What Is The Difference Between a Short Sale, Pre-Foreclosure, Foreclosure & REO?
There are a lot of 'catch phrases' that are used in the media today. Before you can consider selling your home as a short sale, or before you decide to purchase a foreclosure, you need to know what they are... or first, what the differences are between them.
Pre-foreclosure - Before a home is 'foreclosed' by a bank, or even before a home is officially in the 'foreclosure' process, the Seller is deemed to be in pre-foreclosure. A pre-foreclosure is exactly what is sounds like. It is the status of the property BEFORE it is re-possessed by the bank.
Typically, before a home becomes a foreclosure, the Seller has missed payments, and the bank has given notice that they have started a legal process to pursue their right to take back the home. A court date and/or a sale date may have been set. In either case, the home is usually referred to as a pre-foreclosure, because it is BEFORE the actual foreclosure sale takes place. *As a side note, please know that the foreclosure process varies from state-to-state. We are located in North Carolina, and when we speak of the foreclosures, we are speaking of the non-judicial process.
Foreclosure - Many people use the term 'foreclosure' as a general, catch-all word for distressed properties. However, it is a little more specific than that, because as we just read, an owner may be behind on their payments, and they may be facing the possibility of foreclosure, but they may still own the home. However, once the bank repossesses the home through a legal process, then the home may be more specifically referred to as a 'foreclosure'.
REO - An REO is a short term for Real Estate Owned. This is just another term for a foreclosure, or bank-owned property. Typically, when a property is sold on the courthouse steps, it is many times purchased back by the bank, lender or investor. When this is the case, it becomes part of the lending institution's inventory - and as such, it is called an REO. The foreclosure and REO terms are often used interchangeably.
Short Sales - Short Sales are becoming more and more popular, as more home sellers are in financial distress and find that their homes are not worth as much as they owe. Continue reading for more detail on short sales.
What Is A Short Sale?
A "short sale" is the sale of a house in which the proceeds fall short of what the owner still owes to the bank.
For example: If a Seller still owes a bank $200,000 on their mortgage, but they may only be able to sell the home for $175,000 on the open market, then the home and seller may qualify for a short sale, and the bank may agree to accept $175,000 as full payment.
Why would anyone agree to do this? The foreclosure process can be very lengthy and costly for the bank. It can also be very frustrating and emotionally draining for the Seller. Many home owners who can no longer afford to keep mortgage payments current find that a short sale is the best alternative to bankruptcy or foreclosure proceedings. It may also possibly save their credit from total disaster. When lenders agree to a short sale in real estate, they are betting that they can avoid a lengthy and costly foreclosure process.
Technically, it is supposed to create a win-win scenario for all parties involved. Unfortunately, this is not always the case.
Can Anyone Do A Short Sale?
It is important to understand that not all lenders will accept short sales or discounted payoffs, and not all Sellers will qualify for a short sale. Yes, there is a qualification process. In most short sale cases, the Seller must have a proven hardship and must owe more to the bank that what the home is currently worth. It is not enough to simply say that you can not sell your home for what you owe. It is not enough to say that you want to move to a bigger home and that the market isn't good enough for you to get a Buyer. It is not enough to say "Hey, I made a bad purchase, so let's just dump this home". Rather, there must be some sort of extenuating circumstance that is preventing you from selling the home and completely paying off the entire debt. Additionally, you must also show that the current circumstances have affected your ability to continue making timely mortgage payments.
Common hardships that may be acceptable to banks include divorce, curtailment of income, job loss, job transfer, medical issues etc. Banks want to ensure there is a valid reason to take a loss. Sellers must be able to prove that they are enduring a financial storm by providing mountains of paperwork to the bank such as bank statements, paystubs, tax returns etc.
While considering a short sale, sellers are always advised to seek sound advice from an attorney and/or CPA. However, in any case, it it is imperative to contact a real estate professional immediately. A Realtor who is trained in obtaining short payoffs will be able to lead a seller through the long process of gathering information, submitting the short sale request, listing the home, procuring and negotiating a bona fide sales contract... AND communicating that offer to the lender.
Do I Have To Be Behind On Payments to Do Short Sale?
The short answer to this questions is... maybe. It depends. Most people who have successful short sales are indeed late on their mortgage. Some are late by only 30 days, and other have not made a mortgage payment in a couple of years.
There are a few short sale programs which do require a seller to be at least 30 days behind, and some require 60 days late. If your mortgage is backed by HUD or the VA, then you will be required to be late. Additionally, if you take advantage of the HAFA short sale program, you must also be delinquent.
In other cases where a loan is owned by Fannie Mae, Freddie Mac or some other 'investor', the seller may not be required to have missed payments. It is all up to the bank, the investor or some other 3rd party... and frankly, there really is no definitive answer. It is part of the bigger picture that the lender will review. Is it likely that you may become late on payments within 90 days? Is there a reason why you are struggling? Do you have cash reserves to make payments? All of these things will be considered by the lender.
Our best advice is to continue making your mortgage payments to the best of your ability. If you can not make complete payments (many lenders will not accept partial payments), then you must do what is in your best interest. Nobody should tell you to STOP making mortgage payments. If your attorney or real estate advisor counsels you to stop making payments, you may want to think about alternative advice.
Tax, Legal and Credit Consequences of a Short Sale
Since we are not attorneys nor a CPAs, we can not give legal or tax advice, and the following should not be construed as such. Please understand that there may be credit, tax and legal consequences for the Seller in a short sale transaction. We strongly urge you to seek other professional advice.
Sellers often ask which is better... a Short Sale or a Foreclosure? Well, that depends, and it will always depend. More often than not, a short sale is going to be 'better' because the consequences will be less severe than a foreclosure. However, each situation is different, each Seller's needs are different, and each bank is different. Regardless, there may still be credit, legal and tax consequences with both short sales AND foreclosures.
Both foreclosures and short sales will have credit consequences and both may stay on your credit report for 7 to 10 years. However, whereas a foreclosure may prevent a lender from approving you for another home loan for 5 to 7 years afterwards, typically, short sellers may be able to purchase again within 2 to 7 years. A lot depends upon how a short sale is reported to the credit bureaus. If it is reported like the vast majority of cases as "settled for less than full value", then your credit will indeed take a hit, albeit still smaller than with a foreclosure.
Additionally, much of the credit damage occurs with missed payments. So, it is not necessarily the actual short sale that is doing the damage; it might be the delinquencies.
There are other factors which may contribute to your ability to purchase again after a short sale. If you simply decided to walk away from your mortgage and strategically default, then the consequences could me more severe than if you had a valid hardship like a divorce, job loss, health issue etc. You should consult with a lender or mortgage banker to get the complete picture on how credit will impact your ability to purchase again in the future.
Many people think that if a home is foreclosed or sold short, the seller can just walk away, free and clear of any debt. Not so fast! While in some states, that may be true, in North Carolina, laws may allow a lender to pursue a 'deficiency judgement' against the seller for any amount of debt that was not paid.
One of the deciding factors will be whether the shorted loan was a purchase money loan, refi, 1st or 2nd mortgage or an equity line of credit. Another deciding factor will be whether or not the Seller has any assets. Paying off consumer debt with a cash-out refi is not viewed positively by lenders. Neither is requesting a short sale when you have a robust retirement or savings account.
In many instances when short sales have been properly negotiated, the lender may release the entire debt. Instead of just releasing the lien on the property, they may consider the debt 'satisfied in full'! This means that they will take no recourse against any debt unpaid after the close of the sale. Of course, this will vary from lender to lender, seller to seller and case by case. But in cases where the seller is insolvent, it is more likely to happen - but is never guaranteed!
If you are lucky enough to qualify for a short sale under the Home Affordable Foreclosure Alternatives Program (HAFA) you will be fully released of further debt repayment obligations. However, not everyone qualifies for the program - especially those Sellers who make too much money, have considerable assets or are not behind on payments. FHA also sponsors a pre-forclosure program which eliminates the debt repayment obligations.
In cases when a seller may have significant cash reserves, the lender may require a cash contribution or promissory note to mitigate their losses. It would stand to reason that if you can not afford your mortgage and if you can not sell your home for the complete balance, then how in the world could you afford to bring money to the closing table? Yep, we think that too! However, you would be surprised at the resourcefulness of parties involved in short sales. Just when you think there is no way, somehow, a way becomes clear.
You should always discuss legal consequences with an attorney or competent legal counsel.
And then, there are the tax consequences. Whether a foreclosure or a short sale, it may be likely that the Mortgage Forgiveness Debt Relief Act of 2007 will forgive any unpaid debt from a taxation perspective. However, this all depends upon whether or not your property is a primary residence or an investment property. But, if you refinanced your home and took a large amount of cash to buy new furniture, it may be unlikely that the unpaid debt is forgiven. Keep in mind that you may be 1099'd by the lender for any unpaid/forgiven amount.
Please seek professional tax advice to determine the consequences in your specific situation. You may also visit this link at IRS.gov for more information on tax consequences.
There are certain pros and cons to each situation. In most cases, a short sale, regardless of the consequences, is still a better route than simply letting your home go into foreclosure. But do keep in mind, even if you give the keys back to your lender and allow them to foreclose, there is a liklihood that the lender may still pursue a course of action against you, the seller, for any loss they may have incurred, depending upon the program for which you qualify. If you are going to do something, and if a short sale is a viable alternative, a short sale is almost always the best option. If nothing else, the bank will sustain a smaller loss in a short sale than in a foreclosure, thus reducing your potential liability.
Always make sure you seek the right professionals to advise you of the credit, tax and legal consequences of a short sale.
What Should I Do and When Should I Do It?
If you are already behind on your payments, there is no time to waste. In fact, if you are already behind, we hope that you have already contacted your lender or mortgage servicer to see if 'something' can be worked out. Many lenders would rather renegotiate the terms of your debt, than to write off a loss. We HIGHLY recommend that all sellers in this situation first try a modification on their mortgage, as we are now seeing this to be the first requirement under several short sale programs including FHA and HAFA.
If you do not qualify for a loan modification, you should seek the assistance of a Realtor trained in short sales immediately. Not all Realtors are created equal, and not all short sale training is the same. There is no substitute for a Realtor who has the experience to understand the complexities of how the short sale system works.
We get calls from Sellers who are only a few weeks or days away for the foreclosure sale date... hoping that we can help them save their home. This is nearly impossible. The time to contact someone is when you have the first inclination of trouble. It can take months to get a short sale off the ground. Additionally, many Sellers are denied short sales if the foreclosure sale date is within 60 days.
What Do I Need To Start a Short Sale?
Your designated Real Estate Agent should understand the short sale process well enough in order to give you a list of items that you will need to collect to begin the short sale process.
So, I suppose it goes without saying that the first thing you NEED is a designated Real Estate Agent to see you through the process. Yes, you can use and attorney in the negotiation, but all banks require the use of a licensed Real Estate Agent to list the property for market value.
As always, each bank is different, and the items necessary will vary depending upon the type of loan you have (FHA, Purchase, Refi, HELOC, etc). Again, your Real Estate Agent should have the experience to understand the process and he or she should also be able to explain it to you.
Typically, however, the standard fare for required documents is as follows:
A signed and dated Authorization of Release
A signed and dated copy of the listing agreement with your Realtor
A signed and dated copy of a sales contract with all addenda and attachments
A pre-qualification letter from your Buyer
A written hardship letter stating the circumstances for your missed payments and/or default
Your last two bank statements (checking and savings)
Your last two paycheck stubs
A HUD-1 settlement statement (net sheet) indicating the allocation of all sale proceeds
Your two most recent state and federal tax returns (signed and dated)
A form 4506-T
Your most recent summary satements for any 401k, retirement or investment accounts
This is only a short list. Some lenders require Arms Length Affidavits and other documents that they may transmit at some point later in the process.
The short sale process has always been a very frustrating and lengthy one. They can take anywhere from 30 days to several years to complete - if indeed they ever DO reach a resolution. There is nothing short about short sales. In fact, they should be called "long sales".
It seems reasonable: Sellers want to sell quickly so that they don't do any further damage to their credit. Lenders want to lose as little money as possible. And Buyers want to know if their offer will be accepted.
Today, many short sales never even reach a negotiator's desk at the bank. Many files are stuck in limbo with understaffed lenders. On the other side of the blame game, many Realtors attempting to assist Sellers with their short sale needs are inexperienced at providing competent and informed services.
Remember, when dealing with lenders, there is alot of red tape. Many banks are simply 'servicers' of loans that are owned by other entities. This means that the bank does not have much authority to accept or deny a short sale request without checking with someone or something else. As the layers of approval mount, the time it takes to process short sales increases.
In addition, most often, lenders will not do ANYTHING until the complete short sale package (along with all offers and addenda) is received. Only then will they perform their due dilligence to make sure a short sale is warranted. So, while you are waiting and waiting and waiting, the bank is just sitting and sitting and sitting. Many times, the initial paperwork that is submitted gets lost in a pile, never to be uncovered again. So, after weeks of waiting, the process begins again.And this is only a start. If one item is not received, or if one page is not signed and dated, the file is not complete and the bank may go on to the next file.
Once a complete package is received by the lender, they begin their due diligence. Some of these tasks include:
Reviewing the materials submitted for complete accuracy and descrepancies
Assigning a processor to the file
Assigning a negotiator to the file
Ordering a BPO or appraisal to determine the fair market value of the home
Performing complex and incomprehensible mathmatical calculations that no one understands
Sending the file down the line to the department head for further review
Sending the file to yet another department head
Sending the file to the investor
Sending the file to the MI company
Sending the file to The Board
More red tape
Losing all the documents you submitted
Asking you to resubmit all the documents with updated financials
Reassembling and resubmitting
More red tape
And so on...
Remember, we are dealing with a person sitting behind a desk in a city far removed from yours who must pass your file along the red tape line to various processors, negotiators, managers, investors and VPs. Most of these people have very little empthay for your situation.
Many times, the short sale process is more painful than a thousand papercuts on your tongue. Seriously! Other times, it can go so smoothly that you wonder what is around the corner, and what have you missed.
Please be patient! We have seen short sales completed within a couple weeks, and we have seen them take as long as 2 years before the lender calls to accept, counter or reject the offer.
A properly strategized short sale with an involved Seller, patient Buyer, flexible Buyer Agent and most importantly a competent and experienced Seller Agent (Realtor), can make all the difference in the world. When you are led by someone who knows what they are doing, a short sale should last not much longer than 2-4 months.
I know... banks are not in the business of selling homes. All they want to do is lend money and make profits. So, 'why will they not allow me, the seller, to proceed with a short sale?' Or the buyer may ask, 'why won't they just accept my offer?'
As previously mentioned, not all lenders participate in short sales. In addition, not all homes and not all sellers will qualify for a short sale.
A few other reasons a lender may not approve a Seller for a short sale:
The Seller makes too much money (positive cash flow)
The Seller is not yet behind on payments
The Seller has excessive assets
There is equity in the home
The lender simply does not participate in short sales as a matter of policy
The mortgage is insured and the insurance proceeds are more than the estimated short loss
The Seller has not yet received HUD counseling
The planets have not yet all aligned
OK... so the Seller and the home qualify, and there is a bona fide offer on the table. Why will the lender not accept the offer? Oh boy, there are many reasons. Too many to list. However, here are just a few:
The lender feels the home is worth more than your offer
The lender still feels the home is worth more than your low-ball offer
The lender really still feels that the home is worth way more than your ridiculously low offer
(Starting to get the point?)
It all comes down to the numbers. More often than not... if a Seller has been approved for a short sale, but the offer is not accepted, then the lender feels that they could get more money if they foreclose and resell on the open market than if they allow a short sale to proceed. Or, as previously mentioned, the mortgage insurance proceeds may be sufficient to cover the loss.
As strange as it seems, not ALL lenders are willing to accept peanuts for vacant or underperforming homes. It's a numbers game. And if you are in the game of low-balling offers - or if you think you are going to find a short sale and make tons of cash, you may want to reconsider.
We don't want to put the damper on everyone's fun, but please just remember:
Short sales are frustrating and aggravating
Short sales may take a long time
Some short sales may never be completed
Some short sale offers are never even make it to the lender
Always have a professional leading the way
Always seek legal and tax advice on the consequences of short sales
Lenders are not ALWAYS looking for the easiest way out - this means they are not ALWAYS willing to accept less than what is owed. Even in this economy, lenders don't want to lose money. And if they feel they can get more money as foreclosure, they are more than willing to wait. HINT: Gold Diggers, save your time and keep your offers REALISTIC! You never get something for nothing.
In 2009, the Treasury Department introduced the HAFA program to provide a viable option for homeowners who are unable to keep their homes through the existing Home Affordable Modification Program (HAMP). The HAFA program took effect on April 5, 2010 and sunsets on December 31, 2012.
HAFA provides certain incentives to servicers and sellers, attempts to standardize procedures and shortens time frames, but only on loans eligible for modification under the HAMP program.
Complements HAMP by providing a viable alternative for borrowers (the current homeowners) who are HAMP eligible but nevertheless unable to keep their home.
Uses borrower financial and hardship information already collected in connection with consideration of a loan modification.
Allows borrowers to receive pre-approved short sales terms before listing the property (including the minimum acceptable net proceeds).
Requires borrowers to be fully released from future liability for the first mortgage debt (no cash contribution, promissory note, or deficiency judgment is allowed).
Uses standard processes, documents, and timeframes/deadlines.
Provides the following financial incentives:
$3,000 for borrower relocation assistance;
$1,500 for servicers to cover administrative and processing costs;
Up to $2,000 for investors who allow a total of up to $6,000 in short sale proceeds to be distributed to subordinate lien holders, on a one-for-three matching basis.
Requires all servicers participating in HAMP to implement HAFA in accordance with their own written policy, consistent with investor guidelines.
So, what does this mean? It means that if you need to sell your house short, and you don't know what HAMP is... you are behind the 8-ball. Contact a short sale professional immediately!
Let's break it down further:
If you can satisfy the following criteria, you may be eligible for HAMP (remember, this is a loan modification program):
The property must be the borrower's primary residence. No investment property can qualify here.
The mortgage lien/loan must be in first position and originated before 1/1/09.
The mortgage must be in default or imminently delinquent.
The current, unpaid balance is less than or equal to $729,750.
The borrower's monthly mortgage payment is more than 31% of the borrower's gross income.
OK... so you can satisfy the above criteria. GREAT! You are now eligble for a loan mod (HAMP). But let's say that you have gone through the entire HAMP eligibility program, but one of the following criteria is now in your way of saying that it was the best thing since sliced bread:
You do not qualify for a Trial Period Plan
You do not successfully complete a Trial Period Plan
You become delinquent on the mod by missing at least 2 consecutive payments
You request a short sale
Alright... you and your loan are HAMP eligible, but the alternatives that HAMP provides can not be met or are not 'good' for your situation. You then may request a short sale under the HAFA program. Beleive it or not, but the servicer or lender must now consider your short sale request within 30 days!
Once the servicer receives and responds to your request, you have 14 days to respond to them. As part of this new program, the servicer will begin their due dilligence process immediately. Remember, in a standard short sale, the lender rarely does anything until an offer is received on the property. Additionally, the lender or servicer won't even give you an idea as to what price they will accept. They make the borrower and the Realtor figure it out by trial and error.
But under the new HAFA program the borrower/servicer will pre-populate a Short Sale Agreement, one of a few new standardized forms to be used with the Realtor's standard paperwork.
Some of the best 'stuff' is that under the HAFA program are that paperwork and procedures are now standardized across the board. Banks are now willing to help, willing to tell you information and willing to cooperate. They, along with the Seller, will receive cash incentives for their troubles. And did I mention that once an offer is submitted under the HAFA program, the lender has 10 days in which to respond? Hallelujah!
Many homes that are sold as short sales are nice homes in nice condition. Other times, these homes may need a little TLC to make it habitable. Regardless of the condition of the property, to you as a Buyer, the end-result of the short sale is that you own a home, free and clear of all encumbrances of record. It will be no different than if you purchased a home at fair market value from Tom and Susie Homeseller, without the pre-foreclosure stigma. The only difference is that the process may take a little longer to complete.
Be aware that the short sale process is not an exact science. If you see a home that is 'listed' as a short sale, the list price you see may or may not be the price at which you can purchase the home. I know this may sound strange... why can't you purchase a home for the asking price? Many times, the seller or "Realtor' does not know at what value the lender will accept by the time the home is initially on the market. Remember, the whole reason to short a mortgage is to sell it for less than what is owed. The only number the seller or Realtor may know at the marketing time is what is owed. If the full balance owed is more than the home is worth, (which is the real reason for this entire process) then the seller may never obtain an offer. Therefore, in many instances, the seller or Realtor markets the home at their best 'guestimate' of what the lender may accept. Once an offer is received, whether it is more or less than the list price, the seller or Realtor will submit it to the lender for approval, counter-offer, or flat refusal.
Having said all of the above, changes are slowly being made to the entire short sale arena. The US Treasury's HAFA program may allow sellers to understand the exact price for which the lender or servicer will accept on a short sale. Additionally, they may even pre-approve a seller for short sale acceptance, pending only a viable contract. However, before we get excited, we must mention that the HAFA program is not available to all short sale sellers.
So, before bidding on a short sale listing, you need to inquire with the seller or listing agent as to how they arrived at the listed price. Is it the fair market value of the home? Is it a shorted payoff amount that the lender will accept, or is it an estimate of what the borrower and/or Realtor hope the lender will accept? Is this loan part of the new HAFA program? Many questions, so little time.
In any case, there are two main points that need to be stressed and need to be fully understood by the buyer:
1) There may be rare exceptions, but neither sellers nor lenders are looking for extraordinarily low offers. Despite what you may have read in the blogosphere, from your neighbor, or on any cable TV show... buying short sales are not going to make you rich. We have rarely ever encountered a short sale that has been sold for more than 10% to 20% below its market value. A 5% to 10% discount is much more likely, and 20% is only likely if there are severe deficiencies such as mold or foundation problems.
If you are looking to pick up a short sale at 50 cents on the dollar, you can unplug your computer right now. "Flippers" or wholesalers need not apply. Because of increased lending regulations, it is nearly impossible to 'flip' nowadays. There may be cities such as Las Vegas or Florida in which this may still happen, but not here in the Triangle Region of NC.
Remember, however, that most times, lenders will discount off the market value and not off the value that is owed. So, a 10% discount off market value is definitely a deal because it could be 50% of what the Seller originally paid. You may not be able to buy a short sale and step into an equity position immediately, but it may open up the door to a home that you might not otherwise have been able to afford a few years ago.
2) If you are going to make an offer on a short sale, please make sure you have the ability to wait a long time. Short Sales can take as little as 30 days, but more likely, they take up to 4 months to a year. You would be doing a dis-service to yourself, your family, the seller and everyone involved if you chose to 'bail' before you saw your offer continue through the entire process. Be patient and know that this WILL take time and there are no short-cuts.