The Short Sale Process

Seller's first step in the process

The first step is to talk to the loss mitigation department with the lender. In order for the lender to agree to take a loss, they will insist on understanding why the borrowers cannot meet their obligations. So, you need to get your documentation ready. If you lost your job, perhaps a life partner, or a business failure, then banks are more inclined to work out a settlement since the foreclosure process is very costly to lenders. Some estimates show that the average foreclosure costs the lender $50,000. So all parties have some incentive to create a solution. On the other hand, unless you have some good reason, lenders will not look favorably to someone trying to skip out on their obligations without establishing a bona fide hardship. In those cases you need to look for professional advice to see if the terms of the present loan can be restructured.

Upon contact with the Bank, most will order a "BPO", which is a market analysis of the property. It is not an appraisal, but an indication of current value. Some banks will provide the seller with an estimated range of sales prices that will be acceptable.

Second mortgage consideration

If there is a second mortgage on the property, the Seller will need to obtain the approval of both the first and second lien holders. Often, the second is held by another bank. It is the holder of the second that can pose the greatest problem- remember, the first lien holder has a priority and gets dollar one. There may not sufficient funds to pay off the second. 

When does the foreclosure start?

Usually the process starts when the borrower is 3 months past due on mortgage payments. Will the lender stop a foreclosure procedure? Not likely, most lenders will not stop the foreclosure process once it starts- so time is of the essence. When will a lender halt the foreclosure? Normally the foreclosure process will only be halted with an "approved short sale transaction".

The Approval Process

The Approval Process seems to be an area of great misunderstanding. Remember, you have nothing until you have a written approval from the lender, and most likely the foreclosure process is ticking away. So you start with a bi-lateral contract for the sale of the property. Do not expect a lender to provide an approval for the transaction without a bi-lateral contract. The lender will evaluate only when a contract is presented for approval. The lender will first obtain an appraisal of the property. Lenders will compare the offer to the appraisal value and determine if approval will be given or the Bank may make a counter offer.

Guidelines for an acceptable offer

Opinions differ as to how much of loss the banks will take so reasonableness should be exercised. A rule of thumb would be not to propose a transaction that is greater than 10% discount from market value. As a homeowner, you need a real estate professional that does a comprehensive analysis. Do your homework on market value of property; lenders will not approve an unreasonable offer. Once the short sale is approved, the foreclosure proceeding will normally be suspended pending the closing. So you are not off the hook yet- you have to close the transaction.

How is the loss treated?

Will the lender take the loss and walk away, or file a judgment against the borrowers? It depends on your lender so you need to negotiate this. Remember, the borrowers may have the option of bankruptcy which could protect against a judgment and of course the lenders are aware of this option. At this point, you could finally be feeling relief from a serious problem. Are you ready for the zinger? The IRS can take a position that forgiveness of debt is ordinary income, subject to taxation. Lenders are required to file a 1099-C to report the transaction- get professional tax advice regarding the ramifications.