Most buyers know by now that a very low percentage of short sales close. And I don’t mean that buyers need to wait a long time (though they do) — I mean they NEVER close. What are some of the reasons why? And what happens to them?
First, let’s recap: What is a short sale? As I’ve discussed before, a short sale is a “pre-foreclosure” sale by the seller wherein he is “short” on his payoff to the bank on the loan. Therefore the bank needs to sign off on any contract before it goes to settlement. The seller walks away with nothing, while the bank takes a loss.
Sellers often list homes for a very low price because they simply don’t care—the bank is the one taking the loss, and the seller just needs an offer. Once an offer is in, the seller sends it to the bank for approval, a process which could take many months.
Short sales are often frustrating for buyers because they have such a low closing ratio. Just because a home is listed as a short sale does not mean the bank has approved the price. The bank may not even be aware the homeowner is trying to sell!
So why do short sales not close? Let me count the ways…
We can bucket the issues into two categories: Buyer “Problems” and Seller/Bank “Problems.” I combine Seller and Bank into the same bucket because really it’s not up to the seller by the time it reaches short sale status—the bank is the one taking the loss, and so the bank is the one that has to sign off.
There are several reasons a bank may not approve an offer on a short sale:
• Offer Too Low: The most obvious is that the offer price is too low. The bank had no input into setting the price, nor any input on price reductions. The seller is indifferent as to the offer price –after all, they are lucky to be getting out of the house at all, and they certainly are not going to be walking away with a dime. This is why you often see homes listed ridiculously low versus similar homes nearby. The seller just needs an offer to get the process started.
• Second (or Third) Trusts: Closely related to the “Offer is too low” category is that the second trust may not sign off on the amount they are receiving (if any). It’s quite common for sellers to have more than one mortgage or HELOC on the property, and 2nd and 3rd trust holders receive very little, if anything, in short sales. Sometimes they refuse to sign off because they simply have no incentive to do so.
• Seller Doesn’t Qualify: Sometimes a seller simply has too many other assets for a bank to approve a short sale. If the seller has money in their accounts, the bank is going to want that money. Similarly, a seller has to show a hardship—they can’t simply say it’s a short sale because they’re underwater and don’t want to pay anymore. And don’t be naive on this…sellers don’t volunteer this information to the bank at the beginning of the process–they typically wait until they have an offer and hope that the bank will somehow not ask to see evidence of their other assets.
• Why Sell When You Can Live for Free?: Commonly a homeowner will stop making mortgage payments once they realize they are in a short sale situation. Though the homeowner gets the usual form letters and phone calls threatening them with eviction, the fact is that they are living for free during that period of time. Some accept the foreclosure as inevitable and simply live there for free as long as they can…completely unmotivated to accept an offer because once an offer is approved, they have to move and start paying somewhere else. They only have to show the bank that they are ‘trying’ to sell the home.
• Foreclosure Trumps Short Sale: If the bank is pursuing foreclosure, then it’s a race against the clock. The two departments often don’t coordinate. Even if they do, often times a bank will decide that it’s more economical to foreclose than accept too low a payoff.
• Unexpected Consequences: These next two fall into the “I didn’t realize if I did a short sale that would happen” category.
◦ Deficiency Judgments: Most sellers don’t realize that even though the bank accepts a loss, the seller is still technically liable for that amount, and the bank reserves the right to pursue that amount later. (This is also true of foreclosures.) It does not get wiped out as in a bankruptcy. While it’s uncertain whether banks actually will pursue these individual homeowners, the risk remains, and sellers may get cold feet at the last minute, scuttling the sale.
◦ Tax Effects: Sellers also may not realize that they will receive a 1099 for the amount of their debt forgiveness, creating potentially taxable income. There are several ways a seller can be exempt from this, but it’s critical to consult a tax adviser. If during the course of the transaction they realize this and have doubts, they could refuse to go forward.
As if those reasons didn’t provide enough hurdles, even if the seller and bank stars align, the buyer might be the one to torpedo the transaction:
• Home Inspection: Frequently the home inspection is not conducted until after the bank gives its approval of the transaction (and why not…smart buyers don’t want to risk their money on a transaction that has a small chance of closing.) But what if there are problems in the inspection? Short selling sellers rarely have enough money for any significant repairs, and the bank is not going to agree to a lower amount after it took months to get a sign off on the original.
• Appraisal Problems: This cuts both ways—a low appraisal will trigger a buyer to want to renegotiate, but a high appraisal will trigger a bank rejection of the offer as a ‘below market’ price.
• Bank Takes too Long: As noted above, the process can often take many months (count on at least 3, and up to a year or even more). Buyers often get frustrated and back out while waiting for a response. There are also buyers who will put in offers on many different properties hoping that something will hit, and whichever one answers first is the one they pursue. Often you’ll see in the remarks field “already approved at this price” which means the bank finally did get around to approving a contract, but the buyer had walked away by that time, leaving the seller with an approval letter, but no buyer.
So what’s the good news on short sales? Banks are getting better/faster at them, and some government programs are in process to help incentivize both first trust holders and second trust holders (also referred to as first lienholders and second lienholders.) But that only addresses a few of the potential issues above.
There are also programs and professional negotiators who are making tremendous strides in mitigating some of the challenges listed above, significantly increasing the chance of a settlement. They’ve found ways to protect the buyer’s interests while still optimizing the chance of a bank sign off. I’ll discuss some of these in another post, so stay tuned.
So what happens to the short sales that never close? Sometimes they continue to sit for months and months as “Active” or even “Contingent” status in the multiple listing service. Sometimes the foreclosure department wins the race and forecloses on the home. Sometimes the homeowner makes just enough of a payment to keep the bank from moving forward from foreclosing, and sometimes the seller may start again making payments stopping the entire process. Most of these homes, however, will eventually end up as foreclosures if the short sale process is not successful.
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