The decrease in home values has put nearly a quarter of all borrowers in the position of being “underwater” – they owe more on the mortgage balance than the home is worth. Persons in this position who want or need to sell often participate in a so-called short sale, a long and laborious process for all parties involved. It is important to understand the short sale process, both to manage expectations and to allow the seller to take steps to (it is hoped) speed up the process.
Why opt for a short sale?
When a seller receives an offer on their home that is lower than the mortgage balance, they must present their case for approval before proceeding to close. In nearly all cases, there are many parties involved in the transaction and it is useful to describe them and their roles. The end game in a short sale is to persuade the owner of the loan to agree to take a loss so that the short sale can occur.
When approval is obtained – usually after several months – the seller may close with the buyer. The owner of the loan takes the loss by forgiving the difference between purchase price and loan balance.
The short sale process
So who is this “owner of the loan”? Can’t we just say “bank’ and be done with it? A case study will help understand the short sale process. When Barney, a teacher, bought his home in 2005, he paid $200,000. His local savings bank approved a mortgage of $180,000 to help him make the purchase.
Further, since his down payment was less than 20% of the purchase price, the savings bank added PMI mortgage insurance which Barney had to pay for. But, Barney had a fine employment record and home values had increased in the neighborhood for many years. All seemed rosy.
The savings bank sold the loan to Fannie Mae, the government sponsored enterprise (GSE –don’t the bureaucrats love their acronyms!) and received cash in return. This was typical, with Fannie Mae serving hits prime function. Fannie was now entitled to receive Barney’s mortgage payments, but they are not set up to handle that function. So Fannie hired ABC Lender to collect Barney’s payment, and also to handle Barney’s taxes and homeowners insurance – which Barney paid each month with his mortgage statement.
Then 2008 hit and the town began laying off teachers. Unemployment increased and home values began to plummet. Eventually, Barney was laid off and in 2011 had to put his home on the market. His realtor, Mike, estimated the home would bring $165,000 – well below his original purchase price of $200,000, and less than his outstanding mortgage balance of $175,000. Barney was “underwater” on his mortgage, which was owned by Fannie Mae, “serviced” by ABC Lender and insured by PMI .
Mike was an enterprising realtor who used his extensive contacts to find a qualified buyer. Barney accepted the buyer’s offer of $155,000, which was $20,000 below what he owed on the loan. In order to complete the transaction, Fannie Mae had to approve the “short sale” and take the financial hit on the sale. Mike set about gathering all of the documentation needed to obtain Fannie’s approval including bank statements, pay stubs and other personal financial information from Barney. Mike also had to complete a long short sale application and attach a copy of the purchase agreement. All of this was forwarded to ABC Lender for approval.
ABC then had to obtain approval from Fannie to complete the deal. Fannie had to agree to take the loss and allow the deal to go forward, plus agree to pay Mike’s commission. Before giving its approval – a letter of instructions – Fannie contacted PMI to confirm that they would honor the insurance policy Barney purchased when he took out the loan. Fannie and PMI are big companies, and they are handling hundreds of thousands of requests like Barney’s, and neither was prepared for the deluge of loan problems that hit them in 2009 and afterward.
Other factors add to complexity, depending on where Barney’s home is located – in this case Ohio, a “recourse” state. Recourse means that Fannie could, after taking the loss on the short sale, go after Barney’s other assets to satisfy the loss amount. (Many states are non-recourse – such as Arizona.)
Once Fannie completed its review and provided approval for the short sale, Mike and Barney would receive instructions for completing the sale. Several months would likely have passed since the original agreement on the $155,000 sale price, and the buyer may have lost interest. Fannie’s instructions were not forwarded to the title company handing the closing of the sale of Barney’s home. Mike would have to get approval from his boss for the lower than typical commission Fannie was offering.
At this point, lots of work had been done, several months had passed and more homes have come on the market. A lot was at risk. Unfortunately for Barney, the buyer’s offer to purchase for $155,000 had expired only a few days before Fannie had sent its short sale approval. Mike scrambled to persuade the buyer to extend his contract offer period.
When the deal finally closed, Mike received a discounted commission of $7,000. Fannie took a loss of $27,000 – the difference between Barney’s mortgage balance and the sale price PLUS Mike’s commission. Fannie would likely receive some reimbursement from PMI.
The scenario is somewhat better when Fannie Mae or Freddie Mac are not involved. For example, if the savings bank that made Barney’s original loan had not sold it to Fannie, the short sale decision would have been theirs. However, if we have as well, the presence of a home equity loan, everything can be slowed even more considerably.
Why does a short sale take so long to complete?
Anyone involved in a short sale, as either the seller or buyer, should gird himself for a several months-long process. A short sale is a complex ordeal, with many parties, all of whom are bearing up as best they can.
Written By: Patrick Moore