Working with the Borrower
The first step in a short sale is to get the defaulting borrower to agree to the transaction. Most times the borrower has called you because of your marketing efforts. She has seen your bandit sign or small classified advertisement. She is hoping that you will buy her property for more than she owes on it.
Most likely you are not the first real-estate investor she has talked to about her current financial situation. The reason the defaulting property owner has called you might be that another real-estate investor has declined to purchase the property.
The property owner with little or no equity usually cannot afford to list the property with a real-estate agent because of the agent's commission. The defaulting owner has probably thought about selling her home, but the market value and listing price determined by the agent is less than what she owes.
Adding on the real-estate agent's commission for selling the property places the defaulting borrower further into debt. The property owner is looking for some other way to get rid of the property. Keeping all of this in mind, remember too that most real-estate investors will simply walk away from a potential short sale. You could also, but there could be a chance to earn a profit from the transaction.
At first it may not be apparent that a short sale is a possibility. The conversation is likely to start by the property owner pitching his property to you, hoping to sell it. One of your questions will be, “What is your asking price?”
After receiving the price of the property, you should ask if there is any mortgage on the property and if the payments are current. When the property owner indicates there is no (or very little) equity and the payments are in default, start thinking short sale.
Ask the defaulting property owner if he would consider a short sale. Most owners will have no idea what you are suggesting. They will be clueless and ask for more information. “I might be able to help you out with a short-sale transaction,” are your next words. “A short sale is when the lender is willing to accept less than what is owed on your loan.”
Too many defaulting borrowers think that when a lender is willing to accept less than what is owed (a short sale), it means the possibility of receiving money.
Your next step is to visit and inspect the property and meet with the borrower. Give yourself some extra time at the property as you need to gather as much information as possible during your inspection.
Visiting and Inspecting the Property
A property that you will attempt to acquire needs a careful and thorough inspection. You need to identify every potential problem. Take careful notes and, with the property owner's permission, photograph everything that needs to be fixed, repaired, or updated.
Don't perform a cursory walk-through. You need to check everything. It is highly likely you will need this information later as you intensify your negotiations with the lender.
Permission from the Borrower
During your initial meeting with the defaulting borrower, you need to review several important issues. A frank discussion with the homeowner is the best approach. During the discussion you should cover the following topics:
Your position as an investor
Your offers/negotiations with the lender
What you need from the property owner
Issues for the property owner to consider
A frank and open discussion works best. The defaulted borrower needs to understand what you can and cannot do and what will happen if his lender accepts your offer.
Tell the Borrower What You Do
One of the first points you must make clear with the homeowner is that you are a real-estate investor, and the only reason you would attempt to purchase the property is to earn a profit. If you cannot make a reasonable return, you will certainly move on to another property and another opportunity.
Explaining a short sale to the defaulted homebuyer is not difficult. Your discussion should include the information that she will receive no money from the transaction, and she will have to move from the property quickly if the lender accepts your purchase offer.
The deal with the homeowner is simple. Whatever you decide to offer for the purchase of the property will go to her lender. She will receive nothing. You need to get the homeowner to sign an authorization to release form. This will be used to discuss her loan with her lender.
Without a signed authorization to release form, the defaulting borrower's lender will not discuss any part of the loan with you. It is critical that the homeowner sign the release form for you.
A generic authorization form looks like this:
AUTHORIZATION TO RELEASE CREDIT INFORMATION
Date: _____________________________________________
To: _____________________________________________
Account #: _____________________________________________
As a holder of the above referenced loan with you, I (we) hereby authorize and request that you release my (our) credit history with your firm and forward it to Mary J. Johnson. You are also authorized to discuss the sale of my property secured by your loan with Mary J. Johnson. Please be advised, this letter serves as my (our) authorization for the release of my (our) loan information with your firm. Thank you for your assistance and cooperation in this matter.
__________________ ___________________________
Signature Signature of Joint Applicant (if any)
__________________ _________________________
Social Security Number Social Security Number
__________________
Address, Line 1 Address, Line 1
__________________
Address, Line 2 Address, Line 2
Homeowner Ramifications
There are two major concerns for the homeowner when his lender accepts a short sale:
IRS tax considerations
Default judgment sought by the lender
As part of your discussions with the homeowner you should explain that the discounted amount (the difference between the mortgage balance and the short sale) might have to be declared as income on his income tax return if the lender issues a 1099 form (miscellaneous income) to the borrower. The IRS often becomes involved with short sales because they are seen as a relief of debt and may be treated as income.
You should not offer tax advice, but rather refer the homeowner to his accountant or tax advisor for advice. Since he is having severe financial problems, the income reported on a 1099 may have little consequence to him. Always refer homeowners to a tax advisor.
Remember that the agreed upon price for the property is payment in full. You will receive title and possession of the property. However, the defaulted borrower may still owe the difference between the mortgage balance and the discounted amount you paid for the property. This is a deficiency judgment. Unless specifically prohibited in the state where the property is located, you should inform the property owner of this probability.
Should the lender pursue a deficiency judgment, it will affect the homeowners and their credit report just as any other judgment. Inform the defaulting borrower that your purchase offer will include a condition that the lender accepts payment in full without pursuit of any deficiency judgment.
Avoid any future legal complications from the defaulting property owners by sending a follow-up letter reiterating that they check with their tax advisor about the potential of the tax owed on a 1099 and that a deficiency judgment might be possible. A letter provides proof you told them about these consequences during your meeting.
Hardship Letter from the Borrower
Another document you will need from the borrower is a hardship letter. It is best if it is handwritten. In this letter the borrower must tell her story why she is so desperate for the short sale, how she has no financial resources to bring the loan current, and that there is little if any likelihood that the loan could be brought current in the future.
