Short Sale Transaction

Short Sale Transactions
By K. Michelle Lind
Posted: July 2007

Unfortunately, some homeowners today owe more on their home than what the property is worth. Some programs that were intended to make it easier to obtain financing and increase homeownership resulted in loans that required small or no down payment, interest-only loans that do not build equity, and other loan programs that require such small payments that the loan amount actually increases rather than decreases. As a result, some homeowners have negative equity in their homes. Stagnant or decreasing property values add to the problem. Homeowners who financed their homes with loan programs with low initial rates of one percent to two percent will experience dramatic increases in their monthly payments when the loan resets to the market rate. These and other factors have contributed to a striking increase in home loan defaults and foreclosures.

Short Sales
A homeowner in default who owes for example, $300,000 on a property that is worth $250,000, may be able to convince the lender to allow the home to be sold for less than the loan amount, or even accept less than the amount owed as payment in full. This is known as a short sale. A lender may agree to a short sale to save the costs associated with a trustee’s sale, such as attorney’s and trustee’s fees, eviction, and resale costs. Additionally, a lender may agree to a short sale because if the property is foreclosed upon, the loan becomes a "non-performing" loan on the accounting books, which may affect the funds that the lender can obtain from the Federal Reserve for other loans.

Seller Considerations
When considering a short sale, the seller must first determine how much is owed on the property. For example, in addition to the delinquent loan, there may be a home equity loan, past due homeowner’s association fees or unpaid property taxes. Then, the seller must add the costs of a sale, such as closing costs, escrow fees and brokerage commissions. All of the seller’s debt and costs must be factored in before determining whether a short sale is feasible.

The seller should also be aware of some of the downsides to a short sale. A short sale could affect the seller’s credit score. Further, even if a lender agrees to a short sale, the lender, the VA, or the FHA may require the seller to pay the difference as a personal obligation. The outstanding debt could result in a subsequent collection action. Therefore, the seller should be certain of the terms of any short sale before making a decision and obtain any debt forgiveness agreement in writing.

Also, a short sale is a relief of and may be treated as income for tax purposes. A lender who forgives a debt must submit a 1099 form to the IRS indicating the amount the borrower has been forgiven. (Note: The NATIONAL ASSOCIATION OF REALTORS® supports proposed legislation that would change this tax law.)

Different lenders have different short sale department names, so contacting the person who has the authority to authorize a short sale on behalf of the lender may require some tenacity. The appropriate department may be called the loss mitigation, work-out, foreclosure, loan modification or loan reinstatement department. To accomplish a short sale, the seller must convince the lender that it will fare better by agreeing to a sale for less than the outstanding loan amount. A short sale may involve more documentation than the original loan application since the seller must “reverse qualify” and prove that the seller is financially incapable of paying the loan.

Purchase Contract Considerations
The purchase contract in a short sale must be contingent upon a short sale agreement acceptable to both the lender and the seller. AAR is currently working on a short sale contingency clause to add to the Additional Clause Addendum or a separate form to address short sales. In the meantime, the following short sale contingency clause may be used as a guide:
CONTINGENT UPON ACCEPTABLE SHORT SALE AGREEMENT: Buyer acknowledges that Seller owes more for the Premises than the purchase price and the Premises are encumbered by a loan(s) in excess of the purchase price. Therefore, this Contract is contingent upon an agreement between the Seller and Seller’s lender(s), acceptable to both, to sell the Premises for less than the loan amount(s). In the event that Seller and Seller’s lender(s) are unable to reach an acceptable agreement, this Contract shall be deemed cancelled and all Earnest Money shall be returned to Buyer. Seller is advised to obtain legal advice regarding the terms of any such short sale agreement with lender(s) and professional tax advice regarding the tax implications of any such sale.

However, the listing agent and the buyer’s agent should consult with their brokers or managers before drafting a contract in a short sale transaction or using the foregoing clause because there are other issues that should be addressed.

Brokerage Commission Considerations
A lender may demand that the real estate brokers in the transaction reduce their commission as a condition to any short sale agreement. However, the brokers cannot be forced to reduce the agreed upon commission, even if the lender refuses to agree to the short sale unless the brokers do so. A.A.C. R4-28-1101(D) states:
A licensee shall not allow a controversy with another licensee to jeopardize, delay, or interfere with the initiation, processing, or finalizing of a transaction on behalf of a client. This prohibition does not obligate a licensee to agree to alter the terms of any employment or compensation agreement or to relinquish the right to maintain an action to resolve a controversy. Therefore, even if the transaction will not close unless the brokers agree to reduce their commission, the brokers have no duty to do so.

Similarly, if the listing broker agrees to reduce the listing commission, the buyer’s broker’s commission is not affected by the listing broker’s agreement. Unless the buyer’s broker also agrees to reduce his or her commission, the listing broker is obligated to pay the buyer’s broker the amount of commission offered in the MLS, regardless of any agreements between the listing broker and the seller or lender.

Also, the purchase contract should not be used to address commission issues even in short sales. Any commission agreements should be handled by separate signed writings to avoid misunderstandings, disputes or potential violations of either the Commissioner’s Rules or Article 16 of the REALTOR® Code of Ethics.

Consult With Your Broker or Manager
Short sales can be very complex and risky transactions for everyone involved. Unless you are confident in your ability to handle such a transaction alone, consult with your broker or manager for advice and guidance.

Thanks to Martha Appel, Jerome King, James Tsighis, and Mark Ross for their input on this subject.