Short sales, explained

Any agent facilitating short sale negotiations with the seller’s lender needs to first thoroughly understand:

• California anti-deficiency law barring a mortgage holder from collecting a loss due to a deficiency in a property’s value when the mortgage is a nonrecourse debt [See card 9];
• the trust deed foreclosure process and documentation, as well as time periods for reinstatement and redemption prior to the trustee’s sale and elimination of ownership [See card 9];
• negotiations to clear title of any junior financing encumbering the property whether the amount of the first mortgage is either less or more than the short sale net proceeds;
• the Home Affordable Foreclosure Alternatives (HAFA) application process if the seller is eligible to receive government-funded relocation funds [See card 7];
• the California Homeowner Bill of Rights, which restricts lender dual-track foreclosures, prohibiting the lender from advancing the foreclosure process while the homeowner is at the same time working on a mortgage modification with their servicer;
• income tax aspects and defenses to the relief of indebtedness income treatment triggered by the lender reporting a loss on the mortgage; and
• the state of the seller’s income and net worth.

This knowledge, combined with first-hand experience directly negotiating short sales with a mortgage holder, is the true pedigree of a “short sale specialist.”

The mortgage holder consents to a discounted payoff on a short sale based on facts readily available to the seller’s agent at the time the agent enters into the listing agreement. Thus, an agent’s forward-oriented investigation can anticipate mortgage holder approval or rejection before taking the listing. This conserves the agent’s time, talent, reputation and money.

For agents, a basic litmus test to discern which short sale listings are worth the time begins by asking the following questions of the owner:

1. Is the mortgage’s loan-to-value ratio (LTV) ratio more or less than 94%?

If a seller owes less on the mortgage(s) than the home is worth (the LTV is less than 94%), the issue of a short sale is non-existent. The net sales proceeds are sufficient to pay the loan in full.

The agent arrives at the LTV by first developing their broker price opinion (BPO) to establish the property’s fair market value (FMV). The agent calculates a BPO using data available by downloading a property profile (title condition) on the home and a printout of recent sales in the surrounding area from a title company website. This is the agent’s first step in any seller counseling and listing effort, be it a short sale or conventional sale.

2. How many liens are on the property?

When any junior liens encumber the property, the agent needs to deal with each mortgage holder to clear title of their lien before a short sale can close.

Occasionally, the same mortgage holder holds both the first and second mortgage on a home, the now prohibited piggyback financing common during the Millennium Boom.

If the answers to the above are promising, the seller and agent enter into a listing agreement employing the agent’s broker to both:

• locate a buyer (whether a buyer-occupant or equity purchase (EP) investor); and
• negotiate a discount on the existing mortgage(s).

The listing agreement form used by the agent needs to have an additional provision stating:

“The owner will first qualify with the mortgage holder for a discounted payoff of the loan and reconveyance of the trust deed on a sale of the home. When qualified by the lender, the agent will begin marketing the property in search of a buyer.” [See RPI Form 102-1]

On accepting the listing employment, the agent instructs the seller to contact their mortgage holder and discuss how to proceed with a short sale. When the mortgage holder qualifies the seller for a short sale, the mortgage holder indicates they will accept the net sales proceeds in full settlement of the mortgage debt(s).

On contacting the mortgage holder, the seller is referred to the mortgage holder’s loss mitigation specialist, sometimes called a negotiator. In response, the seller is sent a short sale information packet, requesting they deliver the following to the lender:

• Authorization to release information to an agent. This document signed by the seller gives the mortgage holder permission to deal with and furnish information about the mortgage to the seller’s agent. Without this critical authority, mortgage holders will not communicate with anyone acting on behalf of the seller. [See RPI Form 124]
• A hardship letter. The mortgage holder determines whether the seller is financially qualified to make payments on the mortgage. For this, the seller prepares a letter detailing their current personal and financial situation. Here, the seller explains their inadequate sources of income or other financial hardships they are experiencing. The seller also discloses whether they are the only wage earner in their household. [See RPI Form 217-1]
• The seller’s most recent pay stubs, bank statements and tax returns. The mortgage holder wants to confirm the seller is purchasing only necessities in lieu of making mortgage payments (i.e. groceries, car repairs and school supplies). Tax returns are used to verify annual income. The mortgage holder optionally requires the seller to fill out a financial statement (equivalent to an application for a mortgage). With it, the mortgage holder determines whether the seller has other assets available as a source of funds to voluntarily pay off the mortgage without a discount (i.e. cash on hand, equity in other property, stocks/ bonds, etc.).

Proof of occupancy. The seller provides the mortgage holder with a utility bill in the seller’s name delivered to the property address to prove they occupy the residence and don’t rent it to others.

If a second mortgage exists, one of two payoff situations face the agents:

• the net sales proceeds satisfy the first mortgage, but not the second; or
• the net sales proceeds do not satisfy the first mortgage, and by extension do not satisfy the second.

In the first situation, the net sales proceeds are more than sufficient to fully satisfy the first mortgage on closing. Here, the seller’s agent negotiates solely with the junior mortgage holder in the second position. The junior mortgage holder needs to consent to the balance of the net proceeds remaining after payoff of the first mortgage in exchange for a full reconveyance of their junior mortgage.

Here, the agent contacts the second mortgage holder on accepting the listing. If the second concludes the seller qualifies for a discounted payoff in a short sale, then the purchase agreement entered into by the seller and a buyer is submitted to the second mortgage holder for its consent.

At that point, the second mortgage holder typically orders out an appraisal to determine the property value and the appropriateness of the net sales proceeds. Only then does the typical second mortgage holder allow the short sale to close by discounting the amount owed to them.

However, when the net sales proceeds do not satisfy the first mortgage and the second payoff situation exists, there are insufficient funds to pay anything to the second mortgage holder and the situation becomes traumatic for everyone involved in clearing title.

Here, the seller’s agent has to deal with both mortgage holders. The second mortgage holder usually demands some amount of money from the net sales proceeds before they will consent to cancel their debt and reconvey their mortgage.

As a result, the seller’s agent needs to be sufficiently innovative at the outset to be extensively involved in further negotiations. Initially, the agent knows the second needs to be dealt with before the first can be paid off and a sale closed. Thus, the first mortgage holder needs to agree to let the second participate in some of the net sales proceeds, say a few thousand dollars.

Negotiations with the junior mortgage holder need to keep the holder of the first mortgage from being so greedy as to kill the short sale transaction. At all times, agents and their brokers need to resist any requests by the mortgage holders for the brokers to cut their fees agreed to in the purchase agreement.

The broker offering services to help the financially distressed owner and lender is paid to provide services which resolve a bad situation, one not of the broker’s making. Likewise, the title company or escrow providing services in a short sale will not discount their fees because the mortgage holder or owner find themselves in financial straits. [See RPI Form 150-1]

Mortgage holder processing times vary widely. The typical short sale takes three to five months. However, any one of many factors involved can deny the seller’s agent success.

Frequently, the mortgage holder demands more net proceeds at the time of closing, and thus makes a “hail-Mary” bid pressuring the buyer to pay a higher price than agreed to with the seller.

On the other end of the deal, the length and uncertainty of a short sale transaction often triggers a buyer’s decision to withdraw their offer in frustration. Too often, the propensity to walk away from the deal is hastened by the seller’s agent leaving the buyers and buyer’s agents out of the loop without constant updates on the short sale process.

To keep the deal alive, buyers need to be given frequent updates to ensure the process is on the right track and moving. To accomplish this level of communication, buyer’s agents need to stay in contact with the seller’s agent, at least weekly, for status updates to be passed on to the buyer.

Further, frustrated buyers often locate and purchase other property, cancelling or abandoning their purchase agreements during the approval process. Loss of the buyer nullifies all the work done by the agent negotiating the short sale. Once the seller accepts another buyer’s purchase offer and submits documentation to the lender for approval, the loss mitigation specialist assigned to the file starts the approval and appraisal process all over again.

The short sale process is often delayed by yet another monkey wrench — Home Affordable Foreclosure Alternatives (HAFA) money for the seller. [See Card 7]

The Home Affordable Foreclosure Alternatives (HAFA) program is designed to help homeowners avoid foreclosure by providing short sale incentives. It is a supplement to the Home Affordable Modification Program (HAMP) launched in 2009. [See card 9]

HAFA provides incentives for sellers, mortgage holders and agents to consider a short sale rather than lose the home at a foreclosure sale. Sellers participating in a HAFA short sale receive:

• $3,000 to help cover their cost of relocation;
• full release from future deficiency liability for the first mortgage (cash contributions by sellers to help payoff the mortgage are not allowed in a HAFA transaction); and
• standardized timeframes for each step of the process.

Mortgage holders participating in a HAFA short sale receive from the government:

• $1,500 to cover administrative costs; and
• up to a $2,000 subsidy for allowing a total of $6,000 in net sales proceeds to be distributed to junior lienholders.

Agents representing a seller in a HAFA short sale receive fee protection since mortgage holders are prohibited from requiring a reduction of a real estate fee agreed to in the listing agreement (up to 6%).

In order for a seller to be eligible for HAFA:

• the property needs to be the seller’s principal residence;
• the mortgage needs to be a first lien originated before January 1, 2009;
• the mortgage needs to be delinquent or at imminent risk of default;
• the current unpaid principal balance needs to be $729,750 or less;
• the seller’s total monthly mortgage payment needs to exceed 31% of their gross income; and
• the seller needs to first apply for a loan modification through HAMP. [Supplemental Directive 09-01]

Mortgage holders need to consider a HAMP seller for HAFA within 30 calendar days after the seller:

• fails to successfully complete a trial period under a HAMP modification;
• misses at least two consecutive payments after a HAMP modification; or
• requests a short sale or deed-in-lieu of foreclosure.

After all HAFA qualifications have been met, the seller requests short sale consent from their mortgage holder. In turn, the mortgage holder sends them a HAFA Short Sale Agreement (SSA) to be signed by the seller and the seller’s agent within 14 calendar days of receipt. The SSA is then returned by the agent to the lender’s loss mitigation specialist. [See HAFA Form 184]

The mortgage holder gives the seller an initial period of 120 calendar days to sell their home after receipt of the signed SSA, which can be extended up to 12 months (during which time the seller is making no payments.

Once an offer to purchase the home by a buyer-occupant or EP investor is accepted, the seller (or their agent) submits a Request for Approval of Short Sale (RASS) to the mortgage holder within three business days after executing a purchase agreement. The RASS includes:

• a copy of the purchase agreement and all addenda;
• buyer documentation of funds or pre-approval from a mortgage holder; and
• information on the status of subordinate liens and any negotiations with subordinate lienholders. [See HAFA Form 185]

After receiving the RASS, the mortgage holder approves or denies the request within ten business days.

This separate HAFA application, documentation and processing time is completed before the mortgage holder even begins its own short sale approval process. Thus, there is another delay of approximately three months for mortgage holder approval.

If the mortgage holder refuses to approve the short payoff after HAFA approves the seller, the transaction with the buyer is terminated, unless it is somehow revived by negotiations to resolve the mortgage holder’s reasons for disapproving the short sale.

If the sale is terminated, the HAFA process starts all over again for this seller (and the seller’s agent) when the next buyer’s short sale purchase offer is accepted.

For a purchase-assist mortgage secured by an owner-occupied one-to-four unit residential property, called a nonrecourse loan, the most significant tax consequence on a short payoff is the capital loss that is unavailable for reducing taxable income.

A second mortgage complicates the liability analysis. Second mortgages other than piggyback mortgages are generally recourse loans, unless the second lienholder consents in writing to a short sale which converts them to a nonrecourse debt.

Therefore, the short sale discount produces a personal loss (capital loss) on the sale which the seller may not write off to reduce taxable income.

From 2007-2014, short sellers nationwide were able to skip reporting the difference between their short sale amount and the balance owed on their mortgages as taxable income. However, the Mortgage Forgiveness Debt Relief Act expired at the end of 2014 after a previous extension.

That said, losing this Act will not hamper Californians with nonrecourse mortgages. A property owner is not personally liable for a nonrecourse mortgage. [26 Code of Federal Regulation §1.1001-2(a)]

Other states not sharing California’s nonrecourse-anti-deficiency laws rely on the MFDRA’s protection. Without it, federal tax codes treat mortgage forgiveness discounts on recourse mortgages as taxable income.

To further protect short sale sellers with nonrecourse treatment, on January 1st 2011, California expanded anti-deficiency nonrecourse protection to discharge-of-indebtedness income from a refinance of a first mortgage on a short sale.

Then, in July 2011, the state further expanded anti-deficiency protection to include discharge-of-indebtedness income from any mortgage on a short sale, provided a short sale agreement exists between the seller and participating mortgage holders. [Calif. Revenue & Taxation Code §17144.5]

To read more about anti-deficiency law in California, see: Cover for your homeowner: an anti-deficiency primer.

To read more about the short sale process, firsttuesday students see Realtipedia Volume: Buying Homes in Foreclosure Chapter 22: Short payoffs on loans in foreclosure, accessed through your student homepage.

To read more about the reinstatement and redemption periods during the foreclosure process, see: Reinstatement v. redemption.

To read more about HAFA, see the Making Home Affordable website.

To read more about the California Homeowner Bill of Rights, see: Homeowner Bill of Rights is law.