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New: The anatomy of a short sale

Posted on Dec 17, 2009


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One of the most frustrating forms of a real estate transaction of late is the “short sale.” We’ve had a lot of questions lately about this kind of sale, so I want to address some of the primary questions and myths.

1) A boy named Sue: There are a lot of misconceptions about short sales, starting with their name. A “short sale” is not a denotation of time – short sales actually take a long time to close. A short sale is a real estate transaction where the seller owes more for the property than the property is currently worth. In other words, the seller doesn’t have any equity and in order to sell, the bank is going to have to agree to accepting less than what they’re owed. For example, John Doe bought a property in 2007 for $380,000. It’s now 2010, and the local real estate market has tumbled. In a “choose-your-own-adventure” twist, let’s say that John (1) got divorced, (2) lost his job, (3) is transferred out of state, (4) develops a medical condition that forces a move, or (5) simply can’t afford his home anymore. John’s house is now worth $340,000, and since closing costs for most sellers run about 9% of the purchase price, if he was able to sell his home for $340,000 his net proceeds would be $340,000 (sales price) – $30,600 (closing costs), or $309,400. John owes the bank $380,000, so in order to sell, either John has to come up with $70,600 (which he doesn’t have), or (more likely) the bank is going to have to accept $70,600 less than what they are owed. The bank is going to end up short – so, this is a short sale.

2) Mr. & Mrs. Scott Free…: For a seller, deciding to sell your home as a short sale is not an easy one, and so we are always going to encourage our clients to consult with a bankruptcy attorney and their financial adviser. The primary benefits of a short sale to a seller will be reflected in their credit report – if they want to buy a home again in the next 2-3 years, then a short sale will be less damaging to their credit than a foreclosure and/or bankruptcy. The other benefit is simply timing – due to the overwhelming amount of short sales in recent history, the government has instituted The Mortgage Forgiveness Debt Relief Act which runs through 2012. Under the provisions of this act, sellers that short sale their home will be forgiven the potential tax burden that would otherwise occur because of debt forgiveness. For example, if the bank forgave John Doe (in the example above) a debt of $70,000, the IRS would normally treat that as taxable income, and now John Doe owes taxes on the amount the bank forgave. Because of The Mortgage Forgiveness Debt Relief Act, this forgiven debt will not be taxed, and John won’t owe taxes because of it. There are exceptions to this act, which is why we encourage our clients to speak to their lawyer and their financial adviser. Still – the primary benefit of selling a home as a short sale is that it can be less damaging to your credit.

3) …or not? Why wouldn’t I sell my home as a short sale? While the bank may agree to accept less to get the property sold, this doesn’t always leave the seller off the hook for the remainder of the balance. Indeed, there are cases where foreclosure is a better option for clients than a short sale (in short, talk to a lawyer and your financial adviser). If the bank (or banks) has agreed to a short sale, they’ll often forgive most of the debt, and may ask the the seller to sign a promissory note for a lesser amount, perhaps in the form of an interest-free or low-interest long-term loan. In a short sale the seller may not get off completely scott-free, and may have remaining debt after the sale of the home. Still, this debt will generally be much less than the amount forgiven.

4) I want to sell my home as a short sale – what should I know and do? Contact a bankruptcy attorney and discuss your options (if you don’t currently have a bankruptcy attorney, call us for a referral to one). It might cost a couple of hundred dollars, but it could save your credit and a lot of pain and suffering. Contact a financial adviser to see how a short sale or bankruptcy would affect your assets and the future of your assets. Contact a listing agent that has experience marketing short sale properties, and make sure that they work with an experienced negotiator that is going to negotiate on your behalf with the bank. Be prepared – this is usually a long and frustrating process, but working with a team of capable people will save you some suffering. We have enough experience to know what banks will and won’t pay for, and which banks are going to take a long time (national franchise banks) and those that might respond more quickly (local banks).

5) Who pays the real estate agents? And the excise tax? We don’t work for free (not on purpose anyway), and the State of Washington is going to want their 1.78% excise tax on the sale of your home, so a lot of people wonder how these get paid in a short sale transaction. For the most part the bank pays these fees. They usually negotiate these fees down, so the real estate agents might make a little less, and the buyer might have to kick in a little money to get the bank to move forward to closing. The State of Washington doesn’t forgive excise tax easily, so the banks have to pay excise tax if they’ve agreed to a short sale.

6) I’ve heard buying a short sale can be a great value. They can be, but for a buyer, there’s nothing short about a short sale. The process can take 6 weeks or 6 months (even longer – one of our short sales took 2 years!). The seller doesn’t have any money, so the properties usually aren’t in great condition and they aren’t going to be paying for any repairs. Yes – there is value to be had, but only for the patient. If you’re looking for a real value, focus on bank-owned properties. There’s a reason banks agree to short sales – on average short sale properties cost the bank about 15% less than if they were to take that same property through the entire foreclosure process.

Moral of the story: if you’re thinking about selling your home as a short sale (or if you’re a buyer thinking of purchasing a short sale property), you need to call us. Everyone’s situation is different, so the internet won’t give you the answers you need. Let us sit down with you and go over your options. We’re happy to help even if we don’t end up listing your property. Please fill out the form below and we’ll be in touch to help counsel you through this difficult process.

2 Comments

  1. My real estate agent stated that with a short sale he would get his commission. Do I have to pay that commission?

    Post a Reply
    • Are you the buyer or the seller? I’ll answer as if you’re the seller, and if that’s not the case you’ll have to let me know.

      Simply – in either case, and most every time – no, you don’t have to pay the commission. Most commonly, short sale listings and/or purchase contracts on short sale properties include language that states “All terms and conditions (including commissions) subject to underlying lien holder approval.” Part of the short sale packet includes the listing agreement between the listing agent and the seller, and this tells the bank what the contracted commission is. If the lien holder approves the short sale, the lien holder generally pays what it feels is a fair commission to the listing agent and the buyer’s agent based on the listing agreement. Let’s say, for example, that the commission on the listing agreement is 6% with 3% to the listing agent and 3% to the buyer’s agent. The lien holder (in most cases) will pay this commission to the real estate agents, but it’s not uncommon for the lien holder to try to reduce the commissions to 5% (2.5% to the listing agent, 2.5% to the buyer’s agent) as part of their negotiations for approving the short sale. In truth, real estate agents work harder and longer for less money on short sale transactions, so most agents will put up a fight if the lien holder tries to reduce their commission. Every situation varies though, so I can’t generalize too much on this topic.

      In short – if you are a seller and you’ll be listing your home as a short sale, your expense in selling a home will be slight. The lien holder pays commissions and other closing costs, but it’s all a negotiation. It’s best to be prepared to have to cover some closing costs, but as a general rule, no – you will not be paying the real estate commissions. I always instruct my short-sellers to stay current on all their utilities and if you owe Homeowner Dues, you HAVE to stay current on those as well.

      Post a Reply

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