Borrowers that run short and can no longer make their mortgage payments have options to explore, including a short sale, which is when an investment property is sold for less than the borrower owes. A short sale is a way to avoid foreclosure and a negative ding on a borrower’s credit history. It works much like a traditional investment property sale, except that the lender must approve the purchase offer.
☛The short sale, the short of it
If the borrower and the end-buyer are able to negotiate a short sale, the lender agrees to take the money from the sale proceeds—even though some may be lower than the balance of the loan—in lieu of foreclosing on the home. In most cases the borrower is excused from their financial obligations, the lender gets some of the funds back and the end-buyer gets a great deal. Everyone wins!
Short sales were common practice a decade ago when the housing crisis left many homeowners and investors upside down on their mortgages. Since then, the percentage of short sales has dropped significantly, as housing values and employment have risen dramatically. Now with the pandemic tapering down and the Mortgage moratorium recently coming to an end, pre-foreclosures are a serious reality and a great opportunity again.
☛Why would a lender agree to a short sale?
According to a 2008 survey by the Joint Economic Committee of Congress, lenders pay an average of about $50,000 when a foreclosure takes place. This figure can vary substantially from one case to the next and largely depends on the value of the property in relation to the mortgage. Additionally, the process of completing a foreclosure also can take time. In many cases, lenders take several months to a few years to foreclose on a property. During this period the borrower is no longer making loan payments on the mortgage. This means that the lender is missing out on the principal and interest that typically come with a standard mortgage payment. This amounts to thousands of dollars of lost revenue for the lender. During a foreclosure, a lender repossesses and sells a property to satisfy an outstanding debt. In a short sale, the lender agrees to allow the delinquent borrower to sell the property for less than the mortgage balance and costs of the sale. Keep in mind that lenders are in the business of lending capital not buying, selling, or operating real estate. So, with the expense of foreclosing and real estate not being in a lender’s job description, they are more likely to take a short sale in lieu of going the foreclosure route.
☛How Does a Short Sale Work?
A short sale is a viable option if the remaining balance on a property loan is greater than the amount the property can fetch on the open market. Otherwise, a borrower could just repay the full amount of the mortgage by selling the asset. Make no mistake, in the next 12-18 months, lenders will become overwhelmed with foreclosures and will become much more flexible to short sales nationwide because they refuse to hold a lot of bad debt on the books. As an investor, you can help a distressed borrower by guiding the process so you can submit an offer to the lender directly.
Short Sales and Foreclosure real estate investing deals require investors to work with homeowners, direct Banks, REO agents or special foreclosure listing brokers. Most real estate investors dealing with short sales find themselves at the end of a very long paperwork and negotiation process with institutional lenders. So, it is best to deal directly with the borrower and when possible, avoid dealing with the REO Realtors. If you can, select unlisted, off-market direct seller properties if possible. Too many in-between people make it a long process and it will cost you more. Keep in mind, that once it is a foreclosure the banks will have an assigned REO agent. In that case, make sure you get an agent to represent you to ensure you have someone representing you. For this scenario, as a “Pre-foreclosure” you will be dealing directly with the borrower and negotiating directly with the bank. These are a few steps to gaining access to the bank directly without a realtor.
☛How to help the borrower directly with the short sale process:
- Help the delinquent borrower put together a package of the following:
- Financial Hardship Letter
- Short Sale Payoff Offer & Proposal Letter
- Proof of Funds or a strong loan preapproval letter
- FINANCIAL HARDSHIP LETTER: Borrowers normally forward their lender a financial hardship letter direct. Life events like job loss, divorce, sickness, etc., all can be considered reasons for a long-term financial challenge. If the borrower hasn’t submitted a letter yet, you can help put it together. Have the borrower sign and notarize the letter. Here is a sample you can use to get you started.
☛SAMPLE: Short Sale Hardship Letter
555 Anonymous Rd
Salt Lake City, UT 84101
Loan Number: 1234567890
Main Street Bank
1234 Main Street
Main Street, TX 00000
RE: Financial hardship facilitating a short sale of property
Dear Sir or Madam:
This letter is a formal request to short sell my house due to financial hardship.
Company downsizing at my place of employment effectively eliminated my position, resulting in my inability to make mortgage payments for the past 8 months. While I recently obtained another position elsewhere, my salary is substantially less than what I was previously earning, as the enclosed attachments will indicate. Should the short-sale of my house be approved, I can subsequently avoid foreclosure proceedings.
As much as I would like to maintain my financial obligations with you, present circumstances do not allow me to. I believe the only viable solution which would best suit our mutual interests would be a short sale. As you may already know, there are plenty of pre-foreclosures and foreclosures in our zip code. So, selling the property may take time and money. In the meantime, I have a favorable offer for our property on ________________________________. I have attached a legitimate offer letter by __ENTER YOUR NAME HERE____ of ENTER YOUR ENTITY NAME for your consideration. I believe this is a good avenue to take rather than face any lengthy foreclosure proceedings.
I appreciate your time in considering my request. If you have any questions or need further documentation, I can be reached at (123) 555-5555 or firstname.lastname@example.org
Jane Smith, Borrower
Loan Number: 1234567890
Main Street Bank
Jim Brown, End-Buyer
Enter Entity Name Here
Dale Jones, Notary
List of Enclosures
- Short Sale Payoff Offer & Proposal Letter – The lender decides whether to approve the sale or to work out a plan, like extending the loan term or allowing the borrower to make interest-only payments for a set amount of time. If the lender is open to an offer, it is best to give them the best possible offer so they can weigh the pro and cons of the pre-foreclosure in question. Here is a great example of the type of “Cover Letter and Offer Letter to Bank” that a real estate investor should use to get the deal going.
☛SAMPLE: Short Sale Payoff Offer & Proposal Letter
To: [ENTER REP HERE]
Lender: [ENTER LENDER HERE]
Borrower: [BORROWER NAME HERE]
Property Address: [PROPERTY ADDRESS HERE]
Reference Loan Number: [LOAN REF NUM HERE]
*** NET AMOUNT OF SHORT SALE OFFER TO [LENDER HERE] $[LOAN AMOUNT HERE] ***
Dear [REP HERE]:
We are submitting for your review and subsequent approval, this comprehensive SHORT SALE SUMMARY PACKAGE pursuant to our recent telephone conversation regarding the possibility of a discounted payoff on the aforementioned defaulted mortgage loan.
We are working very closely with your Borrower ______BORROWER NAME________________ to facilitate a sale of the above referenced property @ _____________________________. We have in fact entered into a purchase and sale contract (attached). I am _____BUYER NAME________ of _____ENTER ENTITY NAME___________known as the direct buyer seeking to buy the property without the need for a mortgage contingency and subject only to your approval of this short sale proposal. Inspections have been completed. This sale requires and is contingent upon your approval of the short sale offer
Subsequent to our short sale package being approved by a foreclosing lender, we can close very quickly. We guarantee a cash closing of the transaction within 5-15 days of acceptance of our offer.
We have been given complete authorization by the Borrower to discuss the mortgage loan that is presently in default that you are seeking to foreclose. We have again included a signed Letter of Authorization executed by the Borrower, which has been attached for your review.
Our offer is [OFFER AMOUNT] which will net your bank [NET AMOUNT] after all closing costs and expenses which you can see on the Estimated HUD Statement attached hereto.
We understand that in order for our offer to be accepted that there may be additional due diligence that may need to be completed. Should a Broker’s Price Opinion (BPO) be necessary, or if one has never been completed, we urge you to have one completed and as we have control of the property we would like to meet with your representative to ensure a proper assessment of the scope of repairs of the subject property and a true and accurate appraisal of the estimated “AS-IS” value of the subject property.
In order to obtain the most accurate valuation, it is our belief that it is imperative that the interior of the house is viewed and that the BPO not be limited to a cursory drive-by viewing or desktop appraisal or automated valuation. We can provide interior access to the house to your representative and will meet with your representative with 48 hours’ notice.
As this situation continues to escalate, we believe TIME IS OF THE ESSENCE in resolving this matter. We are prepared to close this transaction within 5-15 business days from receiving written notification of your acceptance of this offer or our acceptance of any counteroffer that you may make in response to our offer.
If you have any questions, please do not hesitate to contact us as necessary as we stand ready to facilitate and expedite a short sale payoff on the aforementioned loan.
City, State Zip Code
Dale Jones, Notary
☛Things to think about
Note: Both the Financial Hardship Letter and the Short Sale Payoff Offer & Proposal Letter are offered for the convenience of investors. Please note that this form should not be used as a substitute for a lawyer and that the form should be used only with the understanding that they are in no way, whether expressed or implied, to serve as a contract or as legal advice.
- If a short sale plan is accepted by the lender, the borrower works with the lender to determine the schedule for the sale. If the lender is already on the path to foreclosure, a short sale will need to be expedited. So, the closing date needs to be tighter.
- Keep in mind, that the borrower may have other liens on the property (Mechanics, plumbers, contractors’ home equity or second mortgage, etc. Having several of these can sometimes get in the way of a short sale since all lenders must approve the sale. Once given permission by the borrower, as a buyer, you can contact the lien entities on record and inform them of your purchase intentions. Understanding that in foreclosure all these additional liens and 2nd mortgages don’t get paid after foreclosure so negotiating a discounted amount is ideal. For example, if you have a contractor’s lien for $20,000…I would offer $3-5K at closing if they remove the lien on the title. In this case, the lien holder would rather get something than nothing.
☛What should I offer on a short sale and what’s expected of you?
- Offer a Strong Earnest Money Deposit.
- Gauge the Market Check the Area Comparable Sales and attempt a 65%-85% as-is value.
- Allow the Bank Time to Answer or Provide a Counteroffer.
- Don’t Ask for Special Contingencies, Reports or Repairs.
- Shorten Your Inspection Process and Period.
- Offer to pay the Seller’s Fees and Help with Move Out Fees or Cash, if Possible, to sweeten the deal.
- Provide a Strong Preapproval Letter and Proof of Funds.
- Know that Short Sales Are More Attractive When You Have a Cash Buyer.
- Communicate and Set Expectations.
- Once You Make the Offer, Be Patient.
- Remember That You’re Negotiating with the Lender.
- Be Resolute.
☛Are There Drawbacks to Taking the Short Sale Route?
Lenders may want to look at a short sale as a last resort. Short sales still have a significant negative effect on an individual’s credit, affecting the ability to take out a home loan or other forms of credit in the short term. A short sale may show up on your credit reports as “not paid as agreed.” As both short sales and foreclosures fall under that category, most lenders won’t distinguish between them, according to Equifax, and both stay on your credit reports for seven years. A short sale can be risky for buyers as well. Short sales are usually closed “as is.” If a property inspection did not catch a needed repair, that can lead to unwanted surprises and extra hidden costs.
☛How Long Does a Short Sale Take to Process?
Short sales can be labour-intensive transactions, taking anywhere from 2 weeks to a few months. Each lender is different, and the process varies from lender to lender. In most cases, it can take a while for lenders to review a buyer’s short sale offer for approval, especially if multiple lienholders are involved or the type of property that is being negotiated. If you plan and provide all the details necessary as one complete package, you can help fast start your submission.
If a mortgage becomes too heavy a burden, a short sale can be a lifeline for a borrower. Still, leaving a lender short will hurt a borrower’s credit and can be a long-drawn-out process. Savvy buyers may find a motivated seller and decide to do a short sale and get a great deal in the process. Especially if it is off-market and unlisted. Remember that banks are businesses and, just like any business, they are seeking to earn a profit. If it costs more to foreclose over agreeing to a short sale, the bank is very likely to favour the short sale. With a foreclosure, a bank takes possession of the house and then resells it at a mortgage auction to the highest bidder. So, in most cases, a short sale is always the best economic option for the lender. With the right offer and an option to close quickly, you may get opportunities even in hot markets if you’d your homework. Happy hunting.