Robert Irwin has built homes from the ground up as well as completed dozens of major renovation and remodeling projects. He is best known as a real estate broker and the author of the best-selling Tips & Traps real estate series. He serves as a consultant to lenders, investors, and brokers. With over 50 books, including Buying a Home on the Internet and The Pocket Guide for Home Buyers, Irwin is recognized as one of the most knowledgeable writers in the real estate field today.

How to Use a Short Sale to Stop Home Foreclosure and Protect Your Finances

By ROBERT IRWIN

The McGraw-Hill Companies, Inc.

Copyright © 2009 The McGraw-Hill Companies, Inc.
All right reserved.
ISBN: 978-0-07-163558-5

Contents

Chapter One

How a Short Sale Works

Areal estate broker once told me, “Short sales aren’t hard to put through—they’re impossible!”

She was, of course, reflecting only her own poor experiences with them. Since then I’ve talked with brokers who specialize only in short sales and claim a success rate of from 30 to as high as 90 percent. And I’ve met individual sellers who have successfully handled their own short sales. All of which is to say that while the common perception is that short sales are very difficult, if you know what you’re doing, they can be quick and relatively easy.

What Is a Short Sale?

When you sell your home (whether directly or through an agent) for less than the balance you owe on your mortgage(s), it is called a short sale or sometimes a short payoff. Many lenders are willing to accept a short payoff (less than they are owed) when the owner cannot make the mortgage payments. The reason a lender will forgive all or a large portion of the unpaid amount of the loan is that a short sale saves it time and money by avoiding a more costly foreclosure procedure.

For example, you bought your property for $200,000, putting nothing down; hence you borrowed $200,000. But, the collapse of the real estate market means that the value of your home has plunged. Today it’s worth only $150,000. That means that you’re upside down (under water) to the tune of $50,000. That’s how much more you owe on your mortgage than the value of your home.

Now a triggering event occurs. For example, your mortgage resets to a much higher interest rate and monthly payment, which you cannot afford. Because you owe $200,000 and your house is worth only $150,000, you have negative equity. This precludes you from being able to refinance (no lender will offer you a mortgage when you owe so much more than your property’s value), and you can’t sell in the traditional manner (unless you come up with $50,000 out of your own pocket—something I’ve yet to see a seller willing and able to do!).

You stop making payments, and you face foreclosure. You can’t refi, and you can’t sell (in the usual way). What can you do?

One good alternative is to get the lender to accept less than you owe; in this case, instead of $200,000, only $150,000. If you can get your lender to accept $50,000 less (plus transaction costs), you can still sell your home—and without spending a dime of your money.

That’s the big trick, of course. Getting the lender to take less. When you’re successful, it’s called a short sale.

Who Needs a Short Sale?

In a difficult real estate market, short sales can be a positive force, especially when you’re facing foreclosure. They are extremely useful and can do the following.

What a Short Sale Can Do for a Seller

Here’s what a short sale can do for a seller:

• Allow you to sell when you’re “under water.” (In some areas as many as a quarter of all homeowners owe more than their homes are worth.)

• Avoid or stop foreclosure. (It’s a short sale—the foreclosure process ends the moment you no longer own the property.)

• Preserve your credit. (There’s almost nothing worse on a credit report than a foreclosure. The short sale prevents it.)

• Safeguard your finances. (This will stop you drawing down your reserves by making payments you can’t afford.)

Many millions of homeowners are facing foreclosure as this is written, and many more are likely to join their ranks. Figure 1.1 shows where most of these foreclosures are coming from. Do you find yourself there?

How a Short Sale Works

The following are several examples of how a short sale has worked to help sellers.

Note: While the examples in this book are taken from real life, because of their financial circumstances, the people mentioned have requested anonymity, and hence their names and some of their circumstances have been changed.

The Liar’s Loan

Peta was recently divorced and was now supporting four children all under the age of nine. She worked as a waitress in a coffee shop, and her income, with tips, was under $36,000 a year. She owned a very small two-bedroom, one-bath house that she had earlier bought with her husband. She desperately wanted to move into a bigger place, preferably a house of her own.

One day she was at work in the coffee shop when she met a businessman who struck up a conversation with her. Stan said he was a real estate investor. She spilled her story out to him, and he seemed sympathetic. Stan said he had a home that he wanted to get rid of that would be perfect for her. It was on a bluff with a beautiful view of the mountains, it was more than 3,000 square feet in size, and it was in great condition. He said they might be able to help each other out. It all depended on her credit. Did she have good credit?

Peta’s parents had emphasized the importance of always paying back debts. She had worked hard to maintain excellent credit, even paying off all the debts her husband incurred before the divorce. She had several credits cards, and since she usually paid cash, the amounts owed on them was very low. She had also borrowed to buy a used car and meticulously made her payments on time. And though it was difficult, the house payments were made promptly every month. She said her credit was excellent.

Stan smiled and said, “Good, good, that will work.” Then he drove her to the property and showed her the house where he was living. It was huge with all the modern amenities including three bathrooms and had a bedroom for each of her children. It was, indeed, perfect.

Then Stan told her that the price of the home was $700,000. He said that the house used to be worth a lot more, but the market had turned soft (it was in 2007) and that the fair market price was down a bit. Plus, there just weren’t any buyers out there for that price.

Peta was a stunned by the price. Certainly she’d love to move into such a beautiful big home in such a nice location. But, she couldn’t imagine that she could afford the place, not on her meager income.

Stan, the real estate investor, told her not to worry; he said he’d handle everything.

Stan said that all that he needed from her was a commitment to buy the place. She didn’t need to be concerned about the payments. He just needed someone to buy and get a new loan so he could get his own money out. He realized that the payments would be high, so he’d take care of them. He’d said he’d make her payments for the first two years. And he’d also handle the down payment (there wasn’t any because he was getting a 100 percent loan) as well as the closing costs. It wouldn’t cost her a dime to move in.

On the day the deal closed, he’d said he’d even give her $25,000 in cash to help her get started!

Stan came in for lunch about every other day from then on and kept talking about the deal. Peta was tempted, but she wasn’t sure. She couldn’t put her finger on it, but something didn’t seem right. When she mentioned it to her friends, most of them also were wary. One said, “Peta, it’s just too good to really be true!”

However, Peta couldn’t see how she could lose. So, after several weeks, she agreed to move forward on the deal with Stan. He seemed very happy about it and had her fill out a purchase agreement with the price of $700,000 with an interest-only loan for 100 percent of LTV (loan-to-value).

The purchase was actually made using a “no doc” loan. (This is also sometimes called a “liar’s loan.”) All Peta had to do was to fill out a fairly short application giving her personal information—her name, address, place of employment, and so on. Stan filled in the portion about her income and assets. Nothing was verified.

The lender’s broker didn’t seem too inquisitive. (After all, he was pulling a big commission on the deal). The lender did eventually verify her employment and did pull a credit report on her. Her credit was impeccable, as she had said, and her credit score was above 700. Perfect for the deal.

Stan reported progress to her almost daily and said that the deal was moving along beautifully. Then one bright morning in September, he drove her to a title insurance company where she filled out a mass of paperwork for the mortgage. The next day he came into the coffee shop with the key and gave it to her, telling her the house was hers.

She drove her kids and herself to the home after work that evening. Stan had moved out and had left the place a mess. There were half-empty boxes strewn everywhere, and the paint on the walls in lots of spots was nicked. There were spots on the carpet she hadn’t seen before. But she didn’t care. The house was hers. She moved in immediately.

I’m sure, dear reader, that you are thinking that this story can’t have a happy ending. If you’re thinking that, you’re only partly correct. Read on.

Peta lived in the home for almost five months before she got wind of anything being wrong. It was a registered letter to her notifying her that the mortgage payment hadn’t been made for the past three months.

Peta immediately tried to contact Stan. But that was proving difficult. She had wanted to talk to him about the $25,000 he had promised her when she moved in but never delivered.

The trouble was that once Stan moved out of the house, she couldn’t find him. He didn’t have a forwarding address. And he never came by the restaurant anymore.

The next month another registered letter arrived informing Peta that unless she paid four months of mortgage payments immediately, the lender would put the home into foreclosure. The payments were $4,089 a month, not including taxes and insurance. She owed $16,350 immediately. That was almost half of her entire annual income.

One of Peta’s coworkers was dating an attorney, and the woman arranged for Peta to meet with him on a pro bono basis. Peta explained the situation and said there was, of course, no way the woman could make the payments. He speculated that Stan had probably not been able to sell the house legitimately for that price. So instead, he had suckered her into a phony deal, perhaps in collusion with the lender’s broker, who got a fat fee. He had taken the money from the mortgage, made a couple of payments to throw the lender off track, and had hightailed it out of town. The attorney said he’d look into it, but he doubted that he’d find Stan.

In the meantime, the house was in Peta’s name; she owed the money on the mortgage, including the back payments. If she didn’t pay, the lender would foreclose and at the least she’d lose her good credit rating. At the worst, the bank might find reason to prosecute her for fraud. The attorney told her that the best thing to do was to quickly sell and pay off the mortgage. That should resolve the problem.

Peta contacted an agent that afternoon but quickly learned that prices were falling. Her $700,000 house was now worth only $600,000. After commission and closing costs were thrown in, her “net” would only be about $560,000. That was $140,000 less than she owed on her mortgage. (Remember, it was 100 percent of the purchase price loan.) She’d have to come up with $140,000 just to sell the house!

Peta said that she had only about $2,000 saved in the bank.

The agent said there was another way. A short sale. He would try to find a buyer for the house at the current market value. And then he would try to get the lender to accept a short payoff—take less than what was owed.

Peta began to cry with relief. The agent told her not to celebrate yet. They had to find a buyer. And then they had to convince the lender.

Peta went home feeling much better. There she found another registered letter from the lender informing here that it had filed a notice of default beginning the foreclosure action. She had roughly three months to make up all back payments or lose the home and essentially have her credit ruined. (A foreclosure typically will stay on a credit report for from 7 to 10 years.)

The next month Peta moved back into her old, small home. She had kept it and rented it out; now she told the tenants they had to move. They grumbled but complied.

Then things picked up. The agent found a buyer who agreed to purchase for $600,000—the market price. Peta signed the sales agreement. The agent, it turned out was very much on top of things. He immediately prepared a lender’s package which included a hardship letter. In it Peta explained that she was divorced and that her income was only about $3,000 a month. She included pay stubs and bank statements to prove that she didn’t have the income or assets to make the mortgage payments. The agent also included a comparison sheet showing how much the lender would lose if it allowed the property to be sold at a later foreclosure auction in a market where prices were falling as opposed to accepting an immediate short payoff. (The loss was significantly higher with waiting to go to foreclosure.)

Unfortunately, the lender dragged its feet. And time marched on ever closer to Peta’s deadline for a foreclosure auction that would take the property away from her and virtually destroy her credit.

Then one day the agent called and said the lender agreed. The buyer still wanted the house. She had to come down immediately and sign the papers.

Peta did, and the next day the house was history. She celebrated by taking her four children out for ice cream. Her relief was palpable, and she slept well for the first time in months.

Unfortunately, the story isn’t quite over. As part of the short sale agreement, the lender demanded that Peta pay back something, in this case $5,000 in the form of a promissory note payable at $50 per month plus interest until paid. And there was the chance that the Internal Revenue Service (IRS) could get involved. It could see the money forgiven by the lender, in this case $140,000, as income, in which case Peta would owe taxes on it! (An accountant told her not to worry because a new law had been passed which would probably eliminate this threat—see Chapter 10.)

Nevertheless, Peta considered herself lucky to get out of the deal only partially scathed. (The missed payments did put a nick on her credit, and she did owe $50 a month back to the lender.) But, it was a lesson well learned.

If you were thinking that Peta’s story was unusual or even unique, you’d be wrong. Almost every broker I talked with who handled short sales had some version of it to relay. Apparently this kind of hokeypokey was rampant as the real estate bubble was bursting and prices were collapsing.

The Subprime Lost Opportunity

Suvi and Chad were raising a family in Los Angeles and renting a small house. They had two children, and they desperately wanted to move to a better neighborhood, hopefully into their own home.

Real estate was booming at the time, and everyone said that all you had to do was buy a house, any house, and in a few years you’d be rich. It seemed like a good idea. After all, they were repeatedly told that real estate prices only went up.

So they contacted a real estate agent who told them that, yes, he could probably get them into a decent home in a good neighborhood. But they’d have to move swiftly since prices were moving upward at a very fast pace.

The agent, Castro, showed them at least a dozen different houses, many of which seemed adequate. Suvi felt that one, however, was really perfect. It had three bedrooms and two baths, and it had a living room, dining room, and family room. Best of all it was in a good neighborhood with good schools. They told Castro that they wanted the property.

He said that he’d write up an offer, but first he called a mortgage broker friend of his, Angel, who came right over; she took their information. Suvi worked in a clothing shop as a seam-stress, and Chad was a gardener. Between them their income was about $2,500 a month. Despite this limited income, they were both very industrious, and over the years they had saved almost $13,000.

After they filled out an application, the mortgage broker, Angel, ran a credit check and found that they had missed a few payments here and there. And a few years earlier their car had been repossessed when Chad was out of work. Their credit score was in the 500s.

Angel said that it was too low for them to qualify for an “A” mortgage (a loan conforming to major underwriting standards that offered the best rates and terms) but that they could get a “subprime” mortgage. This meant that the interest rate would be higher and that there were more costs (“points”) to pay, but it would allow them to acquire the property.

The house was priced at $250,000. They could get a 100 percent subprime loan on it, but the interest rate would be 8 percent. The mortgage and interest came to $1,667 a month plus taxes and insurance.

Suvi looked at Chad, and he seemed as shocked as she was. “No way!” he said. Their total income was only $2,500 a month. That would amount to two-thirds of it. They had food to buy and clothing and insurance and medical and everything else that a family needs to live on.

“Not to worry,” Angel said. “We can put you into an ARM [adjustable rate mortgage]. The interest rate for the first three years will be fixed at 3.5 percent, and your payments will only be $730 a month. You can afford that, can’t you?”

Suvi and Chad nodded. It would be tight, but that was affordable. “But,” Suvi asked, “What happens after three years?”

The mortgage broker, Angel, smiled and said, “The mortgage resets. It goes back to 8 percent.”

“Do our payments then rise to the $1,667 a month?” Suvi continued.

“Yes,” Angel responded, “But don’t be too concerned. When that happens, you should be able to refinance and get another mortgage with low payments all over again. You can keep doing it over and over and keep your payments low.”

Suvi and Chad nodded. It was amazing what miracles could be performed in the modern world of finance.

They went back to Castro, the agent, who prepared an offer. The deal was made, and a month later they signed the loan documents to get the house. When they signed, Angel pointed out that there was negative amortization on the loan. This meant that interest not paid during the initial three-year “teaser” period would be added to the loan amount. At the end of the three years they’d owe roughly $280,000 instead of the original amount of $250,000. But that shouldn’t be a worry, she continued, what with the way prices of property were moving up.

Angel further informed them that there were “points” to the loan. One point was equal to 1 percent of the loan amount. Four points on the loan came to $10,000. Plus there was $3,500 in closing costs. All were payable in cash.

Suvi looked at Chad who shook his head. He didn’t understand, and she wasn’t sure she did either. But, they had nearly all the needed cash in the bank. The papers were in front of them, and all they had to do was sign and they had their new home. So they signed.

(Continues…)

Excerpted from How to Use a Short Sale to Stop Home Foreclosure and Protect Your Financesby ROBERT IRWIN Copyright © 2009 by The McGraw-Hill Companies, Inc.. Excerpted by permission of The McGraw-Hill Companies, Inc.. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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