Last week we closed one of the messiest and most stressful transactions we have ever encountered. It was a short sale with two lien holders. Lien holders are the banks who owned the mortgages on the property. In a short sale, those lien holders are asked to release their interest in the property for a payoff less than what they are owed. Often lien holders will lose $100’s of thousands in this process, but it can be more appealing to them than a foreclosure. It is certainly more appealing to a seller than having a foreclosure.
Our buyers got the home that they loved at a good price, but not without a lot of pain and unexpected hurdles. Here is a blow-by-blow recap to see just what sort of obstacles you might have to overcome with a short sale.
- Long timeframe – The property was originally listed in November 2008. They didn’t receive lien holder approval until September 2009, a full seven months later. We didn’t engage on the property until August, so we got lucky and the short sale approvals came through shortly after our offer. This is longer than normal for a short sale, but you need to be fully aware of the delays possible in a process like this. Often there is nothing you or your agent can do to make things move faster. Putting more aggressive deadlines on your offer won’t make anybody move faster.
- Purchase price – The listing agent notched the price down eight times before it sold. Remember, the list price is set by the seller and listing agent as a “guess” on what it will take to receive an offer and also obtain bank approval. The bank had no input on the pricing, so when the final approval came, it was a full $25k higher than our offer at list price. The increased price was non-negotiable, since it had already gone through months of negotiation with the listing agent to get to that point.
- Junior lien payoff – A 2nd mortgage is a junior lien that doesn’t get paid until the 1st mortgage is paid off. In our scenario, the 1st mortgage approved $5k of the proceeds to go to the 2nd mortgage holder. The 2nd mortgage holder wanted 4x that amount to release the seller of their obligation. The only way this would work was to have the buyer pay the remainder, which is what the 1st mortgage instructed us to do. Because it couldn’t be part of the sale proceeds, it also couldn’t be part of the purchase price. The buyers’ cash to close went up dramatically.
- Short sales are negotiated between the seller and their lender – You may feel like you are negotiating the deal with a bank. Technically you are not. You negotiate with the seller, but the actual short sale negotiation is between the seller and their lender. This is an important nuance to remember when the negotiations don’t go your way.
- Make it legal – An unconventional payoff of the 2nd lien needs to be disclosed and approved by all parties to the transaction. If you hide it, you are potentially committing mortgage fraud. None of us wanted to participate in a fraudulent transaction, so it required consultation with numerous lawyers and title companies before we finally found a solution. We found an escrow officer experienced in short sales that was able to craft a HUD-1 Settlement Statement that adequately disclosed all of the money being transferred and was ultimately approved by all parties in the transaction.
- Inexperienced short-sale agents – The listing agent was a self-proclaimed “short sale expert”. As we found out, that expertise involved precisely two successful short sales and a lax attitude toward the legalities required by real estate settlement law. His choice of escrow agent seriously compromised our ability to close the transaction in a fully legal manner.
- Delayed inspection – Inspections can cost $500+, and this one required an additional septic inspection. The buyers didn’t want to spend money on an inspection without having the transaction approved by the bank, for good reason. We knew that the roof needed repair. When bank approval arrived we promptly inspected the property to find that the roof was in worse shape than originally thought, not to mention a pesky rodent issue that needed attention. It would have been nice to evaluate these conditions earlier in the process, but that requires spending money on an inspection that may go nowhere.
- “As-is” really means “As-is” – Sellers in a short sale often have little or no money. In our case, they were facing bankruptcy. When our inspection brought up issues that needed fixing, there was no money available to contribute from the seller. The banks don’t technically own the property and will not pay for repairs in a short sale. The logical next step was to ask the 1st mortgage holder to reduce their payoff amount to account for the big issues. Our numerous attempts at negotiation were met with coldly with one sentence: “NO – short sales are as-is”. Maybe you will get lucky and the sellers have some money to help with repairs, but assume that the buyer will have to pick up the tab for repairs. We’ve actually had better luck negotiating repairs on bank-owned properties than on short sales.
- Tell your lender – Keep your lender informed on the details of the transaction. They need to approve it as well, and any unusual terms of the deal must surface early. We had to escalate our requests to an underwriting manager to get final buyoff on the buyers’ loan.
- Watch for extension fees – The whole process got bogged down and we needed a two week extension for the bank approvals. Like banks are apt to do, they added a “per-diem” fee for each day it was extended to cover their holding costs. (about $1500) The seller had no money, so that left three parties able to pay: the listing agent, the buyers’ agent and the buyers. We ended up splitting this last minute surprise between the three of us to get the darned thing closed.
- Big banks will do as they please – You are simply one file amongst hundreds on the desk of the bank’s negotiator. Sane and logical negotiation tactics that work in a regular sale will fall on deaf ears at these banks. If your transaction fits their guidelines, they will approve it. If it doesn’t fit their guidelines, they won’t. Their guidelines don’t always make sense, but they are not going to change them just for you. Remember, you are just another file to them.
- Why won’t they accept our offer? – You may get in a situation where your offer appears more advantageous to the lenders than going to foreclosure. In the case of the 2nd mortgage, they would be paid nothing if the property was foreclosed, right? Not entirely true. Some banks have their own mortgage insurance which pays them an amount in the case of foreclosure, so they may get something. They may also be able to retain a judgment against the borrower for what they are owed. You also need to remember that banks’ motivations for writing off losses change month-to-month and quarter-to-quarter. They may be more or less motivated, depending on how they want to report their financial results for any given time period.
So what do we recommend if you do choose to pursue a short sale?
- Make sure it is the right house – Short sales are full of risks and hassle. It needs to be the right house for you to go all the way through the process. If you are at all unsure about the house, continue your house hunting while the short sale approval is taking place.
- Work with actual short sale experts – When things get messy, it can pay to have an agent, lawyer and escrow officer versed in short sales at your side. If you need to seek legal counsel in the process, by all means spend the extra money.
- Be honest about the condition
of the home – You may end up with the home “as-is.” Be honest about the condition of the home upfront and you won’t be surprised months later with a surprise set of repairs.
- Patience – If you don’t have the patience to see the transaction through to completion, don’t bother. There is no magic recipe to make the big banks move faster, and no amount of pestering seems to impact their process.