If not done correctly a short seller can end up out of the house, still owing money to the mortgage holder and with his credit in worse shape. As an attorney who handles Short Sales it is of the utmost importance that any seller facing foreclosure know the potential value a Short Sale can bring prior to entering into a contract to sell their home. Negotiating with your lender before you find a buyer can maximize your leverage and place you in a position whereby the Short Sale can happen quickly and the 5 mistakes can be avoided

MISTAKE # 1  THE WRONG NEGOTIATOR
MISTAKE # 2    OWE MONEY AT CLOSING FOR BILLS
MISTAKE # 3   INCORRECT MARKET PRICING/LOW OFFERS
MISTAKE # 4    DELAY LEADS TO LOST CLOSING
MISTAKE # 5   DEFICIENCY JUDMENTS/CREDIT ISSUES/IRS PROBLEMS 
 WHAT IS A SHORT SALE

A short sale is an agreement between a lender and borrower (the homeowner) where the owner sells the home for less than is owed on the mortgage.  The lender must agree to accept less than the full amount due on the owner’s mortgage otherwise a sale is not possible.  If agreed to by the lender at the sale of the house the net sale proceeds (after payment of the sellers closing costs) are paid to the lender who accepts them and releases the house from the mortgage lien.

 
WHY WOULD A HOMEOWNER NEED A SHORT SALE

An owner who wants to avoid foreclosure and its effects on his credit score should try to utilize a short sale.  An owner who is current on his mortgage but is in a negative equity or “Upside Down” may be better off getting out of avoid having to continue to pay a mortgage on a house with no value to him.  
WHEN IS A HOMEOWNER IN AN UPSIDE DOWN POSITION

When a homeowner owes more to his lender than the value of the house he has negative equity or is “upside-down”.  In this situation even if the home is sold for fair market value, the sales price is not enough to pay all the closing costs and satisfy the outstanding mortgage balance.  Since the owner does not have enough from the sale proceeds to pay off his lender (in full) he would be unable to sell the house without having to bring money to the closing to pay the shortfall to his lender.  In this situation it costs him money out of pocket to sell his home.  Here a short sale request should be made to the lender to ask that it accept the amount paid by the buyer (after payment of seller closing fees).  If accepted by the lender the short sale allows a seller to finish the mortgage payments and avoid any further damage to his credit score.

IS THE HOUSE UPSIDE DOWN –

You need to determine if you as the owner have any equity in the house.  Equity is the net amount of money a seller would receive if he sold the house.  This number is figured by taking the sales price less any expenses (mortgages, taxes, liens and closing costs) that needed to be paid to allow the closing.  If the number is positive the seller has equity and if negative the seller is UPSIDE DOWN (negative equity).  It is always preferable to discuss these numbers with your attorney.  While the expense numbers should be available to you, the sales price is a function of the market and should be determined using a broker appraisal.  Your attorney can instruct you on expenses that need to be calculated and the best way to get an appraisal.

WHY WOULD A LENDER ACCEPT A SHORT SALE

In an UPSIDE DOWN situation the homeowner and his lender are both at risk so the question is how to minimize the problem for both parties.  When the owner stops paying his mortgage the lender can enforce its mortgage contract rights to the house but to do so he needs to start a foreclosure.  The foreclosure process takes time and is expensive for a lender. It can cost the lender thousands of dollars in legal fees and court costs and there is no guarantee what condition a house will be in by the time the foreclosure action is completed.  With this in mind it is many lenders will seek to avoid the time and expense of a foreclosure lawsuit and reach an agreement to allow the owner to short sale the house.  While the lender may not get back its full amount due there are substantial benefits to the lender. Besides avoiding the time and expense of the foreclosure process,  the lender gets paid much quicker and gets to take a bad loan off its balance sheet and avoids having to own and manage a foreclosed property. 

HOW DOES A HOMEOWNER DO A SHORT SALE
Steps

1) SPEAK TO YOUR LAWYER-
Many struggling homeowners are contacted by lenders, credit companies and realtors who are all looking to help them get out of their problems.    In times of trouble it is so important to make sure that the person handling your home is someone you can trust who is working for you.  While some of these companies are looking to help most are looking to make some money off your problem so it is critical that you speak to an attorney.  Your lawyer’s obligation is to protect your rights and interests not those of the lender.  He will make sure you understand your rights and obligations and can explain the benefits and problems of different approaches to your situation.  Every case is different; sometimes a payment plan or refinance can be the answer.  Other times even if a short sale can work it may be wiser to live in the home until the foreclosure is done.  These and other options will be discussed with your attorney who can help you decide your best course of action.
2) INFORMATION YOU WILL NEED
To get started your lawyer will need to know the following information about your mortgage, lender name, loan number, principal balance, current interest rate, payment amount and how far behind in payments you are.  He will also need to get an idea about the market value of your home and about other bills you owe including real estate taxes, homeowners or condo association fees and water bills.  He will also ask about your income to determine your ability to make payments and your future plans if you intend to try to stay in the home.  With this information a decision can be made as to whether a loan modification, refinance, short sale or foreclosure is the best option.

3) A SHORT SALE IS MY BEST OPTION WHAT NEXT

You’ve met with your attorney and after going over the options you have decided a short sale is the best way to proceed.  Remember you still need to find a buyer and the lender needs to approve the deal but hopefully in the end you will be done with a bad mortgage and on your way to better credit.  You need to prepare your plan to market the house and get your lender the information it needs to evaluate your short sale request.  Your goal is to assist your attorney in putting together a short sale package that your lender will approve in a reasonable amount of time. 

 
MISTAKE # 1 THE WRONG NEGOTIATOR
  OR
WHAT IS THE NEGOTIATOR’S MAIN GOAL
Many debt relief companies will offer to negotiate with lenders to get you short sale approval.  Short sale approval means that the house can be sold but what about the shortage.  If the shortage is not cancelled by the lender the seller may end up selling his home and still owing money on his mortgage.  Remember, being able to sell is not the borrower’s only goal.  He also needs full debt relief and proper credit reporting.
    When a borrower is seeking a short sale it is best to have someone else do the negotiating on his behalf.  Your negotiator will try to make your case that settling for less now is more beneficial than the lender having to go through the time and expense of the foreclosure process.  The borrower is giving up his rights to remain in the house until the foreclosure process is completed in return for debt relief.  If the numbers make sense most lenders will agree to cancel the mortgage at the closing for less than the amount owed.   But allowing the property to be sold and the mortgage lien released does not make the full debt go away.  Some lenders will ask the seller to sign a promissory note to make payments on the lender’s loss after the closing.  Depending on the amount of the lender’s loss and the seller’s finances this can be avoided by a skilled negotiator.  This is not the major objective of most debt relief companies who are seeking to make money off the closing.  The debt relief company puts its fees into the closing costs.  Their sole objective is for the lender to accept a short sale and to release the house so the company will get paid at the closing.  As seller you want the short sale approved for you to get two other critical objectives 1) to get the underlying mortgage debt released without any further liability and 2) to have his credit report marked as settled not charged off.  If your negotiator does not make this clear from the outset you can be in a position whereby you sold your house, you still owe the lender money and your credit is ruined.

REMEDY MAKE SURE YOUR NEGOTIATOR GETS THE RELIEF YOU NEED NOT JUST THE SHORT SALE
Have your lawyer explain the short sale process to you before you hire a real estate company.  Before listing your home to make sure that the short sale will bring full debt relief and not just allows the house to be sold.
MISTAKE # 2 BROKER LISTS THE SALES PRICE TOO LOW
 
If the buyer’s offer to purchase the premises is too low the lender will reject the short sale.  The sales price must be low enough to entice buyers to make offers but also high enough for the lender to agree to a short sale.  Before picking a broker speak to your attorney about how to find a realtor who understands your goals as a short seller.
4) PICKING THE RIGHT BROKER 

Picking the proper realtor to market your short sale is as important as picking the right attorney.  Your broker will sell the house and help get the information necessary to negotiate the short sale with the lender.  Your lawyer will discuss the role of your realtor and will be needed to start the short sale negotiation.  Your realtor needs to approach the short sale of a house a little differently than a regular house sale.  She needs to be able to fully document the market value as this will be relied on by the lender.  Next after discussing the sellers timeframe for moving out she can determine the best way to market the house to get a quick sale.  A fast sale is a great incentive to the lender.  Also she will need to make potential buyers realistic in their offering price as an offer must be approved by seller’s lender.  Just because the house is in foreclosure does not mean the lender will accept an offer well below market price.

REMEDY PICK THE RIGHT BROKER WHO UNDERSTANDS SHORT SALES AND A SELLERS GOALS
Pricing too high will scare away potential buyers and too low will lead to the short sale lender to reject the offer.  Make sure you understand the market value of the house and the selling strategy before listing with your broker.

MISTAKE # 3  DELAY LEADS TO LOST CLOSING

When completed the short sale package should prominently mention that the buyer has a timeframe for closing.  Everything must be expedited including contract signing, short sale package completion and follow-up.  The completed package should be sent promptly and follow up calls to the lender made regularly so that the approval process does not drag out so long that the buyer backs out of deal.
5) ACCEPTING THE BUYERS OFFER AND GETTING INTO CONTRACT

A potential buyer makes a written offer (signs a binder) with your realtor.  Assuming the offer is close enough to your asking price and the time frame for closing is right the seller can accept and sign the binder.  The binder is then sent to the seller’s attorney who will prepare a contract of sale for the buyer’s attorney.  While containing all the elements of a regular contract, a short sale contract also must contain a clause indicating that the deal is contingent upon the seller’s lender accepting the contract and approving the short sale.  For a buyer this can be problematic as the buyer has to pay money for his engineer inspection, attorney, mortgage application and title search and while all may appears acceptable there is no guarantee that the seller’s lender will approve the short sale and the length of time to obtain a short sale approval may cause difficulty.  From a seller’s perspective the contract needs to fully disclose that the sale is contingent upon the short sale approval and that the seller is not liable for any costs of the buyer.  The buyer will need to discuss this thoroughly with his attorney.  

6) GETTING THE SHORT SALE APPLICATION and PREPARING THE SHORT SALE PACKAGE

a) Requesting the package- You have received an offer and contracts prepared.  Your attorney will send the short sale lender the executed contracts along with your broker’s appraisal report (to show how she came up with a market value) and listing agreement indicating the commission structure. With the broker’s appraisal and listing agreement your attorney can now approach the bank with figures for a short sale approval.  He will ask you to sign an authorization to allow the lender to discuss your case and will send it to the lender and ask for a short sale application. 

b) Package Requirements – The application will contain a list of items the lender will require to process your short sale request.  The items will allow the lender to determine if the sales price is fair and if the borrower’s reason for seeking a short sale is reasonable.  The lender is trying to determine 1) how much the house is really worth and could the lender get more by going through the foreclosure process.  2) Whether the borrower has a real hardship and really can’t make the payments and is not just seeking to get out of a bad mortgage. 3) Can the lender get any more from the borrower after the closing by having a promissory note signed or seeking to sue the borrower on the mortgage note (deficiency judgment). 

c) The Package as a Negotiating Tool – The lender’s negotiator needs as much information as it can get to determine the best way to recover as much of the mortgage loan as possible.  There will be a loss on the mortgage and who bears the loss (lender or borrower) is the focus of the negotiation.  The lender’s negotiator may empathize with the borrower’s plight but his job is to get as much of the loan money back as possible.  To maximize the bank’s return he will want the house to sell for as close to its market value as possible.  Speed in closing is also a concern as the missed mortgage payments continue to mount.  To minimize the lender’s loss, the bank negotiator will try to force the borrower to bear as much of the loss as he can.  This may mean that the borrower will be asked to pay money at or after the closing. The borrower’s negotiator will try to get the lender to absorb the whole (or as much of the) loss as possible to allow the seller to get away with as little additional damage as possible.  Remember, the lender has no obligation to accept a short sale even if the buyer’s offer is fair (close to market value).  With your realtor’s help, your negotiator needs to make your case that the short sale is a better deal for the lender than it would get from going through the foreclosure process.

 
MISTAKE # 4 SELLER HAS TO PAY SOME OF CLOSING COSTS
Once a short sale is accepted an approval letter will be prepared showing the minimum amount the lender must receive from the sale(net proceeds).  If the net proceeds is less than lender agreed to the seller has to pay the shortage at closing.  In such a situation the seller has moved out and has still has to pay money to sell his house.  Failure to properly calculate the net proceeds will cost the seller money.   

REMEDY: PREPARE A PROPER HUD-1 & DISCLOSE ALL POSSIBLE EXPENSES TO BE PAID AT CLOSING – All closing costs need to be fully disclosed to lender as early as possible so that there are no surprises and the short sale approval does not have to be renegotiated

d) Preparing an accurate HUD-1

As part of the short sale negotiation the lender will be given an amount it can expect to  receive from the sale (short sale net proceeds).  A closing document (HUD-1) will used at closing and the lender will require a preliminary HUD-1 as part of the short sale package.   To prepare the HUD-1 your attorney needs to know all of the current and future bills which could affect the closing.  His HUD-1 will be used as part of the negotiation so when done correctly the lender will get net proceeds of at least as much as anticipated.  The preliminary HUD-1 should list all sellers closing fees including transfer taxes, broker commission, attorney fees, release fees and any other items that need to be paid out of the sales price.  After paying all of the closing fees the net balance is given to the seller’s lender as the proceeds of the short sale.  If the expenses on the HUD-1 are greater than the lender has agreed to the difference will need to be paid by the seller at closing or the short sale approval will need to be renegotiated.  Listing all possible seller expenses on the preliminary HUD-1 correctly can avoid costing the seller money at closing.

7) LENDER APPROVAL OF CONTRACT AND SHORT SALE TERMS
The contract was signed and submitted and the short sale package is now complete.  Once the lender has reviewed and accepted the package a short sale approval letter should follow.  Most lenders will not negotiate without a signed contract and the buyer will have a time frame for closing.  Therefore it is important that all requested information be ready to go so once the buyer signs contract a complete package can be sent to the lender.  Upon submission of the package the lender will need to review the documents and in most cases get its own appraisal.  Most lenders want to do their own appraisal so they have a realtor or appraiser do a Broker Price Opinion (BPO) or Automated Valuation Model (AVM) to determine a value on the property.  If the seller’s realtor did a thorough job in preparing her appraisal, the lender’s BPO should come in at close to her appraisal number which makes the price negotiations much easier.  If the rest of the package is complete the lender should be able to reach a decision to give its approval to the short sale.  If however the BPO comes in at a much higher value than the contract price the lender may reject the contract or come back with a counteroffer and ask the buyer to increase his offer price.    
MISTAKE # 5 DEFICIENCY JUDGMENTS/CREDIT ISSUES/IRS PROBLEMS- If the short sale approval is not specific the seller could be liable to pay the amount of the bank’s loss (deficiency balance).  Also, how will the lender report the short sale to the credit bureau.  Most importantly does the short sale result in an IRS issue (tax gain) for the seller.

 
8) SIGNING THE SHORT SALE AGREEMENT
Once the lender agrees to the short sale a short sale agreement is sent to your attorney.  It should detail the terms of the sale and will contain the amount that the lender will accept to release the property from the mortgage lien.  The agreement should specifically mention that the lender is accepting the net proceeds in full satisfaction of the debt and that it is not looking at the seller to pay any additional monies toward the deficiency.  The agreement should also say that the sale will be reported to the credit bureau as settled for less than the full amount not as a charge off or foreclosure.  Third, the agreement should be clear as to what will be reported to the IRS.  The difference between the amount due on the mortgage and the amount received as net proceeds will be reported on an IRS 1099 form.  Make sure any tax ramifications of the 1099 are explained by your accountant prior to signing the agreement.   

9) CLOSING ON YOUR SHORT SALE AGREEMENT AND GETTING THE RELEASE

Shortly after getting the short sale approval your attorney will try to schedule a closing.  At the closing the buyer’s title insurance company will be responsible for getting the net proceeds to the short sale lender to cancel the mortgage.  Make sure that the short sale agreement is sent with the payoff funds and that the seller’s new mailing address is given so that the release documents can be forwarded.  It is important that the seller follow up several weeks after the closing to make sure the loan has been satisfied and the release letter obtained for his records.  Having a credit report updated to make sure that the short sale has been reported to the credit bureau is also a good idea.

10) FILING YOUR TAXES

The seller’s accountant would be notified of the proposed short sale prior to the closing.  He can explain the tax treatment the short sale will receive and the forms that will need to be filled with the IRS.  At closing the seller will receive a 1099 form from his attorney which will show the sale prices.  The seller should also receive a copy of the 1099-S form showing how the mortgage payoff was reported to the IRS.   These forms must be given to your accountant so proper tax treatment of the short sale will result. 
CONCLUSION- A short sale can be a valuable tool in helping a struggling homeowner get out of a bad mortgage situation but it must be done right.  Make sure you understand the process, hire the correct lawyer and realtor and prepare the short sale package quickly.  Review the short sale agreement to make sure any deficiency is taken care of properly.  Follow up after the closing to make sure the sale is reported correctly to the credit bureau and IRS.

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