UNDERSTANDING SHORT SALES
There is really nothing quite like the feeling of going through a foreclosure. The following information will show property owners their rights, options and how to financially survive a foreclosure. The “Short Sale” option or even a deed in lieu of foreclosure is better than filing for bankruptcy. A bankruptcy is deadly for your credit health. Despite the best efforts, short sales are not always 100% successful in getting approved. By no fault of either party, you may simply run out of time. The sooner you can start the step-by-step process to a short sale, the better your chance of success will be.
Disclaimer
This information is not meant to convey any legal, financial, or financial counseling advice. The reader should seek legal representation and advice before acting or agreeing to a short sale.
The Foreclosure Process
The foreclosure process is based on statutory regulations, meaning quite simply, every state handles the foreclosure process their own way. What might take one month in one state may take three in another. The speed in which the foreclosure progresses through the courts is also determined by how fast, or slow the attorney working for the bank or mortgage company moves the case through the court docket.
The case is filed in Civil Court and a “Notice of Lis Pendens” is filed meaning that a law suit has been initiated. On the notice served to the property owner, the Defendant is the property owner and the Plaintiff is the bank or servicing company for the owner of the mortgage note. Once the property owner has been served this notice of an impending lawsuit, they have 20 days in which to respond to the court. The Defendant (property owner) should write a brief letter in response just to let the court know that they are working with a third party in an effort to correct the problem. In almost all instances where a residential property mortgage is being foreclosed, the only recourse or collateral the bank can come after is the property itself. Unlike some commercial loans that may require a personal guarantee from the borrower, residential mortgages generally do not make that provision. So, they can’t take their cars, kids, or pets as repayment.
What Triggers Foreclosure Action
What typically triggers the banks to initiate the foreclosure on a property is non-payment of the monthly principal and interest payment. The speed in which the case gets to the courthouse will be determined by the case load of the attorneys working for the banks and mortgage companies and the banks and mortgage companies’ willingness to move ahead with the foreclosure. The average time to initiate this action runs three months, but some mortgage companies and banks take as long as six months to start their court action against the property owner. The bottom line is that all banks and mortgage companies do not want to own real estate of any kind. They are in the business of making money on money. Owning a piece of real estate that is a ticking expense meter does not equate to making money.
Once the lawsuit is recorded, all parties must be served notice that a lawsuit is pending. All parties on the mortgage will be served the same documents. The same type of notice will be served on junior lien holders to inform them that their lien or mortgage may be wiped out.
The property owner being served the notice of foreclosure in Florida has 20 days in which to respond to the court. A simple hand written letter will do and it should just state that the property owner is working with a third party to work out a solution and if the house is listed for sale. It is important to respond because it puts the owner of the property on the court records as being concerned about the debt and shows they are making an honest effort to remedy the situation.
Once the 20 days are up, the clock starts to tick and there is a set amount of time to get the short sale package completed. The process may take three to seven months or longer until a sale date is set and the property is sold to the highest bidder on the court house steps.
Not All Loans Are Created Equally
Some loans carry more clout than others and this is where your understanding of the loan hierarchy is very important. Some property owners have multiple loans on their properties. In the case of mortgages attached to property, the mortgage that is first in line carries most of the clout. This does not mean to say that the second mortgage holder cannot foreclose; they most certainly can and will in some cases. What constitutes a first or second mortgage? It is simply determined by what mortgage lien gets recorded first at the county courthouse. The reason for the importance of who gets in first position and who gets relegated to the junior positions are basically two fold.
If a first mortgage holder proceeds with a foreclosure action and completes the process and the property is sold on the courthouse steps, all junior liens are wiped out. The first mortgage holder can now sell this property minus all other encumbrances. If the property ends up selling for much greater than the first mortgage balance, the junior lien holders may get some of their money from the excess funds.
Keep in mind that second mortgage rates are usually substantially higher than the first mortgage rates, so don’t feel too bad for them. They market hot and heavy to anyone who might have equity and loan the money freely and sometimes easily. They are willing to live with the risk in an appreciating market and with the higher interest rates they charge. Since they are in the second position, they stand to lose everything if the first mortgage is foreclosed. How could they protect their position? The only way in which they can protect their position when a mortgage ahead of theirs is in the process of being foreclosed is to foreclose themselves and pay off the first or superior lien in full, along with all the attached attorney fess, late charges, and any other cost associated with the foreclosure. If they do pay off the first mortgage in full, they have become the first mortgage holder.
In theory, this is what can be done by the junior lien holders. In reality, they agree to take huge discounts in an effort to get something out of their loan balance. This is where the majority of the debt is reduced when working short sales, trying to create equity where on paper none existed before starting the short sale process. This also holds true for any other lien such as a mechanics lien. Both the IRS and county real estate tax liens are paid first from sale proceeds.
The Clock is ticking
Regardless of where you are in the short sale process, the clock is always ticking towards a final resolution. In many cases that final resolution is a sale date being set by the court on the court house steps. The foreclosure will move as quickly or as slowly as both the attorney who represents the bank and the courts work through the system. There is not an endless amount of time to get the short sale approved.
The Loss Mitigation department is bound by the terms of the mortgage agreement to keep the foreclosure process moving as long as the payment remains in default. The good news is that the people in the Loss Mitigation department are the only ones who have the authority to cancel a sale at the courthouse steps or delay the process in order to complete the short sale. The attorneys work for the banks and are told what to do by the supervisors in the Loss Mitigation departments. They are virtually powerless to stop a sale date.
The longer you wait after the foreclosure process is set in motion to begin getting all documents into the banks and mortgage companies, the slimmer your chances of obtaining a favorable solution. Once the process moves through the courts, a Summary Final Judgment is issued setting the sale date for the property on the courthouse steps and documenting all the court and other costs that will be added to the principal balance of the loan. The typical time frame for this Summary Final Judgment to be issued is between 60 and 90 days on the early side and anytime after that if things are moving slow.
Once this sale date is set, there are only two parties that have the power to stop the sale. As mentioned before, the Loss Mitigation department has the power to postpone the sale. And they will postpone the sale if the property you are working on has a better than average chance to being sold before the sale date and the proceeds will fit within what they are looking to net. The second party is the property owner themselves. They have the right to bring the loan current at any point during this process and can stop the sale right up to the hour before the property is set to be sold on the courthouse steps. Of course they will have to pay all back payments, attorney fees, and any other fees in order to halt the sale.
Barring the sale being postponed or stopped, the property is sold on the courthouse steps to the highest bidder. 98% of the time, the high bidder is a representative of the bank that bids the Summary Final Judgment amount.
The Benefits & Drawbacks of the Short Sale
The textbook definition of a “short sale” is basically the lender, be it a mortgage company, banking institution, private individual, or servicing company for an investment fund that buys mortgage notes as investments, agreeing to accept less for a payoff on the loan than what is currently on the books as being owned from the borrower. For our discussion we will use the term “banks” to cover any entity that falls in the lender category.
Since banks are not in the business of owning residential real estate, they have an incentive to dispose of these properties before they are forced to take them back via a foreclosure. The banks and the people in their Loss Mitigation or Workout departments will never admit this, but they desperately need Agents to submit and work with potential short sale properties on their and the property owners behalf. The Agent becomes the intermediary in the transaction acting as the negotiator for the borrower until a suitable number is reached that will work for the bank. If they did not want the participation of the agent, broker, or other third party, they would not pay a commission out of their discounted payoff.
How the Property Owner Benefits:
Obviously, not having a full blown foreclosure on their credit is a definite plus. They may be able to save having to file bankruptcy. The bank will figure in the Agents commission as part of their closing costs and will account for that commission when figuring out the discounted “net” that they will take for their current mortgage balance.
If a short sale deal is approved following the guidelines laid out in the following pages, the property owner will not have a Deficiency Judgment issued against them for any shortfall in the amount collected from the short sale deal and the final balance of the Summary Final Judgment.
The Negatives to Property Owners:
The bank will not pay the property owner anything at closing since they are agreeing to take less than what is owed on the property. The only real negative aspect of the short sale process is for IRS purposes, the forgiveness of debt is considered income. Check with a tax person to see if you have losses to offset income. The other very important thing to consider is that if a taxpayer can prove to the IRS that they are insolvent (unable to repay debt) then they will waive this as reportable income. There is also legislation that may eliminate or limit the effect of the forgiven debt being considered as reportable income.
How The Banks Benefit:
Clearly their only real reason to work the short sale process instead of getting the property back via a foreclosure is the cost associated with getting the property back, and the additional costs associated with holding and caring for the property after they have taken title back. Keep in mind that if a property is in the process of being foreclosed and the monthly payment for real estate taxes and insurance is not escrowed, the bank may be forced to place insurance on the property to protect the collateral for their mortgage.
If you look at the big picture, the banks would much rather have the property owner in the house while the foreclosure process is going on so they know that at least there is some care being given to the property. If the banks are working with a house that has been abandoned, they will have to pick up the cost to maintain the grounds until they get the property back or face fines and liens from the local code enforcement departments.
The greatest benefit to the bank from not having a defaulted loan on their books is that the more bad loans they have working, the less they are able to lend out. Regulations require banks to set aside funds that can not be used for other purposes other than to settle bad debt in case of default. There is a huge financial incentive for them to work these short sales.
The Negatives to the Banks:
These short sales take a tremendous amount of labor hours away from otherwise more productive activities. On the properties that do not make the short sale approval file, there are expenses being paid for attorneys and other holding costs. What further complicates these foreclosures and adds to the expenses are that some property owners will wait until the last possible day before the sale on the courthouse steps and then file for bankruptcy. This causes the foreclosure process to grind to a stop. Banks hate this.
Full Disclosure!
If the short sale is approved, the property owner gets absolutely ZERO from the closing proceeds and the bank pays the agents commission. Despite the best efforts, the short sale may not get approved and the bank will foreclose. The fact is that on occasions you will do everything right and have all your ducks in a row and still the time will run out or for some reason the bank will not approve the short sale. Sometimes there is an explanation and other times you will never know why the deal was not approved.
Every contract should contain wording that will requires the bank to not seek a deficiency judgment against the seller as a contingency of the deal. If the contract is rejected based on that wording, the seller will have the option to continue or not. If the bank will agree to discount the loan and agree to the short sale on the property, they have at their disposal on the corporate side of the ledger the legal ability to write off this forgiven debt against their income. Since they are being afforded by tax law the ability to write off some of their losses, it makes no sense to me that they should seek a judgment against the property owners.
Any debt that is forgiven is considered income in the eyes of the IRS. If a property owner can prove to the IRS that they are insolvent (unable to repay any debt) then they will not require you to report this forgiven debt as income. Contact a CPA or other tax professional for tax advice. There is legislation that may eliminate or limit the effect of the forgiven debt being considered as reportable income in some cases.
Bankruptcy is always the final option. Sellers should always seek legal advice. If the bank is being completely unreasonable about helping the seller get out from under the debt, the seller can buy more time by placing the property into bankruptcy to slow the process down. Banks will still work short sales with people who are in bankruptcy, the difference being that the bankruptcy court must now also approve the deal and the property must be released from the bankruptcy case to be sold.