Owe more than you own? Heard about Short Sales? What should you do?

If you have been talking to anyone recently about the real estate market, chances are you have heard some people say they are dealing with a short sale or that the property is “underwater.”  What does all this mean?  More importantly, what are the implications if you are trying to buy or sale property that is underwater? 

Help – I am underwater!

Assuming the person is not speaking literally (e.g. the house is next to a river that has just flooded), when someone says the property is “underwater” they mean that the outstanding mortgage on the property exceeds the fair market value of the property.  A “short sale” means that the property is being sold for less than the outstanding balance due on the loan.    

How did this happen? 

Unfortunately, when there is a downshift in the economy and home values are impacted, it is all too common for a home to be worth less than the outstanding balance of the current mortgage.  In most instances, homes that are underwater where either: 

1. Purchased at the top of the real estate market; and/or

2. Purchased with very close to 100% financing. 

In some cases, even when a buyer paid 20% down for the property but purchased the property at the top of the market, the decline in value has exceeded the 20% down payment and the property is now worth less than the mortgage amount. 

What to do if I am selling a home that is underwater?

If you find yourself in a situation where you need to sell your home that is underwater, you should  contact your lender and ask what procedures they have to approve a short sale.  If you are selling your home, you are required to give the buyer good title to the property.  To give “good title” you need to make sure the current mortgage is released.  In a typical sale, once the bank is paid off it will release the mortgage.  Unless you have the money needed to make up for any shortfall between the sale price and the outstanding mortgage, you have to have an agreement from the lender to release the mortgage when the loan will not be paid in full from the sale.    

For example, you want to accept an offer to sell your house for $300,000 but you owe $350,000 on the mortgage.  Unless you can come up with the $50,000 to pay the balance due to the lender, you will have to get short sale approval from the lender.  If you are selling the property, you want the lender to agree to release the mortgage and not pursue you for the balance due.  How the lender will react to your request depends upon the lender and the situation.  Some lenders will review the situation and simply let you walk away from the loan after the lender receives the proceeds from the sale.  These lenders are hard to find.  Other lenders will require that you sign a new promissory note where you are required to pay them the balance over a period of time – e.g. a $50,0000 note payable over 10 years.  Sometimes the note will be at a low interest rate or even no interest.  Sometimes there will be a discount if you pay off the amount in less than the agreed upon time.  For example, you can pay $20,000 within 18 months to prepay the note instead of the full term of the note. 

If you are in a short sale situation and the lender is demanding that you sign a note for the balance due, this would be a good time to explore the possibility of a bankruptcy.  You should also make sure you disclose to any buyer that you must get approval from the lender to complete the sale.  It is important that the buyer be aware of the short sale situation because it is likely that there may be delays.  If your property is underwater and you can still make the mortgage payment, your best hope may be a rebound in the real estate market to increase the value of your home and thereby rescue it from its current underwater grave. 

What to do if I am buying a house that is underwater?

If you are the buyer of a home that is underwater it is important that you work with an attorney so that you can be sure all the liens on the property will be properly released.  Make sure you ask the closing attorney what liens are on the property and confirm that the current lender has agreed to release the liens even though they will not be paid the full amount due on the loan. 

When you are buying property in a short sale a typical problem is the possible delay in getting approval from the current mortgage holder.  Working with banks to obtain approval can be very frustrating and time consuming.  The seller may be doing everything within their power to get the short sale approved, but the bottom line is that the final approval of the short sale is outside the control of the seller and banks can sometimes take a very long time to approve a short sale.  If you are selling a property and need to move into a new home on a specific date, buying a house in a short sale may not be a good idea unless you have a back-up plan for living arrangements on a temporary basis.  In contrast, if you are currently renting and have the ability to stay in your apartment for a few extra weeks or months, or you are buying the short sale property to use as a rental property the timing of a short sale is of less concern. 

What now? 

Selling or buying a property in a short sale presents unique challenges for the seller and the buyer.  You should be prepared for the potential delays and it is more important than ever to work with an experienced real estate attorney, Realtor experienced in short sales and your financial or tax advisor to help guide you through the process.

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