Definition of a Short Sale

Definition of a Short Sale:

A short sale is an “arrangement” between the owner of their home and the bank that lent them the money to buy their home to accept an offer for less than the total amount owed to pay off the home. The “deficiency” is the difference between the amount owed and what the bank collects at the short sale.

Although, the “arrangement” can take many different forms, there is no other definition of a short sale. I say this because many realtors and some investors simply throw the term around as if it meant “a sale under market value.” No. A bank owned (foreclosed) house is not a short sale. A seller deciding to lower their price and take less profit is not a short sale. An older lady who owns her home free and clear, sells her $150k home for $75k, is not a short sale. For it to be a Short Sale, someone must be getting “shorted.” Either the seller, or the bank.

 Another important definition of a short sale is how it differs from foreclosure. In foreclosure, the homeowner falls way behind on their payments and the bank repossesses the house and sells it. In almost all cases, the bank pursues the homeowner for the deficiency! This is not a widely known fact but ask someone who has gone through foreclosure, and they will tell you the only way out of this was to file for bankruptcy.     

How It Can Happen - The Arrangement

Most short sales arise when a seller owes more on their house than they can sell it for (upside down). The owner of the home then attempts to make an arrangement with their lender to sell the house for less than is owed.

The term “arrangement” was used in the definition and is intentionally broad because the arrangement depends on the bank that holds the loan. Though there are general practices, every bank does it differently. This article will give you the most common arrangements, but if you take part in a short sale, it’s crucial you assume nothing until you have the bank’s policies in writing.

There are some overriding principles to consider:

1. There is no such thing as a free lunch. This is not some dream alternative to foreclosure where the money you owe magically disappears. The deficiency will be accounted for. The deficiency can be 100% loaned to seller in the form of a promissory note, which they then must repay.

2. It is a cumbersome process. If you are entering into a short sale as a buyer or seller, don’t expect it to go as quickly as any other sale. There’s a lot of “back and forth”.

3. The employees of the lender that are negotiating the sale are not there for the benefit of the seller. Their only goal is to collect as much money for the lender and they will use whatever means necessary. You can be sure that they will most likely misrepresent their own policies and in a fair amount of cases flat out lie to the seller in order to intimidate and scare them into paying more money.

This is a good example: a lender negotiating a short sale that, as a policy, they don’t “write off” any of the deficiency and that the seller would have to have a promissory note for $40,000. This lender also told the seller that their hands were tied and this decision came directly from the investor who provides the money for the lender. The lender also said there is absolutely no negotiation on the amount owed, either pay the deficiency, or they will foreclose. The lender made the promissory note very manageable (20 years 0%) so that the seller would be more enticed to just roll over.

But the seller called the lenders bluff. The seller then provided a letter from an attorney stating they would qualify for a bankruptcy, thus rendering the lender incapable of collecting anything. That same day, the lender called the seller saying they would reduce the promissory note and write off $30,000 of the debt! It would have to be reported as 1099 income, but it would not have to be paid. Amazing change of policy! Then the seller saw what was happening and just said, “no thanks, we don’t want to owe you anything, we’ll just go ahead with the bankruptcy.” Two days later the seller received a written offer that the lender would completely forgive the debt and simply report it as 1099 income! Wow!

The moral of the story is that the lenders will sometimes use falsehoods to obtain their money. Many of the managers of the collections departments are paid a commission on the total amount of money they collect. Just imagine if that seller had rolled over on the first offer! That employee would have been responsible for keeping $40,000 of his company’s money with one five minute phone call!

One other important thing to remember is that if the lender gets the property back (i.e. short sale doesn’t go through), they have to put it up for auction. This creates the risk that additional money will be lost if the house doesn’t sell for what it’s worth.

The Details of the Arrangement

Different banks have different policies. The best case scenario is to get a bank that actually “writes off” the deficiency. All that happens here is that the seller has some minor derogatory credit reporting, but doesn’t actually owe the bank any more money. This credit reporting can consist of anything from “creditor settled for less than the amount due” all the way to “foreclosed.”

As the example noted, many banks will do a promissory note for the deficiency. 

How did we get to this place in the first point?

A short sale can come about for many different reasons. In some cases the owner of the house could have been making the monthly payments on time. Let’s say you owed 300k on the home, but the best offer you had after having the property on the market for 6 months was 250K. So, the moral of the story is that you do not have be behind on your payments to request a short sale. You just have to show that your home can’t be sold for what you owe.

In other cases, short sales happen when a seller can’t afford to make their payments and is nearing foreclosure or bankruptcy. It makes life much more complicated if you are living in the house in question. The bank’s ability to scare you is much greater in that case. In this case, a short sale is only slightly better than the alternatives. You will still lose your house, and your credit is still destroyed just because you’ve made 4-5 late payments on your mortgage.

People tend to think that a bankrupcty, foreclosure, or reposession will damange your credit rating more than the multitude of late payments that lead up to one of the above mentioned actions.

Conclusion

Again, a short sale is not a magic cure. It’s also not some mystical solution that only an elite few know about. If you’re curious about selling your house as a short sale, the first step is to contact a certified short sale/foreclosure agent. We will be able to give you choices and possibly an alternative to foreclosure and bankruptcy. If you’re an investor, there are much better ways to obtain undervalued homes.

Remember that this is a complex process and you should always seek the help of a professional when considering a short sale.