Short Sales: New Law Should Improve Opportunities For Investors
March 22nd 2008
Not long ago, many homeowners were reluctant to consider a short sale of their property as an alternative to foreclosure. A short sale, in simple language is the sale of a house at a price below the outstanding loan payoff amount. The reason for that reluctance was because the IRS taxed the difference between the mortgage loan balance and the amount at which the house was sold. For example, if a mortgage loan balance was $100,000 and the house sold for $80,000, the IRS considered the $20,000 difference as income. Many homeowners weren’t even aware that they would have to pay tax on this “phantom” income, and were (unpleasantly) surprised when they received a 1099 form from their lender.
Thanks to a recently enacted law, the Mortgage Forgiveness Debt Relief Act of 2007, which permits tax payers to exclude that so-called “phantom” income (up to $2 million) from federal taxes, more and more financially distressed homeowners are seeing the benefit of the short sale as an alternative to foreclosure and a way to avoid long-term damage to their credit history.
Foreclosure rates are skyrocketing, up 60% over the same period last year, and there is a good opportunity for investors to make money from the housing crisis created by the sub-prime debacle. On average, 1 in every 577 homes will go into foreclosure; in some areas of the country, namely Nevada, California and Florida, those numbers could be as high as 1 in every 165 homes.
So, where are these pre-foreclosure homes and where can I get information about them, anyway? They’re everywhere. Find your own contacts by picking up a local newspaper, checking the courthouse filings, or simply word of mouth. Then get busy with cold-calling or mass mailings. It may take a great deal of work, just to get a single qualified short sales candidate.
Your next step is a visit to see and thoroughly inspect the property and neighborhood. Oddly enough, the worse condition the property is in, the better for you when dealing with the lender… the bank does not want to have to fix up a foreclosure property. Get a list of all outstanding liens, attachments and encumbrances on the property, in writing, from the homeowner. You need to verify this; don’t take it at face value.
If a short sales opportunity is feasible, you’ll need to go back to the homeowner and get authorization to receive their mortgage information from the lender, as well as release forms assigning you their property rights, subject, of course, to outstanding liens.
Your destination at the bank or mortgage company will be the Loss Mitigation Department. There, it’s your responsibility to convince the lender that you are presenting the best possible deal. It’s a matter of salesmanship and presentation; the better you are at PR, the less likely your offer will be declined.
Why would a lender be willing to accept a short sale offer? Basically, from a lender perspective, it’s a choice between the lesser of two evils. The banks know that the short sale may be their last best hope to avoid an expensive and protracted foreclosure process. They are cognizant that, either way, they are taking a loss on the bad debt; the real question is how much of a loss and how soon? In general, banks like to write off their bad debt sooner than later.
At a minimum, and each lender or mortgage company has different requirements, you’ll need to present to them:
- A letter of hardship from the homeowner, detailing the reason why they can no longer make payments or their inability to fully repay the loan;
- Proof of hardship, including federal tax returns, pay stubs and bank statements;
- Authorization from the homeowner allowing the bank to release personal mortgage information; and
- Proof that the homeowner has attempted to sell the property through traditional methods, before resorting to a short sale; typically, an advertisement, sales flyer or a copy of the listing agreement with a realtor will suffice. Some lenders require that the property be on the market for a specific period of time.
The lender will either commission a new appraisal or a broker’s price opinion (BPO) on the property, to determine the fairness of your offering price. While it’s tempting to lowball your offer, you should know that, in general, most short sales are between 5 and 35% below the market value. However, given the expected surge in short sales as a result of the new IRS law, you may be able to make an offer of as much as 40 to 45% below the market, and have it accepted.
Though it seems implausible, short sales can be a win-win-win situation; investors can acquire a property below market price; homeowners can avoid foreclosure and maintain their credit rating and lenders can reduce their loss on a bad loan.
Barb Zigah is a freelance writer covering real estate and business topics.
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