Bay Area Short Sales & Foreclosures
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Buying through non-traditional sources can be complicated and emotion driven, so let’s review a few rules to successful property investing.
Rule No. 1: “Know thy-self.” A great deal on a property you don’t really want to own, or can’t afford to own, isn’t a great deal. If you doubt this, ask anyone of the thousands of amateur investors who currently own an “alligator” – a property eating them out of house and home.
Rule No. 2: The only thing that matters is current market value. What something cost 2-3 years ago is irrelevant today. Your goal should be to buy quality real estate at a discount to today’s market.
Rule No. 3: Everything costs something. No property is worth a divorce, financial ruin or a nervous breakdown. Even if you mess up on rules 1 and 2, NEVER forget rule No. 3.
Now for some important legal basics. Title means ownership. When someone owns real estate they are said to have title to it. Transferring ownership from one party to another is accomplished by executing a document called a deed. The holder of the deed controls the property. When recorded (almost always, but not legally required) they become public record.
When someone borrows money to purchase real estate, it’s called a mortgage. In California, at closing, the buyer gets a deed. The bank or lender records a lien against that deed. A lien is a financial claim against a property to secure payment of the debt or other obligation. Key point: Whoever is the legal owner of the deed controls the property.
When a property has a first / second / third mortgage it also has a first / second / third lien. Key point: Before a property can be transferred to a new owner, these liens must be paid off (satisfied) to obtain clean title.
Short Sale: This is a process where the owner of the property behind in mortgage payments attempts to sell a property for less (short) than is owed to the mortgage holder(s).
Why would a lender or lien holders accept less than what is owed? Because a short sale might actually reduce their loss verses a foreclosure, where they might even get nothing! Additionally, foreclosing in California is a lengthy and costly legal process, making the eventual loss even greater. It’s just good business to take a smaller loss now than a greater loss in the future.
Additionally, after foreclosing, the foreclosing lien holder becomes the owner of that property. Lenders don’t want to own property, they want to own mortgages on property!
Now here’s the truth about short sales: Various sources indicate as few as 5 percent of advertised short sales are successful. The reason is that short sales require the full cooperation of everyone involved to be successful. And I mean everyone!
The seller has to cooperate by providing, at the very least, a hardship letter, tax returns, pay stubs, a current financial statement and access to the property for inspections and appraisals.
Why would a seller go through all of this, rather than just letting the foreclosure happen, especially since at the closing table the seller won’t be receiving funds? For two good reasons:
First, on a credit report a settlement looks bad. However, not nearly as bad as a foreclosure looks. A foreclosure can actually prevent future property ownership for many years. A settlement usually doesn’t. In a lender’s eye, a foreclosure is often viewed worse than a bankruptcy. Remember, foreclosing is a lenders last resort.
Second: After foreclosing, a lender(s) or lien holder will often attempt to recover their loss with a deficiency judgment. In a short sale, the settlement agreement can include forgiveness of this debt. And thanks to a new law, the IRS can even forgive the “paper gain” which until recently was considered unearned income and subject to taxation. OUCH!
These two reasons are enough for a distressed seller to cooperate to the fullest extent to achieve a successful short sale verses a foreclosure.
Now the most asked question of all: “How much should a buyer offer in a short sale”? While it’s true that a buyer can make some insane, low-ball offer, it usually will be rejected because foreclosing then becomes a better option. I’ve found in most cases a 10-15 percent discount from current market value will be acceptable.
Current market value is almost always determined by a state certified appraisal ordered by the lender(s) although sometimes a lender will accept a CMA (Comparative Market Analysis). The hard truth is that no lender is going to simply rubber stamp your offer.
So here is a secret that will make reading this article worth it. Before making a short sale offer, get either a third party CMA or appraisal so you will have a defensible basis from which to take a discount. For an offer to be accepted, all lenders and lien holders will have to be convinced (sold) that your offer has a benefit to THEM. So start off right with proper documentation.
Short sale buyers will need patience as the process can take months and often doesn’t succeed. The good news is that you will have both time and access to fully inspect the property and time to secure financing if needed. Finally, you’ll receive clear title with title insurance at closing.
In conclusion; short sales take time, require exceptional skill and the full cooperation of everyone involved. But they benefit everyone; the seller, lien holders and the buyer, making it all worthwhile.