Why Would a Lender Accept a Short Sale?

“A bird in the hand is worth two in the bush.”

One of the most common misconceptions many homeowners have is that their lender is lying in wait for the perfect opportunity to jump out and take their houses from them.  Nothing could be further from the truth.  In reality, mortgage companies are in the finance business, not the real estate business.  They do not want their potential clients’ property.  In fact, a foreclosure has far-reaching financial and regulatory consequences of which the average homeowner is not even aware.

The True Cost of a Foreclosure

When a bank gets a property in foreclosure it is taking on a ton of unwanted expenses including legal fees, taxes, insurance, utilities, maintenance, repairs, homeowners association dues, real estate commissions, and closing costs.  The truth is that on average, it costs a lender $60,000 to $100,000 to foreclose and dispose of the average $200,000 property.  This doesn’t even take into account the opportunity cost the bank incurs by having assets tied up in the house.

In comparison, with a successful short sale, the lender can save significant capital by avoiding some legal fees, property management expenses, and quickly turning a non-performing asset into cash it can use elsewhere.  In fact, in most cases a bank is actually better off with a below-market-value short sale than a full-market-value sale of a property it took in foreclosure. 

Also keep in mind that with a foreclosure the financial situation could end up many times worse for the lender if the property declines in value, needs extensive repairs, a tenant needs to be evicted, or any of myriad other potential expenses arise.  A short sale is a sure thing that allows the lender to keep the property off its books.  It simply makes sense for the bank to avoid further financial exposure by cutting its losses with a successful short sale.

Short Sale Qualifications

It is estimated that most American Families

can only maintain their current living expenses

for 60 days or less when income is interrupted for any reason.

In order for a bank to accept a short sale, you must have a demonstrable financial hardship.  You will have to prove this hardship through a signed letter that will be submitted to the mortgage company along with additional documentation.

What is an Acceptable Hardship?

A hardship can be defined as a material change in your financial situation that is or will affect your ability to pay your mortgage.  Without a hardship, it is highly unlikely the bank will consider accepting a short sale on your property.  Following are some examples of hardships most banks consider acceptable:

Payment Increase or Mortgage Adjustment

This is the single largest reason for distress in today’s market.  Although mortgages increase on a schedule and owners know the higher payments are coming, many people don’t or can’t react until it’s too late.  Or worse, they do nothing because they think they have no options.

Loss of Employment

When an individual loses employment, the loss of income is most often immediate.  Financial distress can occur very quickly and seem insurmountable.

Business Failure

For a small business owner, the devastation of a business failure is often followed by the inability to pay mortgage payments and the loss of their home.  In our area especially, contractors and subcontractors involved in the home-building industry have been hit especially hard.

Damage to Property

Many times insurance companies do not cover the full amount of damage to a property and homeowners are unable to make repairs.  Some homeowners have to use insurance funds to survive and find new living arrangements.

Death of a Family Member

The death of a family member is devastating in many ways other than financial.  However, if the person who passes was also one of the—or the only—wage earner, financial distress will almost always be added to the family’s troubles.  Even if that person was not a wage earner, his or her death can still throw the family into emotional and financial turmoil.

Severe Illness

Severe illness or injury and the medical bills involved, as well as the time it takes away from a family’s productivity, can cause bills to be missed and homes to go into distress.

Inheritance

Rarely does someone think of an inheritance as a means for distress, however heirs are left to pay mortgage bills, utilities and maintenance that they did not expect.  Imagine a son who makes $60,000 per year whose parents pass away and leave him a $700,000 mortgage and payments on a $1.5 million property.  He will quickly need to find a payment solution (which there may not be) or liquidate the property to satisfy the mortgage.  As you can see, even properties with significant equity can get into danger of being lost to foreclosure if a timely solution is not implemented.

Divorce

It goes without saying that divorce is one of the most common reasons for financial distress in the real estate market.  Even when amicable, these situations can become challenging, especially for third parties (such as Realtors) because both spouses have to be involved and in agreement in order for solutions to be implemented.

Separation

When a couple decides to separate even though they are not actually divorcing, the cost of maintaining two households can lead to the loss of the primary residence.

Relocation

Homeowners do not always have control over where they live; many relocations are necessities, not choices.  This can quickly cause unexpected distress since very few homeowners can support two households for any significant length of time.

Military Service

Except for the relief provided in very specific situations by the Servicemembers Civil Relief Act (SCRA), military service can lead to unexpected financial issues.  Servicemembers who have had their periods of active duty extended are suffering a tremendous amount of financial pressure.

Insurance or Tax Increase

For many homeowners, just the increase in taxes on an annual basis or the increase in an insurance payment can cause a family to lose a home or go into financial distress

Reduced Income

If a person is in a commission-based business (real estate, insurance, auto sales, etc.) and the economy suffers, often times their income suffers as well.  Also, many businesses are reducing employee compensation or cutting hours to make up for lost revenues companies have suffered.

Too Much Debt

For a family with credit card debt, even minor increases in their interest rates can mean the difference between paying their bills and missing payments

Incarceration

Time in jail means loss of income and freedom, and usually includes sizable legal bills.  Obviously, no income and additional debt puts the home at risk.

Insolvency Requirement

To qualify for a short sale, you must be financially insolvent.  This means that you have to owe more than you have or that you do not have liquid cash or assets that could be used to buy down the mortgage.

If you do have liquid cash or assets, the bank will expect you to use them to pay down your mortgage.  The bank may be willing to cover any remaining shortfall if you contribute your available liquid assets yet still fall short of the cash required to cover the loan.  This only makes sense since lenders view short sales as a tool for you to use only when you truly can’t pay your mortgage.