Early Action Is Critical With Distress Sales
Making timely decisions is important in all real estate transactions, but it's critically important when it comes to distressed properties, for acting promptly could mean the difference between making the best of an unfortunate situation or ending up with the worst possible outcome.
During the mortgage-meltdown years, when most homes on the market were either short sales or foreclosures, we helped many clients maneuver through financial hardship. And we can tell you with absolute certainty that those who acted at the first sign of financial danger had a much better chance of avoiding foreclosure than those who waited to contact us until the 11th hour.
It’s human nature to ignore worrisome news in hopes that things will turn around. But when it comes to your mortgage, waiting and hoping is the worst thing you can do. That’s because once the Foreclosure Clock starts ticking, things can get very stressful very fast.
The two most common types of distress sales are the Short Sales and Foreclosures. We’ll cover each of these in more detail, but those aren’t the only alternatives to foreclosure.
Forebearance, Loan Modifications & Deeds In Lieu
One alternative is Forebearance, where the lender temporarily postpones your payments. If your financial hardship is due to a temporary situation and you're certain you’ll be able to resume making your payments in short order, it may make sense to contact your lender and ask about a forebearance.
A Loan Modification is another option. Most of the country’s major lenders participated in a government sponsored loan modification program during the economic downturn that allowed some homeowners to permanently reduce their payments and/or the amount they owed. Those government programs have since expired, but if you're struggling to make ends meet and know that a reduction in your payment would keep you on track with your mortgage payments, talk to your lender.
From the lender’s perspective it’s all about managing risk. If it looks like they will be heading to a costly foreclosure and it’s pretty clear that a small modification would enable you to maintain your payments, your lender might be willing to modify your loan, either for a period of time or permanently.
The key, though, is to contact your lender before you stop making your payments. If you haven’t made any payments for several months or wait to contact your lender until after they record a notice of default, they’re probably not going to be excited about modifying your loan.
A third option is what’s called a Deed In Lieu, which is short for deed in lieu of foreclosure. As the name implies, you voluntarily deed the home back to the bank instead of going through the foreclosure process. In return, the lender cancels the mortgage. If you don’t have any equity and know you’re going to lose the home, giving the house back to the bank, freeing yourself from the mortgage and avoiding the unpleasantness of the foreclosure process might make sense for some people.
Though, as with most other types of foreclosure alternatives, a deed in lieu will still result in a major blemish on your credit report.
The three most common types of distress sales, however, are Traditional Sales, Short Sales and Foreclosures. Here’s an overview of each:
TRADITIONAL SALES (With Equity)
If you're having a hard time making your payments but have enough equity to pay off your lender in full, a traditional sale could be your best alternative. Unlike a short sale, the lender in not involved in the sale of your home. You control the price, the terms and all other aspects of the sale. And you get to keep whatever equity is left over after escrow closes. Though, any missed payments will still show up on your credit report. The key, of course, is to close escrow before the lender forecloses, for if the lender does foreclose, the lender gets the house plus all of the equity, too.
A few things to think about if you believe you have enough equity to sell the home without any assistance from your lender:
- Make sure you have an accurate idea of how much your home is worth. We often meet with sellers who think their home is worth more than it really is, due to what an online automated valuation system (such as Zillow’s Zestimate) told them. See our Why Zestimates Are Zinaccurate page to learn more. And please Contact Us if you’d like a professional estimate of your home’s current value (no charge or obligation).
- Make sure you know how much time you have. Once the actual foreclosure process begins you may find yourself in a high-stakes game of Beat the Clock. In order to successfully avoid foreclosure, you’ll need to close escrow prior to the foreclosure sale date. That means pricing your home realistically and allowing time for the escrow process. It will probably take 30-40 days for escrow to close after you accept an offer. So don’t cut it too close. For if the lender forecloses before escrow closes, all that equity you thought you had will be gone forever.
- Find out how much you really owe. Even though you know your loan balance, you might not be aware of the other foreclosure-related fees and charges that your lender will include in your loan payoff. All those missed payments, interest, penalties and the lender’s foreclosure costs will be included in your payoff. So make sure you’ve taken that into account when figuring out if you have enough equity to do a traditional sale. If not, consider a short sale instead.
A short sale (also called a pre-foreclosure sale) occurs when you need to sell your home to avoid foreclosure but there’s not enough equity to pay off your existing loan(s). During the economic crisis of 2008-2013, we handled dozens of short sales for clients who were facing foreclosure.
And while it’s not the most pleasant experience, it can be a better alternative than walking away and losing your home. And you can usually borrow again sooner than if there’s a foreclosure on your credit report.
In a nutshell, here’s how a short sale works:
- You list your home with a local agent with strong short sale experience (we’ve done many, so feel free to Contact Us if we can help).
- You enter into contract with a buyer, which is subject to your lender(s) approval of a short sale. (If your lender doesn’t approve the short sale, you can cancel the contract.)
- Your agent collects your documentation and submits a short sale package to your lender. The package will include copies of your accepted offer plus bank statements, pay stubs, tax returns and other financial papers. You’ll also need to complete a detailed financial statement as well as a letter explaining your hardship.
- Your lender will obtain an appraisal or broker’s price opinion and compare that value to your accepted offer.
- They’ll also want confirmation that it’s an arms-length transaction (you can’t sell the house to a relative or someone you know).
- The lender will obtain copies of your filed tax returns from the IRS and match them up with what’s in your short sale package, to make sure you didn’t doctor up the copies you provided.
- If the lender approves your short sale, it will agree to take a loan payoff for less than what you owe and the sale will go through as planned. The buyer will get the house at the agreed terms and you’ll avoid foreclosure.
- After escrow closes, your lender will report that the loan was settled for less than what was owed to the credit bureaus. (As of early 2019, depending on the circumstances, borrowers must wait 2-4 years before they can obtain another loan).
That’s a very general overview and there’s a lot more to it than simply sending in paperwork and keeping your fingers crossed.
Short Sale Approvals Take Time
Back in 2008-12, lenders had huge loss mitigation departments but even with that large workforce, it usually took at least two months, and often much longer, for the lender to process a short sale. So it’s critical for sellers to make sure the buyer is aware of the anticipated processing time and is willing to wait for the lender to complete its review.
For there’s nothing worse than getting to the finish line only to discover that your buyer got tired of waiting a month ago and found something else.
Several other very important notes:
- If you vacate the property, the lender has the right to Secure the property to protect its interest. So if you move out and later find that the locks have been changed even though you’re still the legal owner, that’s why.
- The seller is not allowed to receive any funds from the sale and no rentbacks are allowed. Plus, the lender may require the home to be sold as-is, so if the buyer performs inspections and requests credits or repair work, the lender may not agree to those concessions.
- It’s critical to stay ahead of the Foreclosure Clock, which starts ticking the day the lender records a Notice of Default. If the short sale isn’t approved before the foreclosure sale date, the deal between the seller and buyer is dead. For once the lender forecloses, the seller is no longer the owner.
And that’s why it’s critical to start the short sale process early. If you wait until the lender staples a Notice of Sale to your house, you’re probably too late. For, not only do you need to allow time to get your home on the market and obtain an offer but you also need to allow time for the lender to review the short sale package and decide whether to approve the sale.
The lender isn’t required to approve a short sale; it’s a business decision and is usually based on several factors:
a) is the borrower truly in a hardship situation?
b) does the borrower have other assets that could be used to reduce or eliminate the default?
c) has the seller made a good-faith effort to sell the home for its highest possible value?
d) is accepting a short payoff going to be better financially for the lender than simply foreclosing?
If the lender feels that the seller didn’t market the home in a manner to generate the best possible offer, it could decline the short sale. Or it could approve the sale but at a higher sales price, which means going back to the buyer and trying to renegotiate the price.
Don't Leave Your Short Sale To An Inexperienced Newcomer
Having an experienced short sale agent is critical, for the agent is the conduit between the short sale lender and the homeowner. They collect the documentation from the owner and submit it to the lender, usually via a special portal that lenders use to correspond with the real estate agent.
The lender won’t start processing the short sale until it has a complete short sale package. So if the agent doesn’t provide exactly what the lender has requested, the lender won’t start the process. And often the lender won’t take the time to let anyone know that something is missing. It’s usually up to the agent to follow up and maintain contact with the lender.
The lender’s short sale department may be in another state and its staff may not be aware of short sale laws or practices that are specific to California. So the seller’s agent needs to be able to educate the processor when necessary and know how and when to escalate the file to a supervisor.
Two Loans? Two Separate Short Sales
Back in the economic meltdown days, it was very common for borrowers to have two loans in default. If there’s a 1st and a 2nd, both lenders have to agree to the short sale. And since the 1st lien holder is technically entitled to all the equity if it forecloses, the challenge was often convincing the 1st mortgage holder to leave enough to satisfy the 2nd lender.
A short sale can’t close unless all lenders agree to accept a payoff for less than what’s owed. But if the 2nd lender isn’t going to receive anything, there would be no reason for it to approve the short sale. So if there is more than one loan, it’s important to make sure the 1st lender is willing to leave enough for the 2nd (and 3rd if there are three loans).
There's No Substitute For Short Sale Experience
As you can see, deciding between an agent with short sale experience or one that will learn as he or she goes along can easily make or break a short sale. Many a borrower back in the 2008-2012 years discovered this the hard way and lost their homes to foreclosure.
That said, even though you do everything right and have a top-notch agent, there’s still no guarantee that the lender will approve a short sale. We had a very high success rate back in the days when short sales were prevalent. We even saved a few that were literally moments away from foreclosure. But despite our best efforts several lenders opted to foreclose anyway.
If you think you might be heading to foreclosure and would like to discuss the short sale process, please Contact Us and we’ll be happy to set up a complimentary no-obligation meeting. Everything you share with us will be fully confidential.
Foreclosure is usually the least popular alternative for those unable to make payments on their mortgage. But unfortunately, for some it’s the only option.
In some states, foreclosure is a judicial process, which can take three years or more. But in California, most home loans are actually deeds of trusts rather than mortgages. And with a deed of trust, foreclosure can take as little as four months from start to finish.
When Does The Foreclosure Clock Start Ticking?
Foreclosure doesn’t technically begin until the lender’s trustee records a Notice of Default (NOD). That starts the clock.
But before the lender can file the NOD, the lender must comply with state and federal foreclosure laws, which requires that they make multiple attempts to reach the homeowner with information on alternatives to foreclosure.
Once the NOD has been recorded, the lender must give the homeowner three months to bring the loan current, which means paying all those missed payments plus penalties, interest and accrued foreclosure costs.
Bring The Loan Current & All Is Forgiven
If the homeowner is able to cure the default, that’s the end of the foreclosure process. And even if the borrower stops making payments the following the month, the process must start all over again. Generally, the homeowner can bring the loan current all the way up until five days before the foreclosure sale date. After that the entire balance (including late fees, penalties, foreclosure costs, etc.) is the only way to stop foreclosure.
If three months go by after the NOD was recorded and the homeowner still hasn't brought the loan current, the lender can then set the foreclosure sale date and record a Notice of Trustee’s Sale (NOTS). It must be advertised one week apart for three consecutive weeks in a general local circulation newspaper.
However, if the homeowner submits an application for a short sale or loan modification before the NOTS is recorded, the lender must wait until the short sale or loan modification review process has been completed. If the modification or short sale is denied, the lender may proceed with setting the sale date and recording the NOTS.
As noted in the Short Sale section above, it’s never a good idea to wait until this point to initiate a short sale. Most successful short sales are the result of the homeowner starting the process the moment it becomes obvious that they won’t be able to continue making their house payments.
Confused about the foreclosure timeline? Here’s an example:
The above example is based on the lender moving ahead at breakneck speed. In real life, things don’t move that quickly. Back in the mortgage meltdown era of 2008-2012, it was not uncommon for homeowners to miss a year’s worth of payments before the lender started the formal foreclosure process.
And it was also common for lenders to delay posting the sale date for many additional months. So there were plenty of instances where the homeowner lived in the house despite not making any payments for several years before losing the house.
Once the foreclosure sale is complete, the owner is supposed to vacate. But that doesn't always happen promptly, so back in 2008-2012, many lenders offered Cash-For-Keys, which, as the name implies, is an incentive payment if the owner moves out quickly. The amount varied widely from lender to lender and even from property to property.
Foreclosure Is The Final Word
When the house is foreclosed, the lender becomes the legal owner and the person who was foreclosed upon must vacate the property. And any equity that the homeowner had vanishes.
The foreclosure stays on on the borrower’s credit report for seven years, which can be a major hurdle if the person is back on their financial feet and ready to buy a few years later. That ding on the credit report can also impact a foreclosed homeowner’s job prospects, since some employers now pull a credit report as part the hiring process.
Foreclosure is not a conclusion that anyone looks forward to but it’s a reality of life for some people. But as you have seen, there are often other alternatives. And we’ll repeat it one more time: if you want to avoid foreclosure, take action right away at the first sign of financial danger. Learn about your options and make educated decisions about what’s best for you.
We’re always happy to meet with prospective clients to share our knowledge and experience. If we can help, please Contact Us to set up a confidential meeting. There's no cost and no obligation.
IMPORTANT: All of the above can have significant legal and financial considerations. And circumstances can differ from person to person. Accordingly, the above is not to be construed as legal advice but rather as an overview of some of the most common distress-property real estate transactions that real estate agents are involved in. Before acting on any information provided on this page or elsewhere in this web site, you are advised to seek legal and financial advice from the the appropriate professionals in those fields.