by David Silver-Westrick

Past President of OCAR and SoCalMLS

Step One: Gather Information

1) Does the seller understand that they might be able to sell their home in a short sale and avoid a foreclosure? Do they want to sell? Some sellers would rather keep their home to the bitter end. Some will not acknowledge that they have a problem. Some feel that a miracle will allow them to avoid losing their home.

2) What (really) is the seller’s total debt? Many sellers do not know. You may be facing a short sale in any listing situation. Always find out early how much the seller owes.

a) Get an accounting from the seller of all the outstanding loans, (first trust deeds, second trust deeds, lines of credit, plus any arrears on the HOA dues, property tax, Mello Roos obligations, and other taxes attaching to the property, plus any other debt for which the property may be security (IRS tax liens have a habit of showing up late). The seller will need to contact each creditor and ask for an accounting. Most lenders will not speak with you directly without a letter from the seller, especially in this era of identity theft. Each lender may have its own form, which you will need the seller to obtain and sign authorizing you to speak with the lender about the loan. Double-check with title companies for recorded debt and judgments.

Is the Seller Already in Foreclosure?

A judicial foreclosure is a type of lawsuit. It is like all other lawsuits. Lawyers get paid…a lot. It can consume a great deal of time (as long as the backlog in Superior Court). If contested, it can take several years. Its sole technical advantage to a lender is that the lender on a nonpurchase money loan (most commonly a refinance) can potentially recover a “deficiency judgment.” In other words, suppose a property owner owes $1,000,000 on a refi loan, and the owner’s property is sold through a judicial foreclosure for $800,000. The lender might be able to recover the additional $200,000 (plus interest, penalties, and costs, from the former property owner (assuming the resources exist). But, in addition to time and expense, another disadvantage of a California judicial foreclosure is that it results in a sale that can be undone by the former property owner for one year after the sale, if the former property owner is able to pay the past due interest, penalties, and fees—a process call the “right of redemption.” A purchaser of property through judicial foreclosure will have to wait for a year to know that he or she will be able to keep the property. How much would you pay for that privilege? Me neither.

By far the majority of foreclosures in California are non-judicial.

Has a Notice of Default (NOD) Been Filed?

1) Have any of the lenders, the HOA, or any tax agency filed a Notice of Default (NOD)? Check with at least two title companies by phone to make sure. Don’t rely on the seller to tell you. If there is an NOD, get a copy of it from the title company, as well as the date the NOD was filed. The foreclosure process is commenced by the recording of a Notice of Default and Election to Sell by the Trustee (the “NOD”). After the NOD, the Trustee must wait three calendar months before proceeding with the sale. After the three month period has elapsed, the Notice of Sale must be published, posted and mailed 20 days before the sale, and recorded 14 days before the sale. During the foreclosure process, the borrower is given the opportunity to cure the default and avoid the loss of the property through reinstatement; by making the delinquent payments and thereby reinstating the terms of the loan. This right continues until five business days prior to the date of the sale, including any postponement. Unlike judicial foreclosure, the debtor has no right to cure the default after the foreclosure sale.

2) If an NOD has been filed, the property may be sold at what is called a Trustee’s Sale— approximately 3 months plus two weeks after the NOD is recorded. The Notice of Sale (NOS) must be recorded 14 days before the actual sale. It will contain the date, time, and place of the sale. Some lenders do not always follow up and file the Notice of Sale on time, but you have to assume that the earliest possible sale date after the NOD gives you a firm deadline. You must close any short sale before the property sells at trustee’s sale. After the trustee’s sale, the seller no longer has any rights to the property.

Is the Seller in Bankruptcy?

1) Is the seller in bankruptcy now? If so, all the seller’s assets will be supervised by the Bankruptcy Court. There is probably not much you can do to help until the lender files a petition to remove the property from bankruptcy protection. If the seller is represented by a bankruptcy attorney, contact him or her (with the seller’s permission) and ask if a short sale might still be in the picture. Sometimes the bankruptcy is filed to stave off creditors for a period of time. In many bankruptcies, though, the homeowner seeks to keep their principal residence, and will let other obligations go to keep the house payments current. That could very well be the best result for the seller. Never argue with attorneys or tax advisors consulting with seller. It is certainly always prudent to suggest that the seller might want a second legal or tax opinion.

Let’s assume you have a simple situation with a seller with just one loan - the first trust deed that was used to purchase the home. Assume that the sellers paid $1,250,000 for the home. They put 20% down and borrowed $1,000,000. They have not made any payments in several months because both the wife and husband were in an auto accident and have not been able to work. The husband may be permanently disabled. The lender has not yet filed a Notice of Default, but has contacted the owners several times. The current balance on the loan, with penalties and interest, is exactly $1,000,000. The sellers acknowledge that they will not be able to keep the home, and worry that a foreclosure will ruin their credit, which was otherwise good. They wonder what they should do. Your careful and realistic CMA (remember there is a ticking clock here as overoptimistic pricing could be fatal) suggests that the property is worth no more than $950,000 in the current market. After commissions and closing costs, the proceeds would be no more than $880,000. What can you say to the sellers?

If the seller is unhappy that the property value is less than the loan balance, but is otherwise under no pressure to sell, keeping the property can be the best solution. Even if there is some short-term financial distress, it need not result in loss of the property. Ask if there are family members or other resources that can carry the sellers through this hard time. Because of the lack of equity, a refinance will rarely be possible, so that will not generally be an option. If the sellers must move, could they rent the property (even at a negative cash flow) and sell it later in a better market?

If the sellers sold the home for $950,000, could they write a check at the close of escrow for $120,000 to make up the difference to the lender between the $880,000 proceeds and the $1,000,000 debt? If they can afford and are willing to do so, you will not need to do a short sale. But many sellers are financially distressed generally by the time their mortgage is in arrears. Some sellers with resources are unwilling to put them to this use.

Allow the Property to Go to Foreclosure

This is always a bad option. The damage to the seller’s credit will be the most extreme. The psychological effect of passively allowing such a traumatic event to happen is damaging too. Most people will feel better about a bad situation if they try to take some control over it.

Restructure the Debt

You know…how all the big guys do it: General Motors, Chrysler, Lyon Homes, Bolivia. Well guess what, your client is probably not a Fortune 500 company or a sovereign nation. Still, it definitely makes sense to attempt to negotiate with the lender(s) as a strategy aimed at lowering payments and either keeping the property or allowing time for a short sale to occur. The seller is the best person to initiate the negotiation, and should ideally be assisted by an attorney or other financial advisor. Do not become involved directly other that to suggest it to your client. It is beyond your area of expertise. Whether the seller wants to try restructuring or not, it is always important to suggest that the seller contact the lender or HOA or taxing agency, and discuss the situation. Creditors generally give debtors in trouble much more leeway if the debtor acknowledges the situation and appears to be taking steps to resolve it. This might take the form of payment reduction or a delay in filing a Notice of Default. Recently, several major lenders have indicated greater willingness to negotiate workouts with borrowers, so be aware of each lender’s policy.

Every big builder in Orange County has done it. You call the lender and say something like, “This isn’t working out,” and offer to mail back the keys in exchange for the lender not foreclosing. In our experience, very few lenders in California will do this for individual homeowners. They appear to want the homeowner to at least go to the trouble of a short sale.

Assuming there is no readily apparent way for the sellers to keep their home, and no ability to make up a shortfall, ask if the sellers would consider a short sale.

From the seller’s point of view, a short sale offers a responsible solution to a bad situation. A foreclosure, especially on a personal residence, will make it very difficult to get credit of any sort for a number of years. Credit will cost more for even longer. It is the single worst thing that can happen to a FICO score. A short sale will still impact credit in a negative way, but to a much lesser degree. We have represented sellers in short sales who were able to obtain a reasonably priced mortgage loan for a new home just a few years later. The seller gets a measure of control that can be a very good thing for them psychologically.

Short sales tend to minimize the difference between what is owed and the proceeds turned over to the lender, thereby minimizing potentially taxable debt relief (although at the time of this writing, there is a temporary tax provision contained in the Mortgage Forgiveness Debt Relief Act of 2007

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From the lender’s point of view, a short sale, properly packaged, is a good business decision. The lender will suffer a loss on the loan no mater what. If the lender takes the property in foreclosure, the bad loan will be in the books longer, the losses will be higher, the administrative costs will be higher, and there will still be the problem of selling the home, in which the lender will be paying all the same costs as in a short sale, with no guarantee the market won’t be worse. Additionally, lenders who have experience with foreclosures know that homes are sometimes damaged by angry owners as they leave, or stripped of appliances, fixtures, fireplaces, and even wiring and plumbing by salvage vandals who sometimes offer the seller a few dollars. A short sale can offer certainty and can minimize loss.

From the REALTOR’S® point of view, you might say that the commission is motivation enough, but as we will see, there is no guarantee of a commission, no guarantee the lender won’t cut your commission, and you will do much more work on a short sale than on any other kind of sale. So why do it? Sellers need your help and expertise. We eagerly represent folks who buy and sell homes when the occasion is happy. We need to be willing to help them when the occasion is not happy. It is part of the deal we make when we become REALTORS®–even if we occasionally forgo a commission. That is a moral argument. The business argument is this, “You are not personally responsible for the state of the market at any given moment, but you are responsible for making sure the market works properly.” Short sales in times of soft real estate values help keep markets from overreacting. They cushion downturns and allow us to avoid more serious recessions by providing an orderly way to identify properties on the way to distress and a rational way of transferring ownership that minimizes transaction costs and wasted time.

The elements of a successful short sale are always the same:

• The property is worth less then is owed.

• The seller is cooperative and willing to work with a REALTOR® to package the short sale.

• The lender is contacted and expresses a willingness to entertain a short sale.

• The property is listed, with appropriate caveats and protections for the seller, properly priced, and effectively marketed.

• The lender is presented with a non-contingent market price offer with a normal escrow period along with a completed short sale package and narrative explaining why the short sale is necessary and desirable.

Assume we have established through our careful CMA that the property is worth less than is owed, as in the example above:

1) Is there a significant seller hardship?

a) You may think this is a funny question. Isn’t there always going to be hardship when the seller owes more than the home is worth? Well, not always. Sometimes the sellers find out their home is worth less than they owe when they decide to move to a bigger and better home. They may want your help so they can be free of the current home to buy a new one. This will be hard work. Nothing makes lenders angrier than sellers who want out of a mortgage so they can get another mortgage. Occasionally the seller has actually purchased a new home, knowing that the old one was overencumbered. Unless there is hardship, it will be difficult to successfully complete a short sale.

b) What constitutes hardship?

i) All the usual things that come to mind – Loss of job, unusual medical costs, death of an owner, natural disasters, even extended military service for reservists can be hardships. There should be a nexus between the hardship and the need to sell. A job loss leading to a problem paying the mortgage is obvious, but an illness might require a family to move closer to specialized medical help, so even without an unbearable financial hardship, the owner simply cannot stay.

2) Is the seller cooperative and willing to sell?

a) You will need the seller to help write a narrative of the hardship involved. The seller will be asked by the creditor to reveal the details of the seller’s financial situation. If there is a short sale application, the seller will have to complete it. This can be embarrassing, and some sellers simply won’t do it. Prepare them and make sure they are willing to do what is required. If they are uncooperative, you will not be able to help them.

3) Is the lender receptive?

a) Let the lender know the situation and your proposed short sale solution. They may ask other area REALTORS® to do a Broker Price Opinion (BPO) to verify your evaluation. They probably will be non-committal. Even institutions go into denial when faced with bad news. They will certainly not welcome your suggestions. Unless they indicate that they will categorically refuse a short sale under any circumstance (a rare occurrence), you can proceed with the next steps.

a) When you list the property it is important to have a record of the discussion you have had regarding the short sale with the seller. The listing agreement should state that the seller’s acceptance of any offer will be subject to the lender’s acceptance of the offer without requiring that the seller bring cash to close escrow, and should include recognition that the broker agrees to accept the commission as approved by the lender, and will not pursue the seller for any shortfall. The seller also should explicitly acknowledge that the seller will receive no proceeds, that there are significant tax and legal ramifications to a short sale, and that the seller has been strongly urged to consult with an attorney and a tax advisor before signing the listing. Use CAR form SSL to cover all these topics.

b) The entry of the listing into the MLS is critical. There is a new mandatory field in the TEMPO listing entry screen entitled “Short Sale - Yes/No.” It is designed to put MLS subscribers and buyers on notice that your asking price is lower than the debt, and that a lender approval is required. Remember that it is not sufficient to simply place this notice in the MLS. The MLS is not the purchase contract. You also will need to use clear language in the purchase agreement or counter offer itself to provide that the seller is not obligated to sell if the lender does not approve all terms. This is a common and serious mistake agents new to short sales make. If you fail to make this clear, you will be obligating the seller to sell regardless of the response of the lender.

c) In the Agent Remarks section, you also MUST use a phrase such as “This is a Short Sale. Price, terms, and commissions all are subject to approval by lender. In the event the lender reduces the commission, listing broker agrees to share the total approved commission equally with the selling broker.” It need not be equally shared, but the procedure for determining the sharing of any reduction must be set forth clearly. If you don’t do this, you may end up writing big personal checks to buyer’s agents. The amount of the commission is, always, up to you. Recognize that you will be working hard, and price your services accordingly. The commission offered to the buyer’s agent should be sufficient to engage their interest, because for them as well, there is no guarantee that escrow will close and no guaranteed amount they will earn. Recognize that all terms are subject to lender approval. Just because you wrote in an X% commission does not mean the lender will approve it. This is an uncertainty with which both you and the buyer’s agent will have to live.

d) Your price should be designed to obtain offers quickly, certainly within 30 days, but should not be so low as to create the impression that you have left some of the lender’s money on the table. They are feeling damaged already. Your marketing should be aggressive and effective. Document it all. The marketing effort will become part of your short sale package. If the seller paints the front door to help you sell the home, document it. If you do open houses every weekend for a month, document them. If you need to adjust your price, do so quickly. There is no point to allowing a short sale listing to languish in a slow market. Keep track of all the feedback and all the showings. The lender will want to know that the property was properly exposed and that you did not simply sell it to your brother at a big discount. You should attempt to obtain the highest price possible, just as if you were representing a typical seller. You just have less time.

When you receive offers, you should negotiate them as you would with any offer, with the seller. If the buyer’s agent did not use the CAR form SSA (Short Sale Addendum), you will need to incorporate it into a counter offer. Be reasonable, but be sure to protect the seller’s interests. You probably will want to place a time limit in Paragraph B of the SSA such as “within 30 days” to let the lender know there is some urgency, and because the buyer won’t want to wait forever. If you choose to have the seller formally accept an offer (subject to lender approval), as opposed to sending it to the lender unsigned, your seller will be obligated to give that buyer a “right of first refusal” at whatever price the lender proposes. On balance, it is probably a better practice to have the seller accept at least one offer, if only because it will give a very insecure buyer precedence in line. If you have multiple offers, you may wish to accept some as “back-up” offers. It is reasonable that the buyer’s time period starts after lender acceptance.

Once you have a clean accepted offer (no sale contingencies, good credit, etc.) you will put together the “Short Sale Package.” You may do this in two parts. Submit most of the  package to the lender when you obtain the listing, and then pass along the offer, or you may wait until you have an offer. The package will ultimately include:

1. A hardship letter, written by the seller or by you with the seller’s information and input. This constitutes your attempt to be as persuasive as possible that the seller is in no position to continue with his or her financial obligations to the lender. It will make or break your short sale. The reasons should be compelling. Be honest and frank. Never embellish. Just tell the seller’s story. Include corroborating material. If the seller was fired, include the termination letter. If the seller has medical bills, summarize them. If the seller is ill or disabled, show how that has made it impossible for the seller to keep the property. If there are tax problems, describe and document them.

2. A copy of the purchase contract signed by both the buyer and seller.

3. A copy of the TDS, especially if the property is dilapidated or damaged.

4. Proof of the buyer’s ability to purchase the property such as a completed loan application, pre-approval by another lender, or evidence of cash on hand (bank statement).

5. A copy of the certified escrow instructions.

6. The preliminary title report.

7. The estimated net/closing statement certified by an escrow officer acceptable to the lender. You need a real estimated closing statement (a HUD-1) rather than a net sheet because the lender is going to refer to it if the sale is approved. It is very important that this estimate be as complete and accurate as possible. Many lenders will reference the closing statement in their acceptance or rejection. You may receive an approval something like “Lender will accept net proceeds of no less than $273,565 no later than November 30, 2008.” If the estimate of proceeds is wrong for any reason, you may have to attempt to renegotiate with the lender.

8. A completed and signed IRS Form 4506, “Request for Copy of Tax Form.”

9. A completed and signed personal financial worksheet.

10. Tax returns from the past two years.

11. Employment paycheck stubs for the past two months.

12. Profit and loss statement (if the seller is self-employed).

13. Bank statements from the past two months.

14. A completed Short Sale Application if the lender provides one. Many don’t.

15. Your CMA with supporting sales data. You want to show that the offer you are presenting is the best market price offer the lender is likely to receive. A short narrative about the market in the area supported by material such as recent C.A.R. economic data and newspaper articles is useful here. The decision maker may reside in another state and will not necessarily understand why the property is suddenly worth less than the loan.

16. Your marketing history, showings, and feedback. Here again, you need to show the lender that you have made a real effort to get the highest price. They must understand that you have done a better job than they would and you have presented them with a quick and attractive solution to a deteriorating situation.

17. A formal request signed by the seller that the short sale be approved as described.

Once you have submitted the short sale package, stay in touch with the lender every day if possible. Make sure they acknowledge that the package is complete. Try to talk to the same person in the Loss Mitigation Department each time and document your conversations. This is not a happy decision for the lender. It will get shoved to the bottom of the to-do list over and over again. Lenders are infamous for “losing” short sale paperwork. Keep the seller and the buyer’s agent up to date. If there is a drop-dead time limit to the offer, remind the lender of it often.

There are different opinions and practices concerning whether to submit all offers received to the lender, or whether to limit the submission to the first offer the seller accepts. Many lenders will require in writing that all offers be submitted, but it is always a good practice to be as transparent as possible. I always would submit all offers to the lender through their final acceptance.

The lender can do one of several things:

1. Ignore the offer. This happens.

2. Refuse the offer, either with or without an indication of what price would work.

3. Ask the seller to bring some or all of the shortfall to escrow. This is a typical first response, and you will need to argue again that the seller is in no position to do so.

4. Accept the offer.

   If the lender refuses the offer, try to find out what net proceeds the lender would accept. Go back to the buyer and see if he or she will increase the offer. This process can be similar to any counter offer situation, but it takes more time. If the buyer refuses, obtain a cancellation and go to your back-up buyers (if any) in order. If there are no back-up offers, ask the lender to give you some time to place the property in the MLS as an “approved short sale” at the price and terms the lender will accept. If you then obtain a buyer who agrees to that price and those terms, you can proceed to close normally.

   If the lender accepts the offer, it will typically be in the form of a letter to escrow (and possibly to you) to the effect that the lender will accept no less than X dollars in proceeds, no later than X date. The lender also may attempt to reduce your commission. You certainly can argue with the lender about this, but ultimately, the lender will decide. This is why it is so important that the estimated closing statement be accurate. If the lender accepts a short sale, they will not care what problems you might have closing the escrow on time, or what unanticipated costs you might face. There simply will be a dollar amount that will need to be available at the close of escrow. Once escrow has the letter, you can proceed to close in the ordinary way. It is prudent for you to have the seller move prior to the close of escrow so that you do not have any holdover or possession problems. Remember that the seller is responsible for all the usual disclosures.

   Is that all there is? No. There is a lot we have not talked about in detail, yet I hope that this summary gives you a sense of the process and a respect for the potential pitfalls.

    

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   1 Short Sale: A short sale is a transaction in which a lender allows the real property securing the loan to be sold for less than the remaining mortgage amount due and accepts the proceeds as full payment of the loan. A lender may accept a short sale when the borrower is in severe financial straits and market conditions make a short sale the best choice to mitigate the lender’s damages. Like a deed in lieu of foreclosure, this saves the lender the costs of foreclosure and the borrower avoids having a foreclosure on his or her credit report. From the November 2006 CAR Legal Bulletin on Short Sales available at www.CAR.org.

Disclaimer: Nothing in these pages is intended to constitute legal advice. This material is intended to give real estate licensees an overview of the short sale process from the point of view of the real estate practitioner, some tools to help sellers through it, and a large dose of caution. A short sale or a foreclosure is a catastrophic event for any property owner, and has serious legal and tax implications. Always advise a property owner in writing to obtain legal and tax advice before undertaking a short sale.