is still a negative credit mark. So you gotta think about what's the difference if you're in a situation of a short sale or a foreclosure, what's gonna be the best scenario? Some people have pressure just to like walk away. I'm just gonna try to let the foreclosure happen, but oftentimes it might be better to work with the bank if possible on it. Any type of property sale that is denoted by a credit company as not paid as agreed is a ding on the credit score. Therefore, short sales for closures and deeds in lieu of foreclosure all negatively impact a person's credit. Short sales don't always negate the remaining mortgage debt after the property is sold. So if you're going into a short sale, you wanna make sure that you look into that it might still gonna be responsible for the amount that is not covered through the short sale. This would be because there are two parts to all mortgages. The first is the lien against the property that is used to secure the loan. The lien protects the lender in case a borrower can't repay the loan. It gives the lending institution the right to sell the property for repayment. This part of the mortgage is waived in a short sale. The second part of the mortgage is the promise to repay. So clearly when you're getting a loan, typically you're thinking about it as you're gonna promise to repay, but then the bank's going to secure that promise with the home. So if you sell the home, then you still don't have enough to repay the loan, you would think you'd still have the promise that you made to repay the loan. So lenders can still enforce this portion either through a new note or the collection of the deficiency. Whatever happens, lenders must approve the short sale, which means borrowers are sometimes at their whim. Short sale versus a foreclosure, what's the difference? The short sales and foreclosures are two financial options available to homeowners who are behind in their mortgage payments, who have a home that is underwater or both. In both cases, the owner is forced to part with the home, but the timeline and consequences are different. A foreclosure is the act of the lender seizing the home after the borrower fails to make the payments. So you can think about that as the bank actually taking action on the foreclosure, right? They're gonna foreclose actively, foreclosing on the property due to circumstances within the agreement, such as not paying on the mortgage. So foreclosure is the last option for the lenders. That's typically, that no one really wants to do that on either side, typically, but that threat has to be there, that option has to be there to hold everything together. So unlike a short sale, foreclosures are only initiated by the lenders. The lender moves against the delinquent borrower to force the sale of a home, hoping to make good on its initial investment of the mortgage. Also, unlike most short sales, many foreclosures take place after the homeowner abandons the home. So if you have a situation, again, where you're underwater, sometimes there's pressure to just leave because you get this feeling that you're no longer invested in the home, which is, again, another reason why when they take out the loan, the banks usually want that down payment. So if the occupants are still in the home, they are evicted by the lender at that point. Once the lender has access to the home, it orders an appraisal and proceeds trying to sell it at that point. Foreclosures do not normally take as long to complete as a short sale because the lender wants to liquidate the asset quickly. So clearly once the bank forecloses, they don't want to foreclose because they're not in the business of selling homes. Once they foreclose, then it's not usually a pleasant situation if the occupant is still in the home and if they're not in the home. So if they're in the home, they might actually, you know, they gotta remove them from the home. Then there's no one in the home. No one's taking care of the home. So it would usually behoove the lender to get the process done as quickly as possible. So foreclosure homes may also be auctioned off at a trustee sale where buyers bid on homes in a public process. A homeowner who has gone through a short sale may, with certain restrictions, be eligible to purchase another home immediately. Depending on the circumstances, homeowners who experience foreclosure can expect to wait two to seven years to purchase another home. A foreclosure is kept on a person's credit report for seven years. So it's quite a while that it's gonna be a ding against you as on a credit score. So while a foreclosure essentially lets you walk away from your home, albeit with grave consequences for your financial future, such as having to declare bankruptcy and destroy your credit, completing a short sale is labor-intensive. So you gotta, if you're in that situation and those are the options that are before you, then that's those pros and cons. You gotta kind of weigh out short sale being more tedious of a process, foreclosure hitting you harder with regards to your future prospects possibly. However, the payoff for the extra work involved in a short sale may be worth it. So typically, you know, going to the bank and discussing your financial situation, probably the first step in your decision-making process if you're having those financial conditions with the mortgage. So short sale alternatives before signing yourself to presort, before resigning yourself to a short sale, talk to your lender about the possibility of revised payment plan or loan modification. So again, note that the bank doesn't want to do either of these steps really because what they would like to do is just keep getting paid. If you're in a situation where you can't pay the loan, then you might be able to talk to the lender and it's in their interest. Once they've already made the loan, they've already committed, they've already made the decision in the past which is a sunk cost to provide the loan and whatnot. At this point, if you're convinced them and say, look, I don't have the financial conditions to pay here, then it might be in their interest to re-up or adjust things in such a way that you may be able to because that would be possibly more beneficial to them than doing some of these other options. So that might be the first step to kind of look into. One of these options might allow you to stay in your home and get back on your feet. So another possible option for staying in your home arises if you have private mortgage insurance, PMI, many homeowners who purchase homes with less than 20% down were required to purchase PMI with their homes. So if the private mortgage insurance company thinks you have a chance of recovering from your current financial situation, it may advance funds to your lender to bring your payments up to date. So this kind of situation is more likely to happen if you didn't put as much down payment down. And if you didn't put the 20% down payment down, then you had to buy the private mortgage insurance. And so they might play a role or have a factor involved in this as well. So that's another kind of strategy to look at if they were in a situation with the PMI. So eventually you'll have to repay the advance though. Details of a short sale, convincing the lender before beginning the process, the struggling homeowner should consider how likely it is that the lender will want to work with them on a short sale by understanding the lender's perspective. So we want to, if we're dealing with the lender, look at it from the lens of the lender and note that the lender has some incentives to want to work with us. And if we're honest with them about our financial situation, then they have to take, if they were reasonable and rational, they would take the situation from this point going forward and see what would be the best circumstance for them at that point. So since the lender is not required to do a short sale, it will be allowed at the lender's discretion. So the fact that they're not required to do the short sale doesn't mean they wouldn't benefit from a short sale possibly against the alternative of a foreclosure. So that's where your mindset is, what's the benefit to the financial institution? The resource, the source of financial trouble should be new, such as a health problem, the loss of a job or a divorce rather than something that was not disclosed when the home buyer originally applied for the loan. The lender won't be sympathetic to a dishonest borrower. So clearly when you're working with a lender, you wanna be upfront with it and you would think that if there was a circumstance that took place that is current, that changed the situation that they would be more sympathetic to that situation. And again, they're really in their own self-interest, they're gonna be making the decisions possibly, but they would be more likely to trust the situation if it was like a current situation that changed how things were working. However, if you feel you were a victim of predatory lending practices, you may be able to talk to the lender into a short sale even if you have not had any major financial catastrophes since purchasing the home. In that case, it might be more of a like a threatening kind of situation. I'm gonna get my lawyers because I think that you had predatory lending practices give me a loan that you know I couldn't afford and so on from that perspective. So details of the short sale to put yourself in a more convincing position to complete a short sale, stop purchasing non necessities. You don't want to look irresponsible to the lender when it reviews your proposal. So if they're like, yeah, I don't have any money to pay my home, but she just bought a $100,000 car, whatever you know, so they're not gonna believe you maybe. So be aware of other circumstances that may prevent the approval of a short sale. If you are not in default on your mortgage payments yet, the lender probably won't be willing to work with you. If the lender thinks it can get more money from foreclosure on your home then from allowing a short sale, it may not allow one. So if they think it's more beneficial to go through the foreclosure than the short sale to for them, that might be the path that they take, of course. If someone cosigns the mortgage, the lender may hold that person responsible for payment rather than doing a short sale. So if you think your situation is right for a short sale, talk to a decision maker at the bank about the possibility of engaging in this type of transaction. Don't just talk to a customer service representative. So clearly you gotta go and you gotta make sure you know who you're talking to that can actually help you out with that kind of transaction because it's not the day-to-day transaction. You're not gonna get it done over the counter talking to just the normal person, customer service person there. So to work your way up the phone ladder, immediately ask to speak with the lender's loss mitigation department. So loss litigation department. If you don't like what the first decision maker says, try talking to another one on another day and see if you get a different answer. So banks are fairly large, kind of bureaucratic kind of situations. Whenever you're dealing with them, you're gonna deal with some kind of people that almost like to say, to make things difficult for some reason. That's just the way it is. So oftentimes, because it is a large bureaucratic place, you can just call back at a different time and you'll find another person that is much more pleasant and will actually help you. So give that a strategy. So if the lender is willing to consider a short sale, you're ready to move forward with creating the short sale proposal and finding a buyer. Consult professionals. At this point, you should consult an attorney, a tax professional and a real estate agent. While these are high priced professional services, if you make a mistake by trying to handle a complex short sale transaction yourself, you may find yourself in even bigger financial trouble. You may be able to pay for these services fees out of the sale proceeds from your home. Professionals accustomed to dealing with short sale transactions will be able to give you guidance on how to pay them. So if you're going to specialists in that kind of area, then they probably, you know, obviously will have more experience with that kind of situation, with people possibly tight on money. And so I just make sure that you do your research in terms of who you're getting advice from as well. When setting an asking price, make sure to factor the cost of selling the property into the total amount of money you need to get out of the situation. Of course, you want to sell the home for as close to the value of your mortgage as possible, but in a down market, there's bound to be a shortfall. So clearly, I mean, if you're selling it for less than the loan amount, you'd like to get as much money as you can to pay off the loan amount. But that's the point is you might not be able to do that given the market situation. In some states, even after a short sale, the bank will expect you to pay back all or part of that shortfall. Gather your documents and find a buyer. Gather all the documents. You'll need to prove your financial hardship to the lender. This may include bank statements, medical bills, pay stubs, and termination notice from your former job or a divorce decree. It is up to you to come up with a proposal. Be aware that a lender ultimately must approve a short sale after receiving all the details because the lender is the recipient of the proceeds. Your job is to find a buyer for your home. Submit your proposal to the bank. Once you have a buyer and the necessary paperwork, you are ready to submit the buyer's offers and your proposal to the bank, along with the documentation of your distressed financial status. Your proposal should include a hardship letter explaining the circumstances that are preventing you from making your mortgage payment. So you got to give them the rationale for that possibly a new circumstance that took place or something like that. You want to make it convincing as possible and protect your interest while also appealing to the bank. Be careful about submitting your financial information to a lender because if it does not approve the short sale, it may use your financial information to try to get money out of you in foreclosure proceedings. If you still have cash assets, you may be expected to use them to continue making mortgage payments or to make up some of the shortfalls between the sale price and the mortgage amount. An attorney experienced in completing short sales can help you navigate the details because short sales can take longer than regular home sales due to the need for lender approval, they often fall through. So the buyer may find another property while waiting for an answer from you because of that long timeframe by be prepared for this possibility. If the short sale transaction goes through, consult with the Internal Revenue Service, the IRS to see if you will have to pay taxes on the shortfall. Also, because if there's a shortfall, if it's forgiven, if the bank forgives the shortfall that was loaned to you, the IRS might say, well, that's income and then you got a tax situation possibly in that situation. So also be aware that a short sale can still affect your credit score in the sense that the months of mortgage payments you have missed prior to the short sale can show up as delinquent payments on your credit report. It is up to the bank to decide what to report. So it's your best interest to try to convince the bank not to report your defaulted payments. So obviously you're kind of at the bank's mercy there, but you'd like to say, bank, come on, don't report. Don't hurt my credit score. So your bank may be more likely to be generous in this regard if you brought up your hardship before you were significantly behind. So you wanna basically talk to the lender if you can so that you can work with the lender at that point. If not, the lender is gonna be upset and when they're upset, they're probably gonna hurt your credit score or more likely to. So for credit purposes, while this is somewhat damaging, it is certainly less damaging than a foreclosure. Short sale strategies for buying and investing investors. Short sales can also provide excellent opportunities for buyers to get into the houses at a reduced price. So of course you might be thinking on the buyer side of thing, this would be great because this person clearly needs to sell the home and is in a distressed situation, but obviously there's gonna be some difficulty on the sales as well, given the circumstances. So here are a couple of tips to help you make smart decisions when considering the purchase of a short sale property. Learn how to find them. Most short sale properties are listed by real estate agents on real estate websites. Some listings may not be advertised as short sales. So you might have to look for clues within the listing such as being subject to bank approval or giving bank time to respond. So if they're talking about the bank needing approval, it might be a short sale because of that short sale condition. An experienced real estate agent can make a big difference in terms of both finding and closing short sale properties. Agents who specialize in short sales may hold a short sales and foreclosure resource, SFR certification, a designation offered by the National Association of Realtors, the NAR. Holders of this certification have received specialized training in short sales and foreclosures, qualifying sellers for short sales, negotiating with lenders and protecting buyers. It's important to note that certification doesn't guarantee that an agent will have the type of experience you are looking for, nor does a lack of certification provide it. Either way, you'll want to vet any potential real estate agent to ensure their short sale expertise. Property to hurry up and wait. Realize in advance that short sales are complicated time consuming transactions. So clearly there's pros and cons going into the short sale situation. It can take weeks or months for a lender to approve a short sale and many buyers who submit an offer end up canceling because the short sale process takes too long. Rules for short sale transactions vary from state to state, but the steps normally include short sale package. The borrower has to prove financial hardship by submitting a financial package to their lender. The package includes financial statements, a letter describing the seller's hardships and financial record records, including tax returns, W-2s, payroll steps, and bank statements. Short sale offer. Once a seller accepts an offer from a potential buyer, the listing agent, since the lender, the listing agreement and executed purchase offer, the buyer's pre-approved letter, a copy of the earnest money check and the seller's short sale package. If the package is missing anything, either because a document wasn't submitted or due to a filing error on the bank's part, the process will be delayed. Bank processing. The bank's review of the offer can take several weeks to months. And the end, if it will approve or deny it, it's important to note that just because the seller accepts an offer doesn't mean the bank will agree to the price. If the bank thinks it can make more money through foreclosure proceedings, it will reject the offer. It's all in the numbers. In real estate investing, it is said that the money is made in the buy. This means that a good purchase price is often the key to successful deal. If you can get a property for a good price, you increase the odds of coming out ahead when it comes time to sell. If the purchase price is on the high end, on the other hand, you're likely to watch your profit margin erode. You should be able to buy the property, but in great condition and sell it at a price where you can still make a profit. So buy low, sell high. That's my motto of investing in real estate and any other kind of thing. So investors need to be able to turn around and sell the house quickly, typically at below market. And a good purchase price makes this possible, of course. The purchase price is only one important number. However, you'll have to make some other calculations as well, including repairs and renovation costs. These costs will vary depending on the property's condition and your plans for it. It pays to put in the time and effort to develop a realistic budget, as this is one of the figures you'll need to determine if the investment can make money. Costs to consider include material, label, permits, inspection fees, trash removal, storage costs, and dumpster rentals. A good inspection before making the purchase can alert you to any large expenses such as cracked foundation, faulty wiring, or expensive termite damage. After repair value, the ARV. ARV is an estimate of the property's fair market value, FMV, after any repairs and renovations are made. So clearly, we're gonna think about what the value will be at that point in time when we're going into an investment type situation. Investors can look at this number to determine whether the property has profit potential. The best way to evaluate a property's ARV is to look at comparable properties. So clearly, we're gonna look at other market properties and what they're selling for as an appraisal tool for us when making our investment decision. These homes that have recently sold in the area, typically up to the mile away from the subject property that have similar features in terms of square footage, such as the number of bedrooms and bathrooms. That's your comparability factor. Carrying costs. Carrying costs are your expenses for holding onto the property. The longer you own the property, the more you will spend on carrying costs, which include mortgage payments, including interest, property taxes, insurance, condo, and association fees, utilities, like gas, water, sewer, trash, and so on. Determine profitability. So in order for an investment to be profitable, the sum of your costs, the purchase price, repair and renovation costs and carrying costs must be lower than the ARV, which you're gonna invest and sell it for. If your costs are close to or higher than the ARV, it will be difficult or impossible to make a profit. You can determine the potential profit by subtracting the purchase price, repair and renovation costs, and carrying costs from the ARV. So it's profit is gonna be equal to the ARV, what we think we're gonna sell it for after we do this stuff, minus the purchase price, minus the repairs and renovations and whatnot, and the carrying costs. Real estate investors might expect to earn at least 20% profit on property, and some use guidelines to evaluate properties in different housing markets. Under these guidelines, total investment, purchase price, repairs, and renovation costs, and recovery costs should not exceed 80% of ARV and market, where home values are rising, 70% to 75% of ARV in a flat market, 60 to 65% of ARV in a market in which home values are decreasing. If the ARV of a property is 200,000, for example, your total investment should be limited to about 160,000 in a rising market, 140,000 in a flat market, and 120,000 in a market with falling values. The various investment levels are used to reduce risk in changing market conditions. You can risk more in a rising market because you are more likely to get your ARV or better when you sell. In a falling market, you are less likely to get your ARV so your investment should be smaller. What is a short sale? In real estate, a short sale takes place when an owner sells their house below its mortgage value. This typically happens when the owner is under financial distress and is behind on mortgage payments. The owner is obligated to sell their home to a third party while the proceeds of the sale go to the lender. The lender must approve the short sale before it happens. The process of a short sale can often take as long as a year due to the scale of paperwork involved. What is the difference between a short sale and a foreclosure? In a short sale, the proceeds is initiated by the homeowner. The owner will illustrate to the lender the extent of their financial distress through documents that may show a recent loss of employment, divorce decree, or bank statements, change in financial circumstances. In other words, after the lender agrees to the move forward, the homeowner is responsible for finding a buyer. In a foreclosure, the lender initiates the process. That's when the bank is gonna actually take the initial process and initiate the step, essentially seizing the home after the owner has failed to make payments. The foreclosure process is generally faster than the short sale as the lender seeks to liquidate the assets as quickly as possible. Is it a good idea to buy a short sale property? In many cases, buying a short sale property can be advantageous for prospective buyers. However, it is important to be aware of some of the drawbacks involved. Short sales can take a long time with lenders sometimes taking months to approve the transaction. After the seller's approval, it may also take many weeks for the bank to approve the price. If the bank believes that a foreclose proceeding is more lucrative, it may reject the short sale and move forward with the foreclosure instead.