Is there a particular type of loan that is most likely to receive a pre-approval price without an offer?

The real answer to this question is that Pre-Approvals don’t really exist.  Each lender is different, each loan servicer is different, and each investor is different.  The type of loan really has no bearing on whether or not an investor will evaluate a property prior to there being evidence of home owner distress.  Sometimes lenders will tell the home owner what price to list the house at, but this is extremely rare.  So rare, it’s not worth thinking about.

Until your creditor has evidence that you are in financial distress (missed payments, application for loan modification, etc.) they have no reason to put any effort into a solution for you.  Truth be told, any “solution for you” is really a method by which the bank will attempt to collect as much money as possible before losing you and your secured asset.

The best way to kick off the short sale approval process with your lender is to present them with all of the facts, including a valid offer, all at the same time.  It’s like serving a tennis ball.  Whack it in their direction with conviction and facts (like, this ball is traveling fast and if you don’t react you’ll miss it) and they’ll have to respond in order to minimize their losses.  That’s something they are interested in doing.

The type of loan product that you originally secured has absolutely no bearing on whether or not your home should be approved for a short sale or not.  What it CAN affect are the potential legal and tax implications as a result of an approval.

So essentially, no.  There is no particular type of loan that is more likely to receive a “pre-approval” over another.

Upon reading one such “custom” addendum, I was inspired to clarify the basics of a boiler plate Arizona Association of REALTOR®S Short Sale Addendum as it is written.

Shall we begin?

Lines 1-4: Identity

As with all other contract documents, this section outlines the Buyer, Seller, Property Address and Date.  Pretty simple, yet often left blank by lazy real estate agents.

Note:  A bullet proof contract will be complete and should indicate the level of excellence your agent strives to achieve.

Lines 5-6: Definition

“The following additional terms and conditions are hereby included as part of the Contract between Seller and Buyer for the above referenced Premises. (See how important it is to be thorough.)  Delivery of all notices and documentation shall be deemed delivered and received when sent as required by Section 8m of the Contract.”

Pretty simple.

Lines 8-15: Short Sale Contingency (condition)

“Buyer and Seller acknowledge that there is more debt owing agianst the Premises than the purchase price.  Therefore, this Contract is contingent upon an agreement between the Seller and Seller’s creditor(s), acceptable to both, to sell the Premises for less than the loan amount(s) (“short sale”).  Buyer and Seller acknowledge that it may take weeks or months to obtain creditor(s) approval of a short sale.  Nothing shall limit a Seller from accepting subsequent offers from subsequent buyer(s) and submitting the back up contract(s) to Seller’s creditor(s) for consideration.  All parties understand and agree that Seller’s creditor(s) may elect to allow the Seller to sell the Premises only to the holder of the Contract with terms and conditions most acceptable to creditor(s).“

Again, quite simple, and quite clear that to lift the contingency, only one thing needs to happen and that’s that the seller and seller’s lender come to an agreement regarding the short sale.  This information, contrary to popular bad-habit in the real estate community, is not incorporated into the purchase contract and therefore neither the buyer, buyer’s agent nor brokerage, nor buyer’s lender need to see the details of this agreement.  Many people have a hard time grasping this concept.  You’ll notice the stricken lines.  This provision is in the addendum by default, but quite honestly, leaving these terms in causes huge headaches and essentially makes your offer as a buyer quite worthless.  In order to show a buyer that a seller means business, I always advise this modification.  We don’t want to give the lender any say over which contract will be approved, and we certainly don’t need to submit more than one offer to a scatterbrained lender at a time.  That would prove disastrous and very confusing on their end.

Line 16-20:  Documentation to Creditor(s):

Seller shall submit to creditor(s) a copy of this Contract, including this and other Addenda, and any other documentation required by the creditor(s) for approval of this sale within five (5) days after Contract acceptance.  Seller agrees to diligently work to obtain short sale approval and will promptly provide the creditor(s) with all additional documentation required, including an appraisal, at Seller’s expense, if required.  Seller instructs creditor(s) to provide approval status updates to Broker(s) and Buyer upon request.

What the…okay, this outlines one very important aspect of real estate contracts.  Notice that contractually, your agent is not the one responsible for handling this task, yet it is what we offer you as a service because we are familiar with it, and we know that you don’t have the time nor patience to learn the process, and quite frankly, most people would give up before getting the job done.  So we do it for you, but you are still the one responsible for making sure it happens.  This is why it is absolutely critical that you respond quickly to any requests we have for documentation from you as you are contractually obligated to perform.  If we ask for something from you that’s critical to fulfilling these terms, we’re doing so because we’re looking out for your best interests, and you need to trust that, and provide us with what we ask for quickly.

That wraps up the first half of the Short Sale Addendum:

• Identity
• Definition
• Short Sale Contingency
• Documentation to Creditor(s)

In the 2nd article in this series, I’ll go over the following topics:

• Terms Upon Acceptable Short Sale Agreement
• Buyer Cancellation
• Legal and Tax Advice
• Unfulfilled Contingency

And finally, I’ll wrap it up with the section that ends up causing the most confusion because of the many variations that agents write:

• Other Terms and Conditions

How The Money Flows When Borrowing

When you buy a house with a loan, a lender agrees to purchase the item with their money with the understanding that if you don’t pay them back, they get to take whatever has secured the note.  In this case, your house is the security.  So, if you don’t pay them, they can sell the house and recover their investment, or a portion thereof.

Since the money used to purchase the home isn’t really handed to you, the buyer, it doesn’t feel like income, and as long as you pay back the note, it won’t be considered income.  But, if the lender decides at any point to forgive you of the balance of the remaining note, it would be the same mathematically had they simply written you a check to buy the house directly from the seller.  In that case, the money would have come directly to you and would be considered income.

The Idea of Phantom Income

So, when debt is forgiven, there’s a sort of “retroactive” income (many people call it phantom income) that is applied to you in the form of a form 1099-C (Cancellation of debt) statement.  If you don’t know now, you’ll soon know that a 1099 is a tax form that declares income.

Why does the lender issue the 1099-C?  Because every money transaction has two sides to it.  The lender is taking a loss which they must report to the IRS in order to deduct it from their taxable income.  Their loss is your gain.

What?  Yep.  Their loss is your gain.  Think about it.  Their original plan was to make a boat load of interest (their gain) over 30 years or 15 years, or whatever, as you paid back your loan.  They weren’t planning on losing their money.  But, since they have lost it, they get to deduct it.  Since they’ve forgiven you, the balance forgiven becomes income to you in the tax year in which the forgiveness takes place.

Yikes!  What Does That Mean?

It means, in short, that you may or may not owe income taxes at your tax rate on the forgiven debt.  Here’s an example:

You buy a home for $300,000 and you faithfully pay for a year.  During that year, the value of the house falls to $225,000 and you lose your job.  You can no longer make your payments, and you go into default.  Your REALTOR®, who happens to be an experienced short sale agent in your area, helps you sell your house for market value, leaving you with an agreement with your lender to write-off the remaining $75,000.

Well, the bank isn’t just going to toss that money aside without a tax benefit, so they file a 1099-C to show that you were the original beneficiary of the money that was used to purchase your home.

Suddenly you’re staring an additional $75,000 in annual income for the year, which may or may not be taxable based on your current circumstances.

Enter the Tax Relief Act of 2007

In 2007 a law was passed that offered protection against owing income taxes on forgiven debt provided you met certain conditions.  That law expires on December 31st of THIS YEAR.

Why is this important?

If your home is underwater, and you’re experiencing financial hardship, you have a little more than 8 months to list, market, and short sell your home to avoid paying income tax on debt forgiveness.  Unless our powers that be extend this provision, short sales, many of which are inevitabilities that home owner’s don’t yet realize due to emotional paralysis, will become very costly to the home owner.

Are you hearing me?  Some of you have been sitting on the decision to short sale for a few years now…and every penny you’ve spent on your house is lost…

…the longer you wait, the more it will cost you.  if you don’t act quickly, it may cost you even more that you ever imagined.

Thus, the importance of acting now must be emphasized.

In the world of short sales, we have what is known as the “3rd Party Authorization.”  This is when you, the borrower, authorize a 3rd party to speak to the bank on your behalf.  It’s not a power of attorney, but it’s similar.  You give someone else somewhat limited access to your identity in terms of your relationship with the bank.

In a relationship where you are the client, usually you’re always right (the only exception in my opinion is at a bar after said customer drinks too much.)  You make the rules.  Why?  Because you hold the power to be their client or not.  The bank cannot force you to be a customer.

A 3rd Party Authorization is as simple as a statement to the bank, in writing, signed by you, that you are authorizing person a, b, and or c etc., to speak on your behalf about your account.  In fact, you can even call the bank and conference in a 3rd party who can then speak on your behalf for that phone call only.

Bank of America is issuing a new 3rd Party Authorization form specific to Short Sales which will soon be required.  Apparently they are calling it a “standard” form, but if you ask me, a standard spans many brands and companies and is not specific to one.  This new 3rd Party Authorization form is BofA’s form, not a standard form.  If they really wanted to develop a standard they’d work with other banks to come up with a true equalizing standard.

(Note:  As I’m writing this, I’m thinking about some of the other “practices” in the Short Sale world that don’t make sense.“)

There are two notable points about this form.  The firstly, it’s specific to Short Sales.  It’s not a general 3rd Party Authorization.  Secondly, the form requires that, in terms of Short Sales, all parties MUST either be a licensed real estate agent, or attorney.

The form can be found here, if you’d like to review it.

One Must Be Licensed

Someone, somewhere said that in order to negotiate a short sale payoff, one must be either a licensed real estate agent or an attorney.  This makes no sense to me.  A real estate sale and a debt settlement are independent of each other.  When you sell your house, the proceeds satisfy the security against the property.  If you owe more than your house brings, payment of the difference is negotiated by the seller and the seller’s lender.  This is the short sale.  In my opinion, the only part of the transaction that requires a real estate license is the sale of the home.

Hypothetical:  What if the seller of the home puts his house on the market as a For Sale By Owner property, finds a buyer, then negotiates with his lender a short payoff of the note, and closes the deal without the use of a real estate agent?  Does he need to be licensed to do so?  Does he need to be an attorney?  This would be absurd.

Hypothetical:  A seller of a distressed property who is horrible at negotiating has a buddy who he knows is great at handling people on the phone.  He puts his house on the market without the use of a Realtor, gets an offer, has his buddy conferenced in on every call to the bank, and closes the sale for less than is owed.  As a thank you, the seller, after receiving his next paycheck, takes his buddy to San Diego for the weekend…clear consideration for the help he gave.  Does his buddy need to be licensed?

It seems the difference between needing a license and not needing a license is consideration.  What doesn’t make sense to me is what a real estate license has to do with settling a debt.

Expiration Dates on Approvals

I suppose I can understand that a lender, after issuing an approval, would want to create urgency to ensure that the deal is closed, however, it doesn’t make sense to put a time limit on closing a short sale for a property that has no pending trustee sale date scheduled.  In fact, closing deadlines are already set by the purchase contract and the Short Sale Addendum to the Purchase Contract.

If we miss the closing deadline due to the buyer’s lender having some sort of problem along the way, and there’s no pending auction date, what difference does it make to the bottom line if we close a week later?

Actually, there is a small difference if there are prorated taxes involved, but if the original HUD-1 that was submitted for approval placed closing far enough out, then the taxes will already be padded, and as a result, if closing happens earlier than the original HUD-1 states, the bank will actually increase their bottom line.

Buyer’s Agents and Lenders Asking for Approval Letters

While it’s been common practice for seller’s to provide buyer’s agents with approval letters, it’s not necessary.  The only argument I’ve heard FOR this practice is that the approval letter is like the Pre-Qualification letter, and as such, should be provided as evidence that an approval has actually happened.

Screech!  The contract isn’t written that way.  While the Pre-Qualification is indicates as an included document on the purchase contract when the buyer submits their bid, the Approval Letter is NOT an incorporated document.  It can be written into the contract as a required document, but it’s not part of the standard contract.  The only evidence that a buyer needs to prove that the short sale has been approved, is the AAR Agreement Notice which is specified in the Short Sale Addendum to the Purchase Contract.

Lines 22 and 23 are clear:

Agreement Notice:  If Seller and Seller’s creditors enter into a short sale agreement, the Seller shall immediately deliver notice to Buyer (“Agreement Notice”).

That’s it.  It doesn’t say “THE” Notice…it says notice, and that’s what the Agreement Notice is, which states:

Seller hereby delivers this Agreement Notice to Buyer pursuant to lines 22-23 of the Short Sale Addendum to the Contract. Seller and Seller’s creditor(s) have entered into a short sale agreement pursuant to which creditor(s) have authorized Seller to sell the Premises to the Buyer for less than the loan amount(s) secured by the Premises (”Short Sale Approval”).

I am negotiating a short sale for a property located in Laveen, Arizona, recorded on the tax records as being in Laveen, not Phoenix.  Due to the fact that the lender who wrote this loan in the first place got the city wrong on the note, the processor assigned to the file continually flags the file as inconsistent and repeatedly rejects my documentation because the tax records, which are the correct records, don’t match theirs.

This is a common occurrence in the Short Sale world.  Banks reinforce the notion that they are unable to properly think through the possibilities surrounding the myriad of potential turbulence surrounding a real estate transaction to come to a rational and logical solution.

So, for today, I’ll be changing files, and modifying documents, hunting down parties for signatures, etc., and none of it has any bearing on the bottom line to the bank.

That’s not to say that everyone is grossly under water, but underwater is underwater.  The degree to which you’re under water will vastly impact your decisions regarding your future, and affect the outcome of a possible need…the sale of your home.

Life continues to happen, and that means that for who are able to make their monthly payments, a shift in circumstances may mean the need to sell their home and reconfigure their lives.  If their house is upside down and they need to sell, they’ll have no choice but to sell the house short of what they owe their lender.  If they have to sell, they’ll either need to cover the difference out of pocket, or ask their lender to take a loss.

The answer to the question, “how long will short sales be around” depends on the rate of growth in the real estate market and the rate of appreciation in resale values.

Let’s take a look at an example of one person’s situation in a highly desirable area of Scottsdale.  Originally purchased at $115,000, this Scottsdale town-home appraised at $240,000 one year prior to the height of the market.  A neighboring property with an identical footprint sold for $319,000.  When the market tanked, the values dropped to their current range of $100-120K.

Why was the home appraised when it was?  For the purpose of taking out a Home Equity Line of Credit (HELOC) which ultimately raised the amount owed on the property from $115,000 to $200,000.

With a town home valued at $100,000 and a mortgage balance of $200,000, there’s a HUGE gap to bridge before the home has any equity.  So let’s look at an example of what happened to this particular condominium.  We’ll look at it first from the “What If” angle.

What if the housing bubble had never happened?

The figure above assumes a 4% annual appreciation.  The town home, purchased in 2002 for $115,000 gradually increases in value to an approximate value of $169,000 by 2012.  Not bad, considering by then the amount owed on the home would be about $88,000.00.  The green line represents the balance owed on the property, which should gradually decrease over time.  In this illustration, there’s no evidence of a bubble, but the bubble was the only reason a line of credit was available, so the green line should continue to decrease.

But that’s not what happened.  In reality, the following illustration shows a more accurate picture of what’s going on.  The current value of the property is $100,000, not $169,000.  So, by shifting the blue line to the right, we get a more accurate picture of how long it will take to break even on the property.

As in the previous figure, this assumes a 4% annual appreciation, but this time we’ve added the bubble, and shown that the value of the property TODAY is $100,000.  Based on this, we can assume that it will be another 7 years before this house is worth what is owed…if 4% is the rate of appreciation and the home owner continues to make payments to the principal balance.  Obviously longer if it’s lower, and shorter if it’s higher.  Either way, this house is under water for a while.  Another factor to consider is the number of interest only loans that cause that green line to remain flat.  I haven’t illustrated that, but if you flat line the loan balance, you can imagine how long it will take for the blue line to reach the green line.  In fact, the property may cap out at a certain value and never be worth what is owed.

What This Means

This means that if there is ANY reason that this home owner would need to sell the home (and life happens) then the sale will be a short sale.  The conclusion drawn from this is that Short Sales will be around for a while.

Property taxes always take priority over any other liens.  When you took out your loan to purchase the home, most likely your lender set up an impound account to hold a portion of your monthly payment to ensure that your taxes were paid on time.  The lender will typically pay that bill for you out of the impound account rather than letting you be responsible for the payment.  Why?  Because property tax liens are a priority, and if you don’t pay them, whomever does pay them, be it the state, or an investor who has purchased a tax lien, can foreclose on the property.  Lenders would be crazy to let you get behind on a few thousand dollars per year to risk losing what you owe them, which is typically hundreds of thousands of dollars.

If you have fallen behind on your mortgage payments, that also means that your impound account isn’t growing either, so when tax time comes, the lender doesn’t have your funds with which to pay the bill.  But, knowing that a tax lien could cost them a fortune, they will still pay the tax bill to keep that from happening.  You still owe it, unless you negotiate it away through a short sale.

In order for any property to change hands, title must be clear of all clouds.  Tax liens are clouds on title.  If your lender approves a short sale, that approval will be based on a HUD-1 that includes clearing up your property tax bill.  There’s no way around it.  The bill must be paid, and if you don’t have the money, the lender will have to pay it.  They don’t have a choice.  They’ll either pay it through the closing of a short payoff, or they’ll pay it when they sell the property after you lose it.  The latter simply costs them more money in the long run (which is why short sales are win win for everyone anyway.)

So, if your taxes aren’t caught up when you bring an offer to the bank, rest assured the net payoff will take into account the past due taxes.  In fact, in many cases, during negotiations, the bank pays the most recent tax bill which in affect changes the numbers on the HUD-1 in your favor.

Short sale approval letters are settlement agreements written by the home owner’s lender setting forth terms and conditions that the seller must meet through the sale of their home.

Most have an expiration date requiring that the settlement agreed upon be paid by that date.  Although it’s of little consequence, in my opinion (as it’s a debt settlement between the seller and seller’s lender), they also stipulate the name of the buyer on the agreement.

This would naturally mean that any settlement agreement would be invalid if the buyer stipulated were to cancel the transaction.  However, since the most important factor to the investor who owns the note is the net payoff, an approval tips their hand to the dollar amount they’re willing to accept, regardless of the buyer.

Sometimes a lender will be pro-active about the prospect of a short sale, and will “pre-approve” a sale amount and terms that will be acceptable to a future buyer.

So, a pre-approved short sale is one of the following:

1. It’s a property that has previously had an offer that met the investor’s payoff requirements but has lost its buyer-OR-
2. It’s a property that has been given a pre-approved price without an offer.

A house is only worth what someone will pay for it.  Period.  If the investor has pre-approved a short sale that has not yet had an offer, it’s likely they’re unrealistic about the asking price, so the 2nd example above is less likely to be a success, but still possible.

On the other hand, if the property has already been approved based upon a contract that was previously submitted from a qualified buyer, then the terms of that deal can be used to attract a new buyer.

Buyers who find short sales opportunities in the middle of this scenario are often pleased to find that it takes a fraction of the time to acquire a new settlement agreement from the lender.

When a real estate transaction closes, there is a document created called a HUD-1 Settlement Statement.  The HUD-1 is a spreadsheet of sorts that outlines the flow of money for the two parties involved in the transaction.

Who are the two parties?  The buyer and the seller.  On the HUD-1 there’s a buyer column and a seller column.  The buyer comes to the table with money for the purchase.  Costs are calculated for each party, and the bottom of the HUD-1 will show two important numbers:  1) Cash to/from buyer, and 2) Cash to/from seller.

You’ll notice we haven’t mentioned any aspect of the short sale yet.  The reason for that is because the lender involved in the short sale, in other words, the investor who holds the note on your mortgage, is not a party to the real estate transaction.

They are a party to the settlement arrangement with their client, the SELLER.  What?  Yep, that’s right.  The agreement between the seller and the seller’s lender is an independent settlement arrangement designed to make the agreement between the buyer and the seller work.

Huh?

I know.  It’s a bit confusing.  When there’s a lender who is owed money on a home that a seller is selling, at closing, some of the money that the buyer is bringing to the table goes to pay off the loan against the house.  If the value of the home is more than the amount owed (the home has equity), then the seller will most likely receive what’s left over after paying the lender and paying closing costs.  However, if the value of the home is less than the amount the seller owes, then the seller won’t receive anything.  Moreover, the seller’s lender probably won’t receive full payment on the balance of the remaining loan.  The only two solutions to remedy this is for the seller to contribute cash to bridge the deficiency gap at closing, or ask the lender to take less than is owed.

In other words, a Short Sale.

If the lender isn’t getting fully paid, then who pays the closing costs?  Bingo.  That’s the original question, isn’t it?  Who pays the commission on a short sale?  On the HUD-1, the line that shows how much the lender is getting at closing is calculated after all associated costs are subtracted from the sales price.

If a home is closing at $100,000 and $150,000 is owed, there are closing costs.  We negotiate with the bank to take $100,000 minus closing costs.

The basic answer to the question is:  The Seller pays the commission, but because there’s no money left over after paying off the lender, the lender backs off enough to allow the buyer’s new funding to pass through to the seller, thereby satisfying all fees.

Who’s eating the cost?  The investor is ultimately eating the closing costs.

In a specific example, a home owner has been told that they are on the verge of an approval, but until they either pay $3,500.00 cash or promise to repay $7,000 in cash over 120 months (that’s 10 years,) the approval will not be issued.

What’s Presented

The bank will typically represent that the mortgage insurance company who holds a policy on the note is asking Wells Fargo to ensure they get a cash contribution before they’ll pay the claim on the loss from the short sale.  They’ll say that it’s their request.

What’s Really Happening

Sometimes the MI company does request cash, but remember, the bank is in the business of getting your money in their pocket, and they’re not beyond using the ruse of a mortgage insurance company request to ensure you pay them so they recover more of their losses.  So more than likely, the MI company has has NOTHING to do with the request.

The bank is telling the seller that the mortgage company needs a cash contribution, but the mortgage insurance company never told the bank that they needed it.  This is a tactic that negotiators use which I contest is converted to incentives paid to negotiators for bringing in more money for the bank.  The bank is still going to file their claim with the mortgage insurer to recover a vast majority of the losses, but the insurer will be none the wiser that they’ve just squeezed the seller for even more.

How I Handle This

I call their bluff.

As a “private investigator” for short sale approvals (that’s basically what we are,) I hunt down the truth.  A simple friendly phone call to the mortgage insurance company will easily reveal whether or not the bank or servicer is telling the truth.  When we learn that there was never a request, it means we have more information than they’d like, and that’s how one wins negotiations.  The person with the most information wins, every time.  (It’s also assumed that that person has walk-away power.)

What if they actually did make the request?  That’s okay too, because that can also be negotiated away directly with the mortgage insurance company provided the details can be “worked out” as they call it.  If the seller has no money, and no room in their budget for a promissory note payment (in our example $7,000 ÷ 120 months = $58.33 per month) then there can be no contribution.

Now, in light of the situation, $58.33 per month is a small price to pay for the mess that we’re cleaning up, but it’s absolutely unnecessary, and likely to be defaulted on.  The notes are usually proposed at 0% interest, and $58.33 per month to a behemoth of a bank is less than peanuts.  It’s not even peanut dust.

So, if it comes down to blows, and the MI company absolutely won’t budge, then a payment might be wise just to make the problem go away.  You can see that we do everything we can to make sure that this is never the case.

The Gap

If the net payoff on a given HUD-1 for the sale of a home does not meet the standards set by the investor as a percentage of the BPO (Broker Price Opinion) then there will be a gap.  For example, if the $100,000 offer yields a payment to the lender of $90,000 after all costs are calculated -AND- the lender is willing to accept no less than 88% of the BPO -AND- the BPO is reported to the lender at a value of $110,000 then $90K suddenly becomes 81.8% of the BPO (90 divided by 110.)  The bank will not approve the deal unless it’s 88%.  This is a general estimate and close to what many banks accept.  If 88% is the magic number, then  it means we need to bring the bank $96,800.  We’re $6,800 short.

Closing the Gap

(Often confused with the concept of counter offers in a short sale, and not always a step in every short sale process.)

There are many ways to close this gap.  One way is to continue to negotiate with the bank to prove the buyer’s offer is more realistic than the BPO report claims to be.  This is done through a BPO dispute.  It doesn’t work every time, and sometimes there’s not enough time before the house goes to auction to achieve this goal.  In some cases the market has changed enough from the time the offer was submitted to the time the bank evaluated the BPO that the buyer’s offer no longer stands up.

Another way to close this gap is to have the buyer raise their price.  This is a sensitive direction to go considering the buyer may simply walk away if they hear any talk of raising the price.

Yet another way to do this is to adjust the HUD-1, legally, to be as accurate as possible.  You see, it’s common to submit a HUD-1 with padded costs to the seller in order to have wiggle room to negotiate once you reach the stage of closing the gap.

Commission reduction is an option, but it’s the last option because we work very hard to obtain approvals for our clients and since the seller is typically not coming out of pocket at all because they’re in the middle of a financial hardship, we aim for a full commission as allowed by the bank once they approve a lower net payoff.

One last option is to have the seller come to the table to close the gap.  This is tough to do, but often can save a house from foreclosure.  This is more common when we see people strategically defaulting on their homes as they intentionally quit paying their mortgage and begin stockpiling the payments.  If this is you, my advice would be to set that money aside and consider it not available to you and to be used solely in aiding the process of short selling.  After all, the two major concerns for a seller are whether or not the lender will be able to pursue them for the difference between what the sale pays the bank and what they owe, and whether or not their tax situation will yield a tax liability for the deficiency.  The two simple questions are, 1) will I have to pay taxes, and can they sue me?  These can only be answered by the corresponding experts in those two fields…a real estate C.P.A. and a real estate attorney.

In Closing, the bank’s perceived market value of your property compared to the net payoff as a result of the sale will determine whether or not money needs to come to the table to get the deal done, and often times the bank is wrong, which is still mind-boggling, as the process of foreclosure will cost them far more than closing the gap.

The BPO

The BPO is that 3rd party opinion of value.  It can make or break the deal because banks look at this number as the letter of the law when it comes to your home’s value during a short sale negotiation.  When that opinion of value is reported back to the bank, they compare that value with the net payoff as shown on the HUD-1.  They don’t compare it to the sale price.  Remember, the net payoff is the number that matters.  If the net payoff is within a certain percentage of the BPO value, the bank will submit the offer to the investor for approval.  Most cases, if a file gets to this point, it will be approved.  The reason this is true is because most cases are Fannie Mae or Freddie Mac owned loans and they have already set standards that your servicer follows.

The Net Payoff

Let’s assume that the house you’re about to sell receives an offer of $100,000 and you owe $200,000.  I can’t stress this enough.  For the purposes of obtaining an approval from the lender, the deficiency DOES NOT MATTER.  The bank, nor anyone else for that matter, in terms of selling the home does not care how much more is owed.

What they DO care about is what the home is worth, based largely on a 3rd party opinion of value, compared to the Net Payoff.  The net is the amount of money the bank will recover once all closing costs are subtracted from the sales price agreed upon by the buyer and the seller.

In our example, the sales price bring $100,000 to the table.  Some of that goes to the brokers for their services, the title and escrow company (in Arizona they are combined,) perhaps an attorney or negotiator, the city or county for taxes, a 2nd mortgage, and perhaps other entities that have an interest in the property.  A house cannot transfer title if it is cloudy.

All records of where money goes in a real estate transaction are required by law to be reported on a HUD-1 Estimate.  This provides full disclosure to everyone involved in the transaction and is required by law.

Normally at the bottom of a HUD-1, there is a line that reads, “Cash to/from Seller” that has a positive number in it.  In other words, money left over after selling the house.  In a short sale this line needs to read ZERO, as all funds have been allocated already, with a majority of them going to the investor who holds the note on your house.

The Offer

When a house goes on the market and someone makes an offer, if that offer is less than the seller owes on their mortgage, then you have a problem.  You have a short sale.  You are going to need to ask your bank if they will accept an amount “short” of what you owe them.  There is a very methodical way to go about this process as a result of miles and miles of red tape surrounding the processing of the transaction that is different for each and every lender, and each and every investor holding a note or notes on your house.  That is why you hire someone who is experienced.  Not every real estate agent knows how to do short sales the right way.

The bank does not determine what an acceptable sales price is.  Period.  The buyer and the seller determine the sales price.  The important resulting number is the net payoff to your lender after all costs have been calculated.

At its core, a short sale is a standard real estate transaction.  A house is listed for sale at a price comparable to the surrounding market activity, including sold properties, competing properties for sale, and properties under contract.  A buyer makes an offer based on their personal assessment of the surrounding market.  Until that offer is accepted by the seller and subsequently closed, a market value is subjective.

Market Value

The market moves.  It’s alive.  It changes from moment to moment.  Our culture, driven by consumerism, is so tied to the idea that a product’s price is set in stone that the value of an item really does remain in the hands of the company or person selling it.  That’s why I so often hear people who call me off of my signs ask me “what a house is selling for.”

This is simply not true.

Price is determined by so many combinations of factors that no single entity is responsible for the asking price and you as the consumer don’t have to pay what someone asks just because they put a sticker on it.  Every product we buy and sell, including a home, is negotiable, and the value of a traded good is only worth what it was last paid for at the moment the transaction took place.  Only moments later, all of the dynamics that led to a certain price being paid for a good or service change and the process of valuation begins all over again.  That is why products that are traded more than once never have the same “most recent” price.

Market value is subjective.

If you are upside down in your house, you owe it to yourself to calculate the long term ramifications.  The point of home ownership is a) to have a place to live that’s paid for, b) to build wealth and security for your family, c) to invest and generate cash flow.

As it is, with a 30 year mortgage, your total cost of ownership is much higher than the purchase price of the home.  Many people consider a mortgage a forced savings account because part of the monthly payment reduces the total amount owed on the house and becomes equity.  If you look at it this way, you also have to realize that during the first 15 years, MORE of your payment, in fact MOST of your payment is paid to the bank in the form of interest and is not “saved.”  Your money hardly starts working for you until the latter 15 years.

Let’s look at a simple example.

Bob and Judy purchase a home for $250,000 at 6% over 30 years.  Their monthly payment is about $1500.00 per month, and after 30 years, the total amount of interest paid reaches $289,500, making the total cost of ownership, not including deferred maintenance, $539,500.  IF the house increases in value over those 30 years by 4% annually, at the end of 30 years, it should be worth approximately $810,000, yielding a gain of $270,500.  If you divide the gain by the total cost, you get the investment gain, which is 50.1%.  If my math serves me correctly, 50.1% over 30 years is 1.67% annually.

A 1.67% annual gain is not enough to outpace inflation.  All things considered, Bob and Judy have a paid for home now, and they don’t have to worry about foreclosure, but the opportunity cost is just too great.  Bob and Judy paid more in interest to the bank than the purchase price of the house.  How much hard work does that represent?  Ugh…it makes me sick to see so much potential thrown out the window.

The example I just outlined is a good standalone argument against 30 year fixed mortgages as it is.  But what happens when you purchase a home and the value drops by 50%, which is exactly what happened in Phoenix in recent years.

Well, Bob and Judy’s original 30 year note would still yield the same numbers and at the end of the loan they would have paid a total of $539,500 as I outlined above, but in this case, they would have lost 50% of the original purchase price only 4 years into their 30 year term (2008-2012).  What they had originally paid $250,000 for is now worth $125,000.

If over the next 25 years remaining on their mortgage, their home increases in value by 4% annually, at the end of the 30 year mortgage, their home might be worth $333,000 and they will have paid out $539,000 for a total LOSS of $206,000.

Is this all starting to become clear?

There’s a point during the loan term at which your house value and the amount remaining on your note will break even, but it’s at a little more than 10 years in.  So for those 10 years you can count your payment as rent to yourself.  It disappears.  What you really have to pay attention to is the total cost by the end of the 30 year term.

So what’s the point?  The point is that it’s time for you to take a look at your current situation and weigh them against your long term plans and the possibility of the unexpected rainy days changing your path.  If you know for certain that you’ll be living in your house or owning the home for the entire 30 year term, then the worst that could happen is you’d lose a truck load of money, but you’d have a paid for home.  If, however, there’s ANY remote possibility that you would need to move for any reason whatsoever before your house is worth more than you owe, then you need to recognize that every penny you spend on your house now is good money after bad.

In other words, if you don’t choose to short sell your house now, you may be forced to later.  Really consider whether or not this is a possibility and then don’t delay on course correcting now.

Regardless of whether or not you choose to remedy your financial situation by paying off your note or short sell your home, you need to take inventory of your financial situation so you can plan your next steps.

Since the buyer and seller are in the drivers seat concerning the terms of a real estate purchase contract, and the bank is simply a 3rd party, the information that comes from the bank to the seller is privileged information that the buyer is not entitled to know.

The information from the bank that the short sale addendum to the purchase contract implies that the buyer is entitled to know is a simple “yes” or “no” regarding short sale agreement.  If the seller and seller’s lender come to an agreement, the seller notifies the buyer.  If the seller and seller’s lender do not come to an agreement, the seller can do one of two things: a) notify the buyer in writing that they will not come to an agreement, effectively canceling the contract, or b) continue to negotiate with their lender.

Aside from proving that the seller diligently pursued the approval to the best of their ability, the seller does not have to disclose the details of the negotiations.  The seller will disclose the final terms of the contract through the HUD-1.  They may also provide the buyer with the actual agreement letter from the lender, but they don’t have to.  All they need to do is notify in writing that an agreement was made.

One of the pieces of information that the seller and seller’s lender often deal with is what everyone has been calling a “Counter Offer.”  In Arizona, the counter offer is a document that is used prior to ratification of the purchase contract and is between the seller and the buyer.  One the contract is fully executed, only an agreement between the seller and the buyer can alter the contract price, and this is accomplished through a standard Addendum.

The lender may look at the seller’s proposal based on the contract and ask the seller to bring more to the table.  This is what many agents are calling a counter offer, but they’re failing to explain that it is a counter offer to the seller, not a counter offer to the buyer.  Therefore, if the listing agent in a short sale conveys to the buyer’s agent that the bank has “countered” the offer, then they are inherently confusing the purity of the short sale process and they’re putting their seller’s short sale success at risk.  When buyers of short sales have come to an agreement on price, it’s the listing agent’s responsibility along with the seller to work hard to get the net payoff as a result of that contract to fulfill the lender’s loss tolerance.

The banks have most people believing that the sales price of the home is the important number, but we know better.  The net payoff to the lender is the important number, and if we can meet that while remaining completely compliant with the law, then the purchase price is irrelevant.

When your lender wants more than the offer, convey that to the buyer as a last resort, but do your best to negotiate with the seller’s lender before scaring the buyer off.

The term Pre-Approved short sale indicates a few possibilities:

1. The lender has evaluated the property prior to it being listed or prior to being notified of a purchase contract on the home, and have indicated a pre-approved sales price.  In other words, “if you bring us this price, we’ll probably approve it.”
2. The lender has already issued an agreement to the seller for a lower net payoff, but the house is no longer under contract and a new buyer needs to step up to the plate.

A short sale is the sale of a home for less than is owed the bank.  In order for this to take place, the lender has to approve the contract which is between the buyer and the seller.  Not the buyer and the seller and the lender.

It amazes me to no end that so many agents do not understand this fact, and the contracts that I receive for my sellers frequently contain language referring to the short sale approval that is irrelevant to the purchase contract.

The real estate agent’s job is to market and sell your house.  The role of short sale negotiator (who is quite often your real estate agent) is to speak on your behalf to your lender to ensure that the offer that you’ve been advised to accept will cut the mustard, so to speak.  The benefit to you is that you don’t have to spend time on the phone (and I mean lots of time) dealing with incompetent bank employees in the midst of your current financial crisis, and that it most likely won’t cost you a cent to have this done for you.

Regarding the terms of the purchase contract in a short sale, the lender is no more a party to the sale of the home than an inspector or appraiser is party to the sale of the home.  The relationship between the seller and the seller’s lender is one by which the seller is asking their lender to allow them to pay off the loan without recourse for less than the amount that is owed.  This is called settling a debt, and leads to debt forgiveness, but the two agreements can be looked upon as separate agreements.

One agreement involves the terms and conditions between the buyer and seller, and one agreement involves the terms and conditions between the seller and the seller’s lender.  Each agreement can sway the terms of the other, but they are not connected.