If you're a homeowner facing foreclosure, a short sale might sound like the perfect solution to your mortgage payment problems. After all, with a short sale, you sell your home for less than the total debt balance remaining on the mortgage and the lender agrees to release its lien on the property. Once the short sale is complete, you're free and clear of the property. What could be easier?
Well, many different potential hurdles could arise that you’ll have to overcome to complete the deal and, sometimes, even afterward. Read on to learn more about common problems that come up in short sales and what you can do to avoid these issues.
A short sale is when the lender agrees to let you sell your home for less than the outstanding mortgage debt. The proceeds from the sale pay off a portion of the mortgage balance and the lender releases the lien on the property. (Find out more about short sales in Is a Short Sale Right for You?)
Example. Say you owe $300,000 on your mortgage. Your lender agrees to let you sell the property for $250,000 and release its lien. The sale price is “short” of the full debt amount by $50,000, which is called a “deficiency” (see below).
In the past, short sales were difficult—if not impossible—to complete. Following the mortgage crisis, servicers and lenders revamped their short sale guidelines and, as a result, it is now easier than ever to complete a short sale. But certain problems do still tend to crop up in short sales.
If you're aware of the most common short sale problems, you’ll be better prepared to deal with them as they arise. Some frequent issues are:
In many states, the lender can seek a personal judgment against you after the short sale to recover the deficiency amount. (Learn more about deficiency judgments in How to Avoid a Short Sale Deficiency Judgment.)
While many states have enacted legislation that prohibits a deficiency judgment following a foreclosure, most states do not have a corresponding law that would prevent a deficiency judgment following a short sale. (Find out which states prohibit a deficiency judgment after a short sale.)
Even if your state doesn't have a statute that prohibits a deficiency judgment following a short sale, you might be able to prevent the lender from getting a deficiency judgment by:
To avoid any nasty surprises following the short sale, you should figure out what will happen to the deficiency before completing the transaction.
Potential purchasers sometimes make ridiculously low offers hoping to get an amazing deal on your property. But banks owe their shareholders and investors a duty to get as much as they can for distressed properties. Lowball offers do not meet investor guidelines and, as a result, the lender will very likely come back with a significantly higher counteroffer and the potential buyer will most likely walk away.
Another potential problem with short sales is the issue of buyer scrutiny. Before you get too deep into the deal, you need to ensure that the buyer is qualified and serious about purchasing the home. For example, make sure that the buyer is pre-approved for a sufficient loan amount, otherwise you might go through the entire short sale application process with your lender only to find out that the buyer can’t complete his or her end of the deal.
In order to obtain clear title following a short sale, the first mortgage lender must obtain releases from all of the junior lienholders. This means that if there is a second mortgage, HELOC, or other lien (like a judgment lien) on the property, all must sign off on the short sale deal—not just your first mortgage lender. To get the junior lienholders to agree, the first mortgage holder will offer each junior lien holder a portion of the total amount they are owed—this is usually a small amount of money—in order to release their lien.
The main obstacle in getting junior lienholders to agree to a short sale is that each party usually wants more money than the first lender offers. This can make it very difficult to get an approval from each lienholder. (Learn more in Short Sales With Multiple Mortgages.)
A few potential solutions to this problem are:
Some banks have a reputation for being difficult when it comes to approving short sales and releasing their junior liens. If you don't devote adequate time and attention to the junior lienholders from the very beginning of the process, it might not leave you with sufficient time to obtain their consent and complete the short sale.
In general, short sales are much faster than they used to be, though the process can still take a few weeks or months. Because it is possible that the lender will reject the first offer—particularly if the offer is substantially lower than the listing price or below fair market value—uninformed buyers and sellers who expect a quick turnaround can get frustrated and bail on the deal before the sale is approved.
Fortunately for some borrowers, Fannie Mae and Freddie Mac, as well as some of the major banks, have streamlined their short sale processes so that homeowners can be more quickly and easily approved for a short sale.
If you have sufficient income or assets, you should be aware that the lender might require you to sign a promissory note to pay back some of the deficiency as a condition of agreeing to the short sale.
The lender might remove this requirement if you:
Example. Say the lender will approve the short sale, but only if you agree to sign a $10,000 promissory note to cover some of the deficiency. Rather than signing a $10,000 promissory note, you could offer to pay $3,000 at closing. Lenders are sometimes willing to take less money at closing rather than hope they’ll get more money out of you at some point in the future.
One common reason that short sales fail to close is problems with the documentation. For example:
Any problems with the documentation can slow the process down or kill the deal altogether. Therefore, it is in your best interest to push for the loan documents to be prepared several days before the closing date and to carefully review them.
If you're considering completing a short sale, you should go into the process knowing the pitfalls so you can take steps to avoid them. Hiring an attorney with experience in negotiating short sales is also recommended. A few of the reasons why this might be a good idea are:
Short sales can be tricky, so be sure your attorney is familiar with how they work.