Last month we started a series on why some homeowners turned to short sales due the foreclosure crises that took place during the recent recession. What we had originally planned to run as a once-a-month post is now going to be a series that we finish in July. While short sales are still happening in the market place, the number is decreasing, meaning you need this information now rather than later.
In this series, we're breaking down the facts on why short selling your home in Central Florida might be necessary. We're giving the basics of what, why, how and when a short sale should be done so you can better understand the process. In part one of the series we answered the number one question, what is a short sale? In part two you learn why you might need to consider a short sale.
Why do you need to do a short sale?
One of the main reasons to consider a short sale is because it is largely an exercise in damage control.
The circumstances leading to missing mortgage payments usually involve great financial distress. In some cases, there is no great distress and the borrower has the ability to continue paying, but instead makes a business decision to stop paying because the value of the property is far less than the debt owed with no hope of the value recovering for many years, commonly referred to as a strategic default. In either situation, a short sale represents an exit strategy to get out of a bad financial situation and move on.
One of the most significant ways a short sale contains the damage from a distressed property is through a far lighter credit impact to the borrower compared to a foreclosure. When a borrower closes a short sale, the credit harm will be much less than a foreclosure completed through the legal process in terms of credit score points lost, the duration of time the transaction remains on the credit report and how it is reported. A short sale is typically reported to the credit bureaus as “debt settled for less than full” or words along those lines. In my practice, I have seen many damage control success stories resulting from a short sale.
Despite beliefs to the contrary, it’s important to note that no bank wants to take title to a home. They are not in the business of owning properties. They are in the business of making money. The lending industry was hopelessly unprepared for the financial collapse they helped engineer and the resulting tsunami of foreclosures that followed. Banks want money and will always prefer to take short sale proceeds instead of becoming home owners. If a lender forecloses and takes title, it will then try to sell the property as “REO” (real estate-owned). At that point, all the bank will receive is the market value minus many additional litigation and carrying costs along with delay that accompanies taking title through foreclosure. When the dust settles, the bank is very likely to net less money in the REO sale than they would have gotten through a short sale. They may be dense, but they understand this. The challenge is making the numbers work to get the short sale deal approved.
Another crucial damage-control justification for the short sale is the opportunity to negotiate a deficiency waiver. The “deficiency” is basically the difference between the market value of the property and the final debt owed to the lender. In a short sale or foreclosure case, unless the lender signs an agreement to waive its deficiency rights, it will have the ability to sue the borrower to collect this amount. I have seen many deficiencies in the hundreds of thousands of dollars as a result of the historic market collapse. In the majority of short sales our firm has handled, we have successfully obtained deficiency waivers for our clients.
Another reason to consider a short sale is it provides the home owner the opportunity to continue living in the property while not paying the mortgage.
For those who have suffered great financial distress throughout these terrible economic times, this means the chance to save up some reserves, pay down other debt or do other productive things while taking advantage of the breathing room that comes from living in a property without paying for it.
Simply attempting to short sell will not delay the foreclosure process indefinitely. Short sales usually do take a long time to close and most homeowners we have represented have continued living in their homes until the closing. It’s sad to note, however, that many borrowers have simply walked away from their properties very early in the process upon missing payments because they failed to understand their rights and options. Additionally, many real estate investors with rental properties have been able to collect rent while pursuing a short sale.
One more reason why a short sale may be the best strategy is the typical alternative to keep the property—a loan modification—usually is a bad deal that doesn’t work out for the borrower.
The much hyped government-initiated HAMP modification program has been a dismal failure that has helped only a tiny fraction of distressed borrowers trying to save their homes. Though there has been a lot of talk, which is cheap, the government has yet to force the lenders to do anything meaningful they don’t feel like doing to help borrowers.
Most importantly, the most difficult thing to get out of a loan modification is a principal balance reduction. Lenders commonly use many slight of hand tricks to lower the monthly payments. An example of this is the deferred principal play, in which a chunk of the upside-down mortgage is taken out of the monthly principal and interest calculation (the amortization) and “put on the back” of the mortgage. This technique may allow the borrower to pay a lower monthly amount, but that piece of the debt must be paid upon sale or refinance of the property and the borrower is often unlikely to remain in the property beyond the point at which the market value surpasses the debt.
I recommend going to a website called youwalkaway.com and using their Walk Away Calculator to determine the estimated time it will take your property to recover its value and have equity. The numbers can be shocking and quite often greater than 20 or 30 years. The bottom line is the loan modification usually represents the only available “stay strategy,” but it is usually a disastrous financial undertaking. All things considered, the short sale, which is an “exit strategy” is more likely to be the best move to recover and rebuild.
Stay tuned for more in this series with answers to how and when to do a short sale. If you are interested in part one, What is a Short Sale?, be sure to check it out, too.
About the author, Charles P. Castellon, Attorney and Counselor at Law: Charles is active in community, civic, and professional associations and has lectured and served as a panelist on real estate and other legal issues for organizations and associations throughout Florida including the Osceola County Association of Realtors, Orlando Regional Realtors Association, Central Florida Realty Investors, Polk County Real Estate Investors Association, National Association of Hispanic Real Estate Professionals, Osceola County Landlords Association, Score Real Estate School, and various other organizations throughout the state. To contact Charles e-mail him at email@example.com or find out more information at www.cpclaw.net.