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Anatomy of the Short Sale

New investors, it seems, are intrigued by words and phrases to which they have recently been introduced. Often I will speak with a prospect on the telephone and just by listening to what they are saying tell you about where they are in the investment process. Newbies (that’s not an offensive term, by the way) and well studied but lightly experienced investors generally have one thing in common: a great use of words they don’t (fully) understand.

Today’s term is Short Sale.

This is a big one and it’s used quite often around investor’s clubs and seminars across the nation. But what, really, is a short sale? How do they work? Why should I or should I not pursue short sales?

I’m so glad you asked!

Let’s first look at the short sale from my standpoint as a lender. For this scenario let’s say Bob bought a house 2 years ago and his mortgage broker used my lending arm to get the loan he needed. Bob didn’t have any down payment but qualified easily, at that time, for a 100% loan.

Recently Bob lost most of his income because his employer, a different mortgage broker, went out of business because they based everything they did solely on refi’s. Now Bob works at a local bank where he makes about 1/3rd of his previous salary. Bob can no longer afford the $2800 payments on his home. He is constantly 2 months to 3 months behind with payments and I’m getting ready to foreclose.

So you, Mr. or Ms. Investor, find out about Bob’s situation and Bob knows he is about to go into foreclosure and I don’t have much equity in his home so I’m really not too happy about the whole situation. Now I’m going to have to pay court costs, attorney fees, filing fees, and Bob is filing bankruptcy which will tie my property up for an indefinite period of time. You and Bob talk and he thinks the best thing for you to do is call my company, speak with my Loss Control Department and see if you can negotiate a short sale.

“A what?” You ask.

“A short sale,” says Bob. “It’s where you offer the lender less than I owe on the home because there is no equity available but they are going to have to spend money to foreclose on my loan but I’m filing bankruptcy and if I file while I’m still on title to the house they’re not getting anything for some time and can’t throw me out without a judge’s order.”

“Really!” You exclaim. “So how much should I offer them?”

Bob gets his calculator, some paper and a pencil, his mortgage coupon booklet and does a few quick calculations. “Well,” he posts. “I bought the house two years ago for $398,900 and that’s how much my loan was. It was worth about the same but now it’s worth about $395,000 and I’ve paid my loan down to $397,200 – that’s my pay-off as of today. If I were you I would start by offering them 15% less than I owe.”

“Fifteen percent?!” You query in a statement. “Do you think they will even consider my offer?”

“No, but it will telegraph your intent … that you are interested in the property,” says Bob.

Now, Bob can’t just say he can no longer afford the property. He’s going to have to file a “Hardship Statement” to my Loss Control Department. It’s going to have to tell the story about how he lost his job and his wife is about to go into labor with their 4th child and they don’t have any medical insurance and their savings, 401(k) and stocks are completely depleted. He’s going to have to prove to Loss that he no longer in any way qualifies for the loan he got just 2 years earlier. In essence he’s applying for a loan in the reverse order – he’s un-applying. And he cannot qualify for any other product I offer.

Now that my Loss Department has your offer and Bob’s un-application they are going to start crunching numbers and doing some serious evaluation. They are going to hire an appraiser and an economic evaluator. They’ll assemble all the numbers and make a prediction on the value of the property over the next few months. From that number they’ll subtract all the costs associated with foreclosure, repossession, repairs, and marketing costs to sell the property again. Believe it or not 15% may not be too unreasonable.

Now as a lender I’ve struck a deal with a real estate broker to market my REO’s (real estate owned properties) at a discount rate. Say 2%. But I can’t negotiate down attorney fees, court costs, sheriff