April 12, 2011 > What are short sales and how they can help?
What are short sales and how they can help?
Submitted By Varoon Sahgal
Short sales account for a large part of the current real estate market. Many troubled homeowners are unaware they might qualify for such a transaction and do not understand the benefits.
A short sale is defined as a sale of real estate in which the proceeds from the sale fall short of the balance owed on the property's loan. If a borrower owes $400,000 on a property whose market value is $300,000, then a sale of that property would be considered a short sale.
Understanding the foreclosure process is key to understanding short sales. If a borrower stops making payments on a mortgage for three or four months, the lender will file a Notice Of Default (NOD) with the county as a public record. This starts the countdown to a foreclosure on the courthouse steps.
The borrower's credit score drops once the NOD is filed, regardless of subsequent actions. How much the credit score suffers depends on the individual but according to Fair Isaac, the FICO credit score can drop anywhere between 70 and 135 points.
If someone has missed one or two months' mortgage payments but has not yet received a NOD, there is more hope. Their credit score has not been affected yet. A NOD will eventually be issued if more payments are missed. If it is possible to catch up with the missed payments, then calling the lender before a NOD is issued is a good idea.
If mortgage payments cannot be made current, then a short sale is a good idea, assuming the borrower has negative equity and some hardship. This will save the person's credit by avoiding a NOD.
Banks know many borrowers are in financial difficulty and are renegotiating the terms of the loans to such homeowners to help make their payments more affordable. This is called a loan modification which may entail extending the term of the loan to reduce the size of monthly payments, lowering the interest rate, and other terms and conditions. One thing that is not common is reduction of the unpaid balance of the loan.
However, loan modifications do not always make sense. For example, there is little point of modifying the terms of a $550,000 mortgage on a property with a market value of $400,000 just to continue paying for a home that is worth far less than the original purchase price. Loan modifications do not address the issue of negative equity but a short sale does extricate people from such a situation.
The short sale process starts much like any other home sale; a realtor must sign a listing agreement with the homeowner to obtain the latter's approval to sell the property.
From this point, the process differs from a normal sale. The realtor must compile and send what is called a "short sale package" to the homeowner's lender to secure the lender's approval for a short sale. The short sale package contains several items such as W2's, bank statements and a hardship letter which informs the lender of the homeowner's extenuating circumstances; it might be divorce, unemployment, illness, etc.
In a short sale, the real estate agent is paid entirely by the bank when the transaction is completed. For the borrower in difficulty, keeping his credit intact is a major advantage of a short sale over a foreclosure, if the borrower has not received a NOD.
Fannie Mae, which establishes guidelines for many loans, is prepared to lend to someone, who has had a short sale, two years later. Anyone who has suffered foreclosure must wait five years before being considered for a mortgage loan.
Another benefit of avoiding foreclosure is simply that foreclosure has far reaching consequences. Prospective employers may even turn down a job applicant.