On the heels of Jaded’s excellent post I have my own Seller underwater scenario to recount. I had a listing close escrow on Thursday. The home was one of Monterey Development Group’s courtyard homes located in the Village at Somersett Town Center. I took the listing in February of this year. The Sellers had previously listed it with another agent for $475,000. After receiving no interest in the property, the Sellers dismissed their first agent and then came to me. After discussing the asking price with me, my clients decided to go with $449,900. This price was higher than the number I had recommended, but I conceded and took the listing anyway under the condition that we would revisit the price in 30 days, if needed. One month later, after seeing little or no interest in their property, my clients became more realistic and reduced their asking price to $409,000. This was in March.
With the new price things started to pick up. I began holding weekly open houses, sometimes on both Saturday and Sunday. My plan was to try to capture some of the traffic coming through the Village and heading to Monterey Development Group’s sales office. This strategy worked well. I had many visitors stop by my open houses. Additionally, I picked up a few leads and even a couple new clients. However, no one submitted an offer.
Then one Sunday afternoon in late April, I received a call from a guy who had seen my For Sale sign in the property’s front yard. This prospect was from California and was looking to relocate to Reno. He had spent the previous day viewing the new inventory from builders throughout Somersett. On this day he was driving around Somersett picking up flyers from the resale properties. I showed him the property; he liked what he saw; and within three days he had submitted an offer. Negotiations between the Buyer and Seller went through three rounds of counter offers before both parties finally agreed on a sales price of $382,500. On May 4th we opened escrow with a 30-day close.
With most transactions, receiving an offer and signed acceptance is usually the most challenging task. Little did I realize the fun was only about to begin. A few days after signing the acceptance the Sellers informed me that there was “no way” they were going to be able to make up the difference between what was owed on their mortgages and what the sales price was. I asked them how much they thought they would be short and they replied, “All of it.”
It should be noted that until now the Sellers had assured me that they would be able to cover the expected shortage. However, upon receiving the settlement statement they immediately realized they were in trouble. Part of their predicament stemmed from the price reductions and, lower still, final sales price. Another contributing factor arose from the fact that their home did not sell as quickly as they had anticipated, and because they had purchased another home, they were carrying two mortgages and depleting what reserves they once had.
This set into motion a “short sale” situation. The Sellers, who by now had relocated out of state, were faced with asking their lender to forgive a portion (or all) of their debt in order to enable closing the deal. Using Jaded’s format from yesterday’s post, let’s look at the Seller’s situation:
05 May 2006 purchased for $419,500
1st $335,424, 2nd $41,928, 90% w/ 1st National Lending Services
06 June 2006 the 2nd was either sold or refinanced, with National City Mortgage, to the tune of $92,000.
It appears that later these mortgages were sold/transferred to other lenders. The 1st went to Washington Mutual and the 2nd to Bank of America.
I’ll spare the breakdown of the closing costs associated with this transaction but with closing costs, transfer fees, and commissions the Sellers were short over $89,000. The debt owed to Washington Mutual was going to get paid off by the proceeds of the sale. Bank of America, on the other hand, was only going to receive about $3,000 from the sale. This was because they were 2nd in line. It became immediately obvious to us that Bank of America was the lender with whom we would be negotiating this short sale.
You may be asking, why would a lender allow a sale to proceed and accept less than the amount of the outstanding debt? Well, faced with the alternative option of foreclosure Bank of America would receive nothing. I have seen reports that estimate the after-cost proceeds obtained from a foreclosure sale amount to 50 – 70 cents on the dollar. In that scenario, not only would BofA receive nothing, but Washington Mutual would also take a sizable hit. That being said, what were the chances that BofA would simply write off the remaining $86,000 owed to them? I was about to find out.
My Sellers’ case was assigned to one of BofA’s Loss Mitigators. On the first day our case worker informed us that he personally had 90 cases sitting on his desk at that moment. Things were not starting off well for us. My Sellers and I decided right there that it was imperative we stay on this guy’s radar and that our file stay at the top of his stack. So, over the next five weeks the Sellers and I were in almost daily contact with this case worker.
The bullet points below outline the sequence of events that occurred on our road to approval.
• Demonstrate that the Sellers made a good-faith attempt at achieving the highest price possible for their home. BofA wanted to know: how many days has the property been listed; what has been the price history of the property during this time; how many offers have been received and when were they received; what was the outcome of each; how long has the property been under contract; and did the Sellers negotiate hard? In my clients’ case, they had received only one offer during the entire listing. And that offer came after nearly four months of listing their property for the first time. I have heard from other agents who have been involved in short sale transactions that some lenders will not even consider the case until the property has been listed for a minimum of 90 days.
• Demonstrate that the offer was consistent with the going market price. I spent considerable time researching, analyzing and providing data to Bank of America explaining precisely what the housing market was like in Reno, Somersett, and the Village at Town Center; and why the offer was a strong offer; and why BofA was not likely to receive another offer. I included comps, solds, trends, builder inventory levels, medians, the competition, and projections. I documented everything and sent it all to the Loss Mitigator.
• Show that the Buyer was sound. BofA wanted verification that the Buyer was pre-approved and had a loan commitment from his lender. Providing this information was not a problem, as this is (or should be) performed in any real estate transaction, short-sale or not.
• Re-appraise the property. Although the Buyer’s lender had recently appraised the property as part of the Buyer’s loan process, BofA sent its own appraiser to perform another appraisal. The intent, again, was to validate the offer price.
• Run the appraised value and the offer price through BofA’s calculator and make a determination. This was a part of the process over which my clients and I had no control. Furthermore, no details of the formula were given to us.
• Negotiate with all parties. After BofA determined what amount of loss would be acceptable to them they set out to receive concessions from each of the interested parties (including the Broker) in an attempt to reach that amount. Because Chase International, my Broker, was representing both the Buyer and the Seller we were asked to reduce our commission two points. On a $382,500 sale, that concession amounted to a $7,650. Of course, BofA also determined an amount that the Seller’s were required to contribute, as well.
• Obtain Approval letter from BofA. After all of BofA’s requirements and concessions were met we held our breath as the file was sent to BofA Management for approval. There are no guarantees in the process. The file may be denied at any point during the short-sale approval process. Fortunately for my clients, BofA approved the short sale.
• Close escrow and record. After we received the letter approving the short sale, our escrow officer was able to release the transaction to be recorded. That was Thursday.
So, after much effort and cooperation by all parties involved, we finally reached a closed sale.
Although I would prefer to not involve myself in another short-sale transaction, I realize this is an unrealistic wish. Short sales are common today and will increase in numbers. To our readers who are real estate agents, it’s not a question of “if”, but “when” you will encounter a short sale situation. For this reason, I’d like to share my lessons learned with the other real estate agents out there:
• Allow for a much longer closing period than the standard 30-day close. I’d say 60 days is a minimum. Setbacks and delays are commonplace. And you will be unable to hurry the process along. The lender considering the approval of a short sale has an established process in place, and they will follow it to a T.
• Keep in mind that your Buyer will likely be unable to lock a rate for as long as this whole process may take. Although rate lock extensions may be obtainable, they can be very costly; usually one point per 30 day extension. Using the above transaction as an example, a rate lock extension would cost over $3,000. And then who pays for this? Buyer or Seller?
• Stay in constant contact with the person assigned to your transaction. Daily phone calls, emails and faxes can become tiresome for you and annoying for the receiving party, however you do not want to get lost in deluge of short sales happening in this market. And remember the bigger the lender the greater the number of files they are handling at the moment. And so what if the number of calls you’re making border on annoying; you may very well expedite the handling of your case simply because the case worker wants the calls to stop.
• Remember there are no guarantees that the lender will approve the sale. Additionally, even if they approve, they can change their mind anytime prior to close. If you are representing the Buyer, be sure to build in safeguards into the contract to cover your Buyer’s upfront costs (appraisal, inspections, etc) in the event the sale is denied. For example, having the Seller (rather than the Buyer) pay for the inspections might be a good idea. If you are representing the Seller, be sure to build in safeguards into the contract to protect your Seller against claims for failing to perform should the sale be denied.
• Be present at the lender’s appraisal. Provide the appraiser with your market research (comps, inventory levels, etc.) and analysis. Although an appraiser’s market value determination should be independent, your contributions can’t hurt.
• And finally, be prepared to be asked to reduce your commission. I have talked to other agents who have gone through short sales and all have reported having to reduce their commission. No agent with whom I spoke reported a (total) commission over 5% being allowed. If you were asked, what would you do? Ethically, can you refuse to cooperate at the risk of derailing your client’s transaction over your commission? Talk to your Broker.
• When concessions are being asked for, remember that funds can come from anywhere. The lender doesn’t care what the source is; they’re simply attempting to minimize their loss. Be creative when thinking of sources for additional funds. Is there a 1st mortgage holder involved in this transaction who may be willing to chip in? What do they stand to gain from a successful sale of the property? More importantly, what do they stand to lose if the sale is denied and then goes to foreclosure? Can the Seller borrow funds from relatives, employer, etc? Is the Buyer willing to contribute additional funds? Don’t worry if the amounts you obtain seem small. They all add up and you’d be surprised at what a difference they might make.
• And don’t forget to keep your escrow officer in the loop with every new development. Each time a concession is made or any amount changes during the course of the transaction your escrow officer will need to draw up a new settlement statement and you will need to forward that updated document to your case worker. I lost count of how many settlement statements were calculated for this short sale. But at the end of the day we got it done.
GreenNV
Now THIS is what I call a post! Every buyer, agent and seller out there dealing with a short sale owes you a huge debt of gratitude for sharing this inside information on what goes on during a short sale, and how to manage the process. I had no idea.
I don’t sympathize very offen with real estate agents, but it is sad to see the big institutions performing commissionectomies on the very deals where you are earning your commissions. I’m proud you and Chase stood by your sellers, idiots that they may be.
Curious if you know when the seller signed their purchase agreement for the property? That date really sets the point from which the 9% reduction in value started.
Do you have any advice for the owners of 1685 Painted Rock who purchased their unit in the Village 23 Feb 07 for $465,000 and just listed it for $579,000?
Reno Ignoramus
Guy:
Do I understand correctly that the 2d loan owed to B of A was not purchase money? Do I understand correctly that the 2d was a re-fi that involved a cash out?
If so, how much is B of A going to 1099 to your sellers as forgiveness of debt?
SkrapGuy
Guy:
I am confused. The purchase price was $382,500. The first lien holder, WaMu, was got paid in full on its approx. $335,000. Why was B of A only going to get $3,000 on its 2d? Would there not be approx. $47,500 left to partially pay B of A? Are you saying B of A forgave all $92,000 owed to it so this sale could go through? I don’t think that’s what you are saying, is it? How much did B of A get out of escrow?
How much did B of A actually forgive of its debt? Is this amount taxable to your sellers as forgiveness of debt?
Lindie
Let me see if I have this straight.
Your clients buy this place for $419,500. They put down 10% and finance 90% with a $335K first and a $42K 2d.
Then they decide to get their down payment back, and a little more, by re-financing the 2d for $92K.
So they end up borrowing $427K on a place they paid $419K for.
Then they decide to sell at $475K, which would have paid the off the 103% of value they have borrowed, plus closing costs and commissions. The greater fool does not show up. So they fire their agent and hire you.
You list at $449K. The greater fool still does not show up, and you all ride the market down some more.
Now you drop to $409K. Finally the greater fool does show up and offers $382,500. (Do you think the new owner knows that Pulte is selling the Vue at $122 a sq. ft.?)
After you go into escrow, for the first time, your clients figure out they are in trouble. The sales proceeds are not going to be enough to pay off their $427k in debt, let alone your fees and other related costs. They can’t bring a check to the closing table because they are already paying on another mortgage on another house.
So the bank does a short sale, comps fall in the development, and this fabulous transaction contributes to a “rising median”.
Priceless. This deal is a poster child for the state of our housing market. How many thousands of other ones are there out there just like this?
Yes, surely, there has never been a better time to buy than now.
BanteringBear
Nice post, Guy. What I find most hysterical, is that another fool came along and paid $382,500 for the place. I mean c’mon, that’s less than 10% off peak pricing! Let me guess, WAMU and BofA also provided the financing for the current sale. Perhaps you can represent this poor sucker on a short sale next year. Unreal.
smarten
Guy –
Why did you ever take this listing in the first place? Didn’t you do a title search to confirm your sellers actually had equity in the property when they gave you the listing [even at a $449K listing price, your sellers owed $30K more than all outstanding encumbrances against the property]? And when you were able to get your sellers to drop their asking price by $40K, didn’t you realize your clients would have to come up with $70K out of pocket? Are you telling us you realized their over encumbrance but simply took your clients’ word they would come up with $70K out of pocket at coe [if so, I’ve got a bridge you might be interested in]? And same question when they agreed to a counter offer that meant they would have to come up with $89K out of pocket?
I don’t think your sellers EVER intended to come up with $89K out of pocket [and quite frankly, I can’t imagine many sellers would]. I think they were using you to solve their problem.
You should have never taken this listing and given the work you were put through and the cut in commissions to boot, I’m betting that in retrospect, you would agree.
I think your check list of things to do when considering a listing likely to involve a short sale needs to be expanded to cover what very well could have occurred had B of A not agreed to discount its indebtedness.
rkybarl
I’m sorry, but I just don’t find it credible that these sellers did not know they were in deep sh!t until they got their estimated settlement statement. Do you need a scientific calculator to figure out that an ASKING price of $409K is not going to generate enough sales proceeds to pay off $427K in debt???
So how much did the bank write off? The joy these sellers experienced in pulling off the short sale will no doubt be serioulsy muted when they get a 1099 from the bank. It’s a real bitch having to pay taxes on phantom income. But then, it really wasn’t phantom income was it? Your sellers just took their income early when they refinanced.
GuyJohnson
Thank you for all of your comments. Many of you have asked what was the amount of debt that was forgiven. Unfortunately I can not disclose that due to confidentiality reasons. All of the other figures I disclosed (sale prices, deeds of trust, etc.) is public information and readily available through county tax records and the MLS. Many of you are correct that the amount of debt forgiven will appear as additional income on a 1099 to the Sellers at the end of the tax year.
I learned much from this experience. I will handle things a little differently with my next underwater Sellers. For one thing, verifying that the Sellers have the funds necessary to close is a good idea. Taking it a step further, an agent representing Sellers who need to “bring money to the table” may request that the Sellers deposit the necessary funds into an escrow account upfront.
As I said in my post, avoiding short sales is probably not realistic in this market. But with safeguards put into place to protect all parties involved in the transaction, agents can successfully navigate the transaction through to close.
Reno Ignoramus
Guy, a lesson learned no doubt. Short sales are not nearly the panacea some people think they are. For the realtor, they are three times the work for a reduced fee.(They do, however, produce a fee, and in a market where 3200 realtors are closing 400 deals a month, a fee is a fee, I understand).
My experience with short sales back in the past was also that the lenders wanted verifiable assurance that the seller had no ability to bring the “check to the table.” It was sort of like qualifying for a loan in reverse. The seller had to demonstrate a total lack of financial ability. Surely, no lender is going to write off, say, $75,000 in debt for a seller who has $200,000 in a savings account just because the sales proceeds are insufficient to pay off the debt.
And yes, there is always the thorny problem of imputed income to the sellers in short sales. Any forgiven debt that was not purchase money debt is going to have to be dealt with in the form of a 1099. This indeed can take the bloom off the rose for the short seller.
Tom
Very interesting discussion. I have fought the deemed income battle with the Service in several prior cases involving clients and their discharges of indebtedness.
As to the income tax consequence of forgiven debt, it is a highly complex area which involves more than just the constructive receipt of ordinary income accompanying a discharge of indebtedness. The 1099 to be given by the lender reports the item and the Service can start with a `deemed income’ position. But the taxpayer in some cases can establish that there is no changed position in terms of improvement to his position, i.e., he was insolvent before the discharge and remains insolvent afterwards, no property has been freed-up, thus no net improvement to taxpayer’s overall positition has taken place. IF taxpayer can prove the “insolvency exception,” measured both before and after the discharge, it is possible to avoid the adverse constructive receipt of income result. But the taxpayer has the burden of proof, and unless he is prepared to meet the `before and after’ tests of legal insolvency, it is a difficult case. Taxpayer must prove that no enhancement to his economic circumstances has taken place via the discharge, and that can be very difficult, if any assets remain which might be executed upon, or even if he is employed and the lender has waived rights to a deficiency judgment as part of the short sale, if the projected earnings of taxpayer indicate that the non-exempt part of his take-home pay would make payment of the deficiency judgment a bankworthy resource to the judgment creditor. If it is a bankworthy asset for the disappointed lender, the taxpayer has avoided future garnishment, and evaded a judgment that could be collected over time, so even if insolvent, he does have an income stream and has in a sense protected it. The Service will argue at audit that his estate has been enhanced, thus the insolvency exception is inapplicable. Thus it becomes hard for this taxpayer to make out this exception. Taxpayer has to PROVE (and you are proving to the administrative appeals officer, himself or herself an IRS employee) that his portion of net income which may be executed upon (the non-exempt part under state law) would be so small that collection of the deficiency judgment is only remotely possible, and accordingly, not a bankworthy asset, thus taxpayer has not received anything through the discharge which has “improved” his overall net worth. Consequently, you have to prove not only the before and after insolvency test, but also that the taxpayer is impoverished and only minimally employable in terms of non-exempt take-home pay, to rely upon this exception. You might have to pay the tax and then go to Tax Court, certainly a costly proposition and not a great improvement over the odds at the internal administrative appeal within the Service.
The insolvency exception works best when there are no assets, and there is no demonstrable non-exempt portion of a future earning stream in existence against which a deficiency judgment, to be otherwise waived, might be collected.
The audit and administrative appeal to discuss and adjust the deemed income consequence are costly to the taxpayer, who will need to retain a tax attorney, CPA or enrolled agent to attend with him. The outcome favors the Service. Anyone entering a transaction with a foregiveness aspect to it should have it tax-reviewed first, to avoid later expense and at the least, avoid surprises.
Tom
(practice consists of family wealth transactions, trusts, estate and tax planning)
Guy Johnson
Tom,
Thank you very much for sharing your insight regarding the tax consequences of debt forgiveness. Your comment is very informative, and we sincerely appreciate your contribution to the blog.
– Guy
smarten
So based upon Tom’s insight regarding the tax consequences of debt forgiveness, it looks like Guy’s short sellers are looking at a big tax bill [given they had the resources to purchase a replacement residence].
So my question: does not the agent representing a short seller have the duty to advise his client that by participating in a transaction such as this he/she/they may have to declare the foregiveness of indebtedness as income for tax purposes? Assuming the answer is yes, does Guy’s broker need to be concerned that this seller may come after him once he/she/they receive notice from the title company or the IRS?
GuyJohnson
Smarten,
You raise a good question. As agents we need to always be mindful of our clients’ interests. One of the duties spelled out in our “Duties Owed By A Nevada Real Estate Licensee” form states: “Promote the interest of the client by disclosing to the client material facts of which the licensee has knowledge concerning the real estate transaction.” My interpretation of that statement tells me that I am obligated to inform my client of the potential tax consequences of the “short sale”. For the record, I did inform my client of this. It turned out that he was already well aware of, and fully expected that, the amount of debt forgiven would be reported to the IRS. And just in case it still wasn’t clear, BofA also informed the Seller that they would be reporting this transaction to the IRS.
– Guy
Darin
Props for being a realistic and professional realtor
NAS
Good Blog Guy!
As a potential Reno buyer, I have been watching the area with a great deal of interest. We visited last December to look and then again, last April, with Guy.
I have kept watch on approx. 12-15 listings in Somersett and Arrowcreek, etc. The good news is for a few of the sellers, their homes have sold (post price reductions & finding a bigger fool to buy at the present time). The remaining 95% (my wall of shame) are either stagnating on the market, chasing the market down with half-hearted price reductions, in foreclosure or very close.
I don’t look forward to it, but a foregone conclusion is our next purchase in Reno (some exceptions) is likely to be an REO and requiring us to navigate through the mess a seller has managed to get themselves into.
Good luck getting a distressed seller to haul in 25K, 50K, or 90Kto the bargaining table to close a deal. They will walk.
I’ll stay with Guy and Diane, carefully select my title and escrow officer and proceed with caution.
Michael Spickes
Short Sales: Knowing Lender Thresholds for VA, FHA, and Conventional Loans = Saving Your Commission!!!
In working Short Sales, there are some numbers and calculations that are especially critical and knowing how to run these calculations will ultimately save you many headaches in the long-run. For instance, the initial list price for the Listing Agreement that is submitted to the bank, the initial list price for MLS, the net amount that banks typically require in a Short Sale given the type of loan, the bottom-line offer that will be necessary to cover the bank’s required net, as well as all broker commissions and Seller closing costs. In addition, you need to know how the numbers are affected if there are multiple mortgages on the property. All of these numbers are critical for you to facilitate the transaction effectively, gain credibility with the bank, and best represent your client.
Determine the Lender’s Discount Threshold
Banks have a threshold at which they will accept or reject on offer in a Short Sale. And knowing these approximate discount thresholds is imperative in determining your list price for MLS, so that you are able to generate an offer that will meet the bank’s requirements, as well as cover all the Seller closing costs and protect your commission. When we refer to the banks “discount threshold”, we are referring to the net amount that the bank requires in the transaction after all approved closing costs and commissions have been paid in the transaction. As a reminder, when it comes time to go active on the market in MLS, you need to adjust the price in the Listing Agreement and have your client initial off on this price change.
Calculating the initial list price for MLS is a critical part of setting up the Short Sale. We all know that when considering market comparables for a specific area, if the price per square foot of your client’s property is equal to or higher than any other property in the neighborhood, your chances of getting an offer quickly are pretty slim and the whole goal in a Short Sale is generating an offer quickly so that the house doesn’t go to foreclosure. In many states, the foreclosure process is a very aggressive one, so knowing how to calculate your initial list price for MLS is imperative. To do this, you must know what kind of loan you are shorting and have a good idea as to what the lender’s discount thresholds are for each type of loan.
Currently…
FHA loans are insured at 82% of the current market appraised value
VA loans are guaranteed at 88-91% of the current market appraised value
Conventional and Home Equity lenders expect net proceeds of no less than 85-92% of the current market appraised value.
Note: These thresholds represent a percentage of current market value, not the loan balance. Currently, the Conventional threshold is 85-92% of current market value. This threshold fluctuates with the market and is lender-specific. We have been working Short Sales for almost 5 years and FHA and VA thresholds have not changed during this time. Know that changes in market conditions, bank policy and/or the passing of legislation can effect these thresholds. If the market takes a turn for the worse and property inventory increases for lenders, you will most likely find that Conventional thresholds will decrease.
Know the numbers, save your commission, and enjoy building a commission-generating machine in Short Sales!
The Team at America’s Home Rescue
http://www.ShortSaleSolutions.biz