Short sales make up a huge percentage of the Denver real estate market. Depending upon the area, we are seeing as much as 50% of the market consisting of short sale transactions.
For those of are unfamiliar with the term, "short sale" these are sales when the homeowner is selling the home for less than the mortgage value. Many homeowners have found themselves in a position where their home value has dropped. This fact plus the typical expenses associated with selling a home mean the only way a seller can sell his home and move on is to bring cash to the closing table.
Some buyers have the cash reserves to bring to the closing table, but many do not. When this happens, the homeowner has to make a choice, do they sell as a short sale or just give the keys back to the bank and let the bank foreclose on the property.
To get a short sale, the homeowner needs to ask their lending institution and provide evidence of proof, a hardship letter, income statements and find a buyer who is willing to wait while the bank goes through the steps to approve the short sale.
This process is anything but short. In fact the term short refers only to the amount the seller is "short" from being able to sell rather than the length of time to complete the short sale.
Many sellers are overwhelmed by the lengthy process and work involved. These sellers may think the better option will be to just let the bank foreclose. This may be true, but there are long-term benefits to doing a short sale over a foreclosure.
The KCM Blog offered a great example recently demonstrating examples:
Example A- Short Sale
Mr. Smith owns a home in which he has a mortgage balance of $220,000 and a current market value of $150,000. Mr. Smith has elected to short sell his property. His Realtor successfully obtains a buyer who puts forth an offer price of $120,000 (80% current market value according to Realty Trac Foreclosure Report 5/26/2011). After reviewing the buyers offer and the financial hardship information from Mr. Smith, Mr Smith’s bank agrees to accept the short payoff of $120,000 which would leave a deficiency balance of $100,000.
The transaction closes and is final. Mr. Smith then pulls his credit report 30 days after the transaction takes place. On the report he notices that the mortgage trade line states “Mortgage debt was settled for less than full” and the balance on the mortgage is $0. Mr. Smith is now on the road to financial recovery.
Example B- Foreclosure
For the ease of illustration we will use the same value and mortgage debt amounts as in Example A. However, Mr. Smith has elected to forgo the short sale process and let the bank foreclose on the property. The bank holding his mortgage facilitates the proper legal procedures to foreclose on the property, all of which are costly. Mr. Smith is notified and his property foreclosed upon of which is taken back by the bank to sell as an REO.
Six months later, the bank finally sells Mr. Smith’s home only they sell it for $90,000 (60% of current market value according to Realty Trac Foreclosure report dated 5/26/2011). Remember, as a short sale, the home would have sold for $120,000 keeping the deficiency to $100,000. In addition to the deficiency now being $130,000, the bank has elected to add on legal costs of $15,000 and asset preservation costs of another $5000 for a total deficiency liability of $150,000. Mr. Smith pulls his credit report 30 days after being notified that the bank has sold his property and of his liability.
On the report he notices that the mortgage trade line states “Foreclosure” and the balance is $150,000. Because of Mr Smith’s choice to choose foreclosure vs. short sale his road to financial recovery has taken a major detour. He not only has a foreclosure on his credit report but now has a much larger deficiency balance in which the bank, in most cases, will report on his credit report as a balance owed.
When considering the consequences of a short sale vs. a foreclosure, the decision should be clear. Typically a foreclosure is going to cost more and stay on a credit report forever.