Short Sale Tip of The Week 5-13-09

Posted on 12. May, 2009 by ctlms in Short Sale, foreclosure

My client needs a short sale but is current on their payments.

What is my best course of action with this listing?

Lets first start by saying that YES, any home that is upside down “can” be short saled.  However, just because it is possible does not make it a guarantee.  Short sales on a whole are not guaranteed.  A short sale is a privilege not an entitlement.  So setting proper expectations with both the seller and the buyer is crucial to a smooth transaction for the real estate agent.

For transactions involving an upside down property that is not in default, there are extra circumstances that are important to discuss with the seller.  The most important of which is the likelihood of a promissory note for the deficiency balance.

When a homeowner is in default and has very little or no money or income to make any payments toward the deficiency created by a short sale, it is rather easy to convince the lender to settle the account in full and relieve the homeowner from the obligation to repay the balance.  However, when the homeowner is not in default it becomes more difficult.

The whole short sale process is more difficult for the negotiator when the homeowner is not in default.  Lenders need to see a Financial Hardship and the fact that the property is not worth the debt in order to approve a short sale.  In the case of a seller that is under water but not in a financial hardship there are some extra hurdles to overcome.

The first hurdle is getting the lender to look at the file all together.  Today most lenders are in firefighting mode.  That means they are trying to put out the hottest fires first.  A loan that is current is not a fire at all to the lender so it tends to go to the bottom of the pile.  So persistence is necessary to get the file looked at.

Once the file is looked at another hurdle is met.  The fact that the homeowner can afford their payments makes the lender want to just tell the seller to not sell and keep paying.  That way there is no issue for the bank at all.  But we all know there are circumstances that force homeowners to sell such as divorce, job transfers, reduction in pay, etc.

Now a homeowner still has a legitimate hardship if they have had a reduction in pay or increase in expenses, is current on their payments but expect to fall behind in the future.  This is known as imminent default.  Their financials will clearly show that they will no longer be able to afford the home.

If their financials do not show imminent default but the homeowners still need to sell the bank will most likely require some sort of promissory note.

A promissory note is basically an unsecured loan.  Most notes in a short sale are for all or part of the deficiency balance and have low or no interest with set payments per month.  The notes are negotiable and that is where the real work comes in for the negotiator in these cases.

Obviously the homeowner wants the account settled in full.  But the lender is unlikely to approve that when the homeowner has the ability to repay some or all the money they borrowed.  So negotiating these notes to as little as possible and for as low an interest rate as possible is the aim of the negotiator.  This is not something you would see your average real estate agent being familiar with. 

So let’s go over an example.  The facts:

Loan balance is $290,000

Property’s current fair market value is $250,000

Payments are current and sellers have no financial hardship but have no cash to bring to closing.

So a sale will create a $40,000 loss to the bank right?  Wrong.  There are closing costs totaling about 6%, that’s another $15,000.  So the total deficit is $55,000.

The lender will most certainly ask for the $55,000 in a note.  The negotiator will try to negotiate that lower, sometimes to as low as 10-20% or $5,500 to $11,000 with zero or 1-2% interest.

So let’s say that ends up with a note for $11,000 at 2% interest for 10 years and payments of $101.21 a month.

Not so bad to be able to walk away from the $55,000 deficit for $100 a month.  Better than having to find the cash or facing foreclosure.

But this all leads to another question for the real estate agent.  How aggressive should you be with the listing price?  Right now the sellers are paying money to the bank every month they will never see again.  That money could be used to pay down the promissory note instead.  Now if it takes 6 months to sell the house plus another 60-90 for short sale approval and closing that is 9 months of payments thrown out the window never to be seen again.

Let’s work the numbers.  Sellers have a principal balance of $290,000 and the original loan was $300,000 at 6% fixed for 30 years.  They are paying $1798.65 for principal and interest every month plus taxes and insurance.  Of that $1,456.95 is interest and $341.70 is principal, all of which is never to be seen again.  Add that up over 9 months and you have $16,187.85.

The takeaway here is that you could have priced the property lower to start and sold it months sooner and not lost the sellers anymore money.  Remember it is possible to settle promissory notes at 50% or less of the balance.  So even if the house sold for $20,000 less but months sooner, that’s a note for $2,000-$10,000 at low interest.  That’s still financially more beneficial than throwing away an extra $5,000-$10,000 because it took months longer to sell.  Remember the promissory notes are low interest where the payments they are making now are mostly interest.

Obviously this is a conversation to have with the seller when listing the home.  Knowing their current payments and interest can help to demonstrate that getting the home sold quicker but for less is in their best interest.  As always, if they are behind on the payments, getting it sold quicker is best, especially if you can get a contract to the lender before they file for foreclosure.

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