According to a real estate analysis firm CoreLogic, at the end of the fourth quarter 2011, more than 11.1 million American homeowners have negative equity or owe more on their mortgage than the fair market value of their homes. In addition, 2.5 million borrowers have 5% or less equity in their homes. In total, 27.8% of all borrowers have what some call “underwater mortgages.”
This phenomenon has caused many people to suffer through foreclosure because of an inability to refinance. Other homeowners have “strategically defaulted,” which signify they walked away from the properties.
Homeowners looking to sell their homes, but have a negative equity, should consider a real estate transaction called a short sale.
What is a Short Sale?
A real estate short sale simply means the mortgage lender accepts less than the total amount due on the loan balance. The National Association of Realtors reports that 14% of February 2012 home sales consisted of short sales. The mortgage lender’s willingness to accept a discounted payoff determines if the borrower can sell their home with a negative equity.
In some cases, lenders fare better financially by foreclosing on the property of homeowners who have delinquent mortgage payments instead of accepting short sales. This especially applies to mortgages insured by government agencies, such as FHA, Fannie Mae or Freddie Mac.
Seller and Property Must Qualify
Sellers who decide to pursue the short sale strategy must determine if their home and personal circumstance make them eligible for short sale.
The criteria to qualify for the short sale transaction process include:
- The market value of the home has dropped below the unpaid mortgage balance, which includes any prepayment penalty.
- Seller is close to defaulting on the loan or has severely delinquent mortgage payments. Some lenders will even consider a short sale for homeowners current with their mortgage payment, but facing basis other difficulties.
- Present the lender with a hardship letter that outlines why the seller cannot pay the difference between the payoff to the bank and any remaining balance on the loan. Hardships may include divorce, bankruptcy, unemployment or medical emergency.
The seller will have to show proof to the lender of any financial difficulties, or evidence of other hardships. This may include up providing copies of the tax returns or financial statements. Sellers with other assets, such as real estate, equities, or savings account may not meet the hardship criterion or receive a smaller discount for the short sale.
Short Sell Process
Generally, the process of a short sale may vary depending on the circumstances. Nonetheless, most short sale transactions follow the scenario below:
- Seller executes a listing agreement with a real estate agent that makes it subject to a short sale approval by the lender
- Real estate agent locates a buyer who makes an offer for less than the balance due on the loan
- Seller accepts the Offer to Purchaser
- Bank accepts the Offer to Purchase
- Transaction closes — the lender releases the lien and seller delivers the deed to the buyer
Sellers who decide to use the short sale process to sell their house because of negative equity should speak to their accountant and attorney regarding the tax and legal consequences of a short sale transaction.