If you are a homeowner in foreclosure or considering a short sale and you are thinking about selling your house then it is important for you to understand the short sale process and how you can successfully complete a short sale. Below is an explanation of why banks allow short sales and how the process works.
When a bank loans money by giving a mortgage to a homeowner, the bank expects to be paid back in full when the homeowner sells or refinances the property. A typical bank mortgage is a loan at a loan to value (LTV) ratio of 80%. The standard conventional loan requires a 20% down payment and an 80% mortgage.
As long as the property does not decline in value, the bank has the house as collateral and can be assured of getting their money back by selling the house via the foreclosure process in the event that the homeowner does not pay.
However, sometimes prices decline so rapidly that the equity in the home is diminished to the point that there is no equity left in the property for the homeowner. In extreme cases, such as over the past few years, homeowner’s may be “upside down” meaning that they owe the bank more money than what their house is worth. This is not a great situation to be in, especially if the house is worth a lot less than what the homeowner owes the bank.
Upside down situations usually result from either a sharp decline in prices, high LTV loans or mortgages that do not have fixed rates like negative amortization mortgages and adjustable mortgages. The foreclosure crisis that we have all experienced over the last few years is a direct result of poor lending standards and sharply deteriorating property values.
When a homeowner is “upside down” and cannot afford to stay in their home then the best option is for them to try and sell their house. However, if prices have dropped dramatically and they cannot sell the house for anything close to the loan value then when they do receive an offer from a buyer, the purchase price will be substantially lower than the amount that is owed to the bank. In this situation they will have to receive prior approval from the bank to accept an amount less than the full amount owed on the mortgage. This is called a “short sale”.
In this situation, the bank will have to decide if they want to accept the “short sale” offer which is an amount less than the full value of the mortgage balance. The bank has to carefully weight many factors including the condition of the house, the time it will take to foreclose on the property and the legal costs and holding costs of lost mortgage payments. Typically banks will easily accept a 5% to 10% discount off the face value of a mortgage when faced with a homeowner in foreclosure. However, many banks are not willing to negotiate with a homeowner that is current on their payments. They are only willing to negotiate with homeowners that are behind on payments or are facing foreclosure. From the banks perspective as long as the homeowner is still paying they can afford to pay and there is no reason for the bank to negotiate. This creates a dilemma for the homeowner who has a good credit record and would like to maintain their good credit.
In order to proceed with a short sale, the bank has to feel that the homeowner is willing to walk away from the property and is going to allow the bank to foreclose on the property and take the property back. Usually a homeowner needs to be at least 90 days late in order for the mortgage bank to file a foreclosure notice called a “Lis Pendens” (which means law suit pending in Latin). Once the property is “in foreclosure” the bank will be more willing to entertain offers that are less than the full value of the mortgage balance owed to them since the bank now has an incentive to negotiate.