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Published in the August 2007 California Real Estate Magazine

Short Sales Basics
What you need to know to serve this market
By Elyse Umlauf-Garneau

Homeowners faced with stalled appreciation, little or no equity, and subprime adjustable-rate mortgages (ARMs) that are resetting to higher rates are combining into something of a perfect storm. * Many subprime borrowers are barely treading water and others have precipitated a wave of foreclosures that is unlikely to ebb anytime soon. * The statistics are daunting. In April, DataQuick reported that the number of default notices (NoDs) sent to California homeowners last quarter increased to its highest level in almost 10 years. Between January and March, NoDs were up by 23.1 percent over the previous quarter.

Lenders, facing a surge in delinquencies, increasingly are willing to accept short sales—sales in which the loan balance exceeds the market value of the house—to avoid costly foreclosures.

George Brown, owner of Thompson + Brown Real Estate, Antelope, Calif., anticipated in 2005 that some homeowners would be in distress when subprime mortgage rates adjusted upward. His company developed radio ads and a separate Web site (www.noforeclosurehere.com) on the topic and started training salespeople to build a niche in short sales. Such transactions now account for more than half of the company’s business. “Whenever we have a downturn like this, you have to look at other options beyond traditional business to survive,” he says.

And it can provide for more than mere survival. “Right now, there’s almost an unending supply of short sales,” says Lance D. Churchill, legal counsel and lead instructor of Frontline Seminars, San Diego. The company (www.frontlineseminars.com) puts on intensive two-day seminars on short sales. “REALTORS® can do these [transactions] and make a great living,” says Churchill.

But doing short sales requires stamina. Though they’re not hugely different from a normal sale, there’s a higher volume of paperwork and lenders impose aggressive schedules. The process for short sales differs depending on the lender, but here are some guidelines.

Qualify prospects

Examine loan terms to determine if there are second or third mortgages and prepayment penalties. Also assess clients’ financial status and whether they meet the criteria for relief, recommends Lawrence D. Elliott, a REALTOR® with Prudential California Realty, the Mulhearn Group, Hacienda Heights.

Lenders will accept job losses, illness, death, and divorce as hardships, but typically won’t offer relief for someone who gambled away assets. If financial problems are temporary, lenders may consider reworking loans to allow a homeowner to catch up and keep the house.

List and market the home and ask clients for written permission to communicate with lenders on their behalf.

Once NoDs are filed, there’s little time (approximately 122 days from NoD to Trustee’s sale) to sell properties before lenders take them back, so the earlier in the process you get started, the better your chances of selling a property at market value. That’s why practitioners recommend promoting your short sales services to clients. “Homeowners usually wait too long to get help and assume that if they miss a payment, their house is gone. I wish they’d contact me before NoDs are filed,” comments Elliott.

Most lenders won’t consider a short sale until homeowners are behind on payments, though some are starting to in order to avoid having an REO. “The rules and processes are changing fast because lenders are trying to adapt to the problem,” observes Churchill. “But you have to demonstrate homeowners’ inability to meet their payments.”

Develop a lender package

Experts recommend contacting lenders and asking for a workout package, which outlines a given lender’s modus operandi. The aim is to make a plea on behalf of clients by illustrating their hardships. Paperwork is similar to qualifying clients for a mortgage, though you’re showing how financially distraught or insolvent clients are, using documentation like W-2s, tax returns, banks statements, expenses, and so forth. If there are second and third mortgage holders, send the same package to them.

Develop a broker price opinion (BPO), an assessment of the property’s condition and worth, and outline current market conditions, including the number of sales versus listings and the number of distressed properties on the market, suggests Brown. You want to show lenders they’re financially better off today with a short sale than they are with an REO later.

Include a hardship letter outlining the homeowner’s crisis. Elliott asks for hand-written letters from homeowners. “My goal is for them to write a letter that leaves a tear on the page,” he comments. After all, he argues human beings read the letter and the prose should be moving.

Most lenders want a solid buyer and offer in hand, though some are agreeing to short sales even before there’s a buyer.

Many lenders are ill-equipped for the onslaught of problems associated with subprime borrowers and are short on staff, time, and patience. “You can call lenders everyday for two weeks and not get a call back,” warns Brown. He sends his materials in brightly colored envelopes imprinted with his Web address. The strategy: Staffers will start recognizing that his packages are complete and can be processed quickly.

Negotiate

Negotiation skills are critical, especially since all aspects of the deal are subject to lender approval. You’ll also have to negotiate with second lien holders and get them to accept the terms. “When you present offers to lenders, be prepared for a ‘no’ out of the gate,” warns Steve Bognacki, broker-owner of Exit Realty West, Corona. You have to arrive at a price and timetable agreeable to all parties and you frequently have to haggle over your commission. “We’re willing to negotiate our commission, but we’re not in a position to accept nothing,” observes Brown. “Most lenders are fair and pay accordingly.”

Long-term prospects

Most experts see no quick end to short sales. Many are anticipating several more years of steady business, given that another package of subprime loans will reset in 2008.

Doing short sales goes beyond just benefiting your bottom line, believes Brown. For homeowners, a short sale keeps a foreclosure off their credit record and lenders get more money than they would in a foreclosure. “We’re also protecting home values and eliminating having foreclosed, rundown houses in neighborhoods. It’s a win across the board,” he adds.

Despite efforts of politicians and non-profits to earmark funds for and halt foreclosures, most believe that such efforts will be insufficient and that the subprime crisis will continue building steam. So learning to do short sales will benefit you now and throughout your career. After all, there are always homeowners facing financial hardship. “With this skill, you can always find work,” comments Frontline Seminars’ Churchill. “It’s a way to bob and weave with the economy as it changes.”

Know the Law

There are a couple of California-specific legal wrinkles to consider.

*Understand the difference between recourse and non-recourse loans in California. Purchase loans for owner-occupied properties are considered non-recourse, so if there’s a deficiency in a foreclosure, the borrower can’t be held liable for that deficiency. “The potential problem is that most loss mitigators are being trained to ask borrowers to sign a note for any unsecured balance in order to approve the short sale,” explains Lance D. Churchill, legal counsel and lead instructor of Frontline Seminars, a company that provides educational seminars on short sales. Say no to such requests and explain to loss mitigators that it’s a non-recourse loan.

*Be aware of California Civil Code Sections 1695 & 1695.17. One aspect of the code has an enormous effect on real estate practitioners. When buyers of a property in foreclosure are investors (persons not intending to be owner occupants) of a one-to-four unit property—one of which is owner-occupied—the real estate agent representing an investor must have a real estate license and be bonded for twice the value of the property. The Catch-22: Bonds aren’t available, so investor buyers can’t be represented by a real estate agent. For more information, see Civil Code 1695 (www.car.org/index).

If an investor wants to purchase a one-to-four unit owner-occupied property on which a NoD has been filed, the investor has to use a contract that incorporates certain legal requirements such as a five-day rescission right for the seller. C.A.R. forms NODPA, HEAA, and HENC comply with the requirements of the law and should be used by investors who wish to make an offer to purchase property from a seller with a recorded NoD on their property.

Finding Business

1. Check the notice of default sites, some of which charge fees for access, and none of which C.A.R. endorses or recommends. County Records Research (www.countyrecordsresearch.com); foreclosures.com; redloc.com; retran.net
    
2. Search for-sale by owner sites and magazines. Lance Churchill, legal counsel and lead instructor of Frontline Seminars, San Diego, says people sell on their own because they can’t keep up with payments and believe they’re not able to pay an agent’s commission.
    
3. Check with title companies to find out what ARMs are about to reset in a given neighborhood.
    
4. Advertise your short sale expertise to clients and colleagues. One of Churchill’s students receives daily referrals from colleagues who don’t know how to work short sales.
    
5. Work your neighborhood. Lawrence D. Elliott, a REALTOR® with Prudential California Realty, the Mulhearn Group, Hacienda Heights, walks his farm area, chatting people up, leaving his card, and asking for referrals to those who might need to sell.
    
6. Promote short sales to buyers. Steve Bognacki, broker-owner of Exit Realty West, Corona, has a pool of interested buyers he can tap when a short sale comes up.

Pitfalls

• “It’s not done until it’s done,” says Lawrence D. Elliott, a REALTOR® with Prudential California Realty, the Mulhearn Group, Hacienda Heights. Sometimes lenders won’t halt a foreclosure, even if there’s a buyer. When deals dissolve, so does your commission.
   
• Be sure clients seek advice from lawyers and certified public accountants. Homeowners could incur a tax liability on forgiven debt.
   
• Be certain buyers are fully qualified and pre-approved. Once lenders say “go,” closings tend to happen quickly—within two weeks.
   
• Be accurate on HUD-1 figures showing what lenders will net. If numbers are off, lenders could cancel the deal.
   
• Warn sellers that if they committed mortgage fraud to get loans, lenders could prosecute them.
   
• Visit http://legal.car.org and refer to the Legal Supplement, “Legal Guide to Foreclosure-related Transactions,” which was mailed with the June issue of California Real Estate magazine.

Consumer Real Estate News

Can You Afford That Loan?

You’ve read or heard about the crisis that many homeowners are facing because they can’t pay their mortgages. Some of these homeowners were lured into loans with extremely low rates (teaser rates) that adjusted up. When the rates reset, monthly payments rose beyond what many homeowners could afford, and some borrowers are losing their homes to foreclosure. Consequently, maybe you think this is a good time to get a deeply discounted property.

When loan shopping, remember there’s a big difference between qualifying for a mortgage and affording it. Frequently, lenders will qualify you for mortgages that are too big of a stretch for your budget, so it’s up to you to crunch the numbers and decide what you can really afford.

Seek advice: Don’t rely on a single loan officer for advice, recommends Paul Leonard, the California director for the Center for Responsible Lending, Oakland. “Consumers have to be vigorous in their own financial self-interest, not relying on recommendations of lenders who are not their financial advisors,” he says. Shop multiple lenders and fully understand the loan products you’re considering. Seek advice from a real estate lawyer or a U.S. Department of Housing and Urban Development-certified counselor. For a list of HUD-certified, California-based counselors, see www.hud.gov/local/index.cfm?state=ca. “Even if a lawyer costs a couple of hundred dollars, it’s money well spent before you lock into a financial transaction and put thousands of dollars at risk,” argues Leonard.

Be a wise consumer: Don’t base mortgage decisions on low teaser rates. When rates rise, will you be able to service the loan? Factor in principal and interest, as well as taxes and insurance, when considering the monthly payment. Know that taxes will likely rise. Consider other major expenses—saving for college and retirement, for instance—and monthly costs, such as gas, food, car insurance, and entertainment. 

Be realistic: Rising housing prices aren’t a sure thing. Don’t sign a mortgage betting that housing prices will rise and that you’ll sell if times get tough. Realistically evaluate your long-term ability to make the payments and only borrow what you can afford.

Crunch your numbers: There are a multitude of online calculators to help you determine how much house you can afford, whether to opt for a fixed- or adjustable-rate mortgage, and how different down payment amounts will affect your monthly payments. One source is www.credit.com/calculators/home_mortgage.jsp.
 
Debt-to-Income Ratios

This term refers to how much you earn versus how much you owe (excluding your mortgage). The ideal ratio is a matter of debate, and to determine your threshold for debt, you need to consider all of your expenses. Typically, financial planners recommend that this ratio not exceed 20 percent of your take-home pay. In addition, financial planners recommend that this ratio does not exceed 40 percent when including your mortgage payment. For more information, visit www.debtsteps.com.

Avoid Foreclosure

If you’re behind on your mortgage, don’t automatically assume you’ll lose your house. Quick action might allow you to keep your property.

Raise funds: Examine your spending to see if you can slash expenses. “People waste lots of money on things like $3.75 lattes,” comments Randy Johnson, author of How to Save Thousands of Dollars on Your Home Mortgage and contributor to Credit.com. Can you get a second job? Swap your car for a less costly one? 

Contact your lender immediately: Lenders prefer a performing asset over a foreclosure and are frequently willing to work out a repayment plan. You’ll need to provide a detailed financial picture and outline your strategy for staying up-to-date with your mortgage. Here’s an example of what lenders will need: www.housingeduca tion.org/edi/pdf/edi_worksheet.pdf.

Whenever you’re asking for help from a lender, Speare Valasakos, CEO and corporate broker, Frontline Realty Group, San Diego, suggests clearly illustrating what you’ve done—selling a car and meeting with debt counselors—to avoid future crises. Here are some options they often consider.

Forbearance: Lenders may let you make a lower or no payment temporarily—say for three to six months. You’ll likely have to make higher payments when you start paying again to bring the loan up-to-date.

Repayment: If you’ve recovered from your crisis, lenders may allow you to pay more each month for a set period to make up missed payments.

Modifications: Lenders can reduce interest rates and extend loan terms to reduce the monthly payment.

Short refinancing: Under a short refinance, you refinance and the original lender accepts a payoff for less than you owe. Valasakos had a client with good credit who was going to be upside down on a loan. The $470,000 property was 100 percent financed and its value had dropped to about $425,000. The lender accepted $425,000 once Valasakos showed that the lender would lose more by foreclosing.

Short sale: You can sell the property and lenders may agree to accept less than you owe. This saves you from having a foreclosure on your credit record.

Before accepting any deal, consult with your accountant. Depending on the type of loan you have, you could owe income taxes on forgiven debt.

Elyse Umlauf-Garneau is a freelance real estate writer.

Reprinted with permission from California Real Estate magazine, copyright 2007 by the California Association of REALTORS^®, all rights reserved.