Home Equity Advantage: the short-sale solution
6/7/2009
A disturbing trend nowadays is when a borrower, perhaps because of illness or loss of income, gets behind in paying the mortgage one or more months, then, perhaps in denial, does not respond to the letters that will come from the servicer of the loan with the warning that if the monetary deficiencies are not resolved soon, foreclosure proceedings will begin. To make matters far worse, the borrower owes $250,000 on the property that is now valued at $200,000, for example, due to declines in the local real-estate market. The poor borrower, looking for some way to avoid foreclosure and a mutilated-beyond-all-recognition credit rating, hears about a thing called a "short sale" where the bank agrees to the sale of the property for less than what is owed, and feels a glimmer of hope. Can this be a valid rescue? Maybe.
There are big barriers to having the lender agree to the short sale. Not least is the loss of the $50,000 in this example. Lenders are in business (and stay in business) by making money, not losing it. For them to agree to a known loss, there are going to have to be some pretty convincing facts that can help them mitigate their losses. This is a financial decision, nothing less. The short sale will have to be more cost-effective than the foreclosure process. Procedures regarding short sales will vary with the servicer of the loan and with state law, but what follows is a general description that may apply generically.
Before a lending entity is willing to agree to a short sale, it's going to want to see that there has been a serious attempt to sell the property: that the property has been listed with a Realtor for a few months and priced to sell. The lender will also require an explanation of the hardship that has caused the delinquencies, and will want financial verification to support the explanation. An appraisal and a market review will be needed to analyze the value and ability to sell the property. And there is the issue of liens (how much is owed) on the property. If there is a first and second mortgage against the property, both lienholders will have to agree to the short sale. This may be difficult to obtain, because the holder of the second mortgage may not receive anything after the sale.
If the lender agrees to the short sale, and the property sells, the seller/borrower may still be responsible for the deficiency, and the lender can seek a judgment for that amount and garnish wages or place a lien on another property purchased in the future. Any debt forgiveness can be viewed by the IRS as taxable income. As you can see, this "solution" is rife with problems. The salient point here is that it is not a simple thing to make problems disappear by giving a property back to the lender, who really doesn't want it.
A borrower in financial distress needs to communicate with the lender to see if there are other solutions well before the short-sale question is asked. Currently, there are numerous loan-modification programs available to help avoid a loss of residence.
David Hultin (505-946-2521) is a residential mortgage-loan officer for New Mexico Bank and Trust. He previously worked in the mortgage divisions of two of the largest banks in the United States.