Recognizing Problem Short Sales Early

There are two types of short sales: (1) The relatively[1] easy ones that, while perhaps prolonged, ultimately will close; and, (2) The hard ones.  How can you recognize, in advance, what category yours will fall into?  What follows is a short discussion on what to look for.

The first category of short sales consists of two broad categories:  (a) Those where there is only a single lender; and, (b) Those where there are two loans, both with the same lender.

If there is a single lender, the primary issue will be whether their BPO confirms the short sale offering price.  All other things being equal, the transaction will likely close.  And today, we are seeing many situations where, depending on price point, there will be multiple offers, sometimes even above the listing price.

If there are two loans on the property, and both are with the same lender, say, Wells Fargo, there is a pretty good chance that even if you’re dealing with two separate negotiators, they will fall into line, and approve the short sale.  Again, it may take more time, but ultimately, I believe the guy holding the second mortgage, at one end of the hall (figuratively speaking), will not kill the sale for the guy holding the first mortgage at the other end of the hall.  Why? Because the option for Wells Fargo, the Big Bank, is for the first to foreclose out the borrower and the second, and get the Boobie Prize – the underwater house.  A short sale, even with Wells Fargo getting little or nothing on the second, at least gets the home back into the market, and cuts off the bank’s continued carrying costs.

The second category of short sales is not necessarily impossible to foresee.  And just because you know they will be more difficult is never a reason not to try.

One such short sale that can be problematic is where there are two loans on the property, each held by different owners, AND, even a full price offer will be insufficient to pay the entire first loan.  This means that the second is doomed to receiving a Goose Egg, unless Lender No. 1 gives them a $3,000 or $6,000 payment to incentivize them to consent to the short sale.  If Lender No. 2 is carrying a loan of say, $30,000 – $80,000, there is good reason to believe it will consent.  Why?  Because Lender’s paper is not worth face value.  It is essentially an unsecured loan that can be quickly discharged in bankruptcy.  So getting 10%, plus or minus, will likely be acceptable – it is preferable than a Goose Egg.

However, when the second mortgage is over $100,000, on say a home now valued at $150,000,[2] there is a likelihood that the first will offer them only $3,000, which Lender No. 2 may find unacceptable – especially if they know that the seller/borrower has some liquid funds.[3]

The other type short sale that can be difficult is where the borrower secured mortgage insurance at the inception of their loan.  These mortgage insurers (MI) have reached agreement with most of the Big Banks that they will pay them the loss they take on the short sale,[4] so long as the MI carrier can force the seller/borrower to make some kind of lump sum payment or sign a promissory note for an even larger amount.  In these cases, it can be difficult or impossible for the short sale to go through unless and until the seller/borrower can reach some agreement with the MI carrier.

So, for Realtors® handling a short sale, it is recommended that they vet these issues at the inception of the listing.  If there are two loans, who owns them?  Will there likely be enough money to pay off the first entirely, and get some proceeds to the second lender? Did the seller/borrower pay mortgage insurance?  To be forewarned is to be forearmed.  And lastly, never promise what you can’t deliver!  Too many times I hear clients tell me that their agent said they would “negotiate” everything.  But this is impossible, since the issue can get down to whether the seller/borrower will have to pay money to push the short sale through.  This is not something the agent can or should negotiate, without authority from the seller/borrower.

Conclusion.  The above discussion is summary only.  There can be other circumstances where a relatively straight-forward short sale can become complicated.  However, the “take away” is that a good short sale Realtor® should be able to vet the important issues early and not promise something they cannot deliver.

[1] This word, “relatively” is the operative word.  I acknowledge short sales are never “easy” – at least compared to the standard, garden variety equity sale, where there are only two parties, i.e. the seller and the buyer.  In short sales, there can be one or more banks, and this third party involvement makes almost any short sale slower, and perhaps more frustrating.

[2] For example, where the home was bought at $250,000 with 100% financing.

[3] Note: Even if the seller/borrower has money, if Lender No. 1 isn’t being paid in full, it will never permit them to pay money to Lender No. 2. The only way Lender No. 2 can get some money from the seller/borrower is to kill the short sale and negotiate with him/her, or kill the short sale, let it go into foreclosure and then try to collect on the $100,000 after that.

[4] The reason for this is because technically, the MI policy only pays the lender upon foreclosure.  Any pre-foreclosure payment, such as a short sale, will come with strings, allowing the MI carrier to “shake down” the seller/borrower during the short sale process.  If you think the term “shake down” is too harsh, keep this in mind:  The MI carrier will be the first to acknowledge that they have no legal claim against the seller/borrower.  They could not “make” them pay a penny of the money they pay to the lender, even after foreclosure.  So the only leverage that the MI carrier has on the seller/borrower is to make them pay money so they can get the short sale through, rather than have to go through a foreclosure.