SHORT SALES: WHAT THEY ARE AND HOW THEY WORK
During times of real estate price decline, it is not uncommon for homeowners to be desperate to sell their properties. Often, the equity (the difference between what is owed on the loans on the property and its fair market value) is negative meaning that the homeowner owes more for the home than it is worth. When an owner takes out several loans secured with the property (second deeds of trusts and/or third or fourth deeds of trust) the likelihood of negative equity becomes higher. This is what happened to many people in 2008-2010 in California.
In such situations, owners often cannot or will not continue making payments on the property, allowing the bank or lending institution to foreclose on the mortgage or deed of trust and abandoning the property. Many states, including California, do not allow the bank to both foreclose and proceed against the owner for the difference between the loan and what is netted from the foreclosure sale. These laws are often termed “anti-deficiency statutes” and restrict recovery to what the home foreclosure will bring. The owners thus feel they have nothing to lose by abandoning the property.
While the owner may have his or her credit ruined by failure to pay the bank, realistically the credit rating is probably already low and given the lack of equity, the owner has little else to lose. The bank, also realizing the low value of the home, would much rather not go through the process of foreclosure if an alternative can be found.
That is how short sales became widespread in the last downturn and may again become prominent in any declining real estate market.
A short sale is simply the purchase of a home in foreclosure but before the foreclosure sale. If there is more than one lending institution involved, it requires the purchase to be approved by all such institutions as well as the title holder. The process and some pitfalls are described in this article.
Most short sale transactions are handled using real estate brokers, often brokers who regularly work with the very bank that has begun foreclosure proceedings. Since the original owners still own the property until foreclosure is completed, the required parties who must consent to the offer are:
- Owner of record title
- All the banks holding the various deeds of trust or mortgages on the property.
- Any other creditors on title, be they tax liens or mechanics liens or judgement liens must either be paid off or must consent to the sale.
Such consents to the sale often require the holder of the deed of trust or lien to agree to a lesser payment than the amount of the lien. If that holder refuses to discount what it is paid, the various parties must determine a way to pay off the lien or mortgage entirely or must abandon the short sale.
As an example:
Assume that there is a first deed of trust on the property for $200,000.00 and a second deed of trust for $100,000.00 plus a tax lien for unpaid real estate taxes for $10,000.00. Assume that the property is only worth two hundred and fifty thousand dollars in today’s market, thus has a negative equity of $60,000.00. Banks holding deeds of trust are paid off in the order of date of their deed of trust. The first is paid before the second, the second before the third, etc. Tax liens come first. The holder of the first deed of trust is fully secured with the amount of equity in the property and will probably insist upon being paid in full. The holder of the second can only hope to net half of the outstanding loan at best, and tax liens will be paid before that lender is. Thus, the holder of the second deed of trust is likely to agree to a discount on his note in order to avoid the trouble and expense of foreclosure. Thus, if the buyer offers two hundred and twenty thousand dollars, the holder of the first is paid in full; the taxes are paid in full; the holder of the second is only paid ten thousand dollars.
Will that holder consent? It comes down to whether the holder of the second thinks that a foreclosure sale will net more than two hundred and twenty thousand dollars after expenses.
But note that any of the interested parties can veto the sale and force a full foreclosure.
Such a process also requires far more time to get consents than a typical sale. All the banks and creditors are often involved with the usual bureaucratic delays that large institutions often impose.
As times, the original owner, dispirited and angry at losing the home, simply refuses to cooperate or even leaves the area and cannot be easily located. All must come together to make the short sale work and when there is a third and fourth deed of trust on the property (not that uncommon in 2008) the complications are even greater.
That said, the bargains available for short sales can be worth the effort.
The tendency of people to borrow on their homes can result in equity becoming negative and open up the door to short sales if the lenders are convinced that the discount of their loans to a new buyer at a lower price will profit them more than proceeding with the cost and delay of full foreclosure. The original owner may decide that helping the banks net the most will help their own credit rating, thus bargains may be available to the buyer willing to face the complexity and delay of short sales.