Points to Ponder Regarding “Short Sales” and Foreclosures in NW Arkansas

This post is somewhat long—but the topic is complicated. Be patient and bear with me.

A lot of what’s on the market right now in NW Arkansas is either a short sale or a foreclosure (REO). This type of property is called a “distressed” property, and is very common across the country as well as in NW Arkansas.

When a home is sold for less than what the seller owes the lender, it is called a “short sale.”
In that case, the seller’s lender must approve the sale. But this is not as easy as it sounds.

Short sales were originally seen as a good deal for homeowners who found themselves in the sad position of owing more than their home was worth in the current market. It seemed simple enough for those sellers who were being relocated or absolutely had to sell for other reasons--get the mortgage holder (bank or other lender) to sign off on the sale, and everything would be over and done with. The seller would list and sell for less than what was owed, get a recordation of release or Satisfaction of Mortgage from the mortgage lender upon receipt of funds.

However, to sell a home as a short sale requires that the seller have a bona fide emergency (i.e. medical emergency, etc.) and not be able to sell his/her home under normal circumstances. This is a pre-foreclosure measure to try to protect the seller’s credit. But there is a lot of paperwork involved (including a “hardship letter”), and the banks are extremely slow to approve this type of transaction, despite recent government incentives to do so. Also, unlike REO or foreclosure properties, procedures for dealing with short sales within financial institutions have not yet been established and often take a long time. Thus even agents who specialize in short sales often have trouble getting the banks of their sellers to agree.

Ultimately if a seller has other assets (which would allow him to pay off his mortgage), is current on his payments, or is in the process of bankruptcy, the seller may not qualify for a short sale. Just being “upside down” with regard to selling one’s home is not enough.

On top of it all, it often turns out that buried in some fine print somewhere, mortgage holders have the right to pursue the difference between what was owed and the sales price. If the property has a second mortgage, a separate negotiation with that lender would also be required.

Lawsuits are becoming more frequent as lenders pursue every option to recoup their losses, especially if they determine the seller has other assets as opposed to being bankrupt.

Another aspect of short sales that was frequently overlooked is the income tax due on the amount of forgiven debt. In the past, IRS ruled that the amount of the discharged indebtedness had to be added to gross income for that year.

Now the feds have given a temporary break to most homeowners who sell short. A special form, Form 982-Reduction of Tax Attributes Due to Discharge of Indebtedness, needs to be filed with IRS.

Not to be overlooked is how state tax commissions will treat the situation. I highly recommend that anyone in this position consult with a tax professional, not to mention a real estate professional who specializes in this type of transaction.

If this all seems to be too complicated, the most important thing that people, who are behind on their mortgages, can do is talk to their lenders. It may take some doing to find the right person to talk to, but sometimes arrangements can be made for paying back their loans on new terms, etc. (i.e., loan modifications), so as to avoid a short sale or foreclosure. Basically the first step for people who want to remain in their homes is to contact their lender to see if there is a way to make an arrangement. They should not avoid calls from their lender when they are behind on their payments.

There are also important issues for buyers of properties listed as “potential” short sales.

Getting approval from the seller’s lender in a short sale situation often takes a long time – average about 90 days, and sometimes more. Thus if a buyer needs to "lock in" his interest rate for a 30- or 45-day period, there’s a good chance the short sale will not be able to close in that time.

From my point of view as a buyer agent, purchasing foreclosed properties (many of which are listed by realtors) may be easier and quicker than purchasing a property as a short sale. Those properties have already passed through the foreclosure process and can usually close in a normal time frame.

But there are also pitfalls there. First, foreclosure properties are normally sold “as-is, where-is”, which means that what you see is what you get. The seller (bank or other financial entity) will not be doing any repairs.

According to the normal Arkansas real estate contracts from the Arkansas Realtors Association, a buyer has 10 business days to have an inspection. If issues that make the buyer not want to purchase the home arise, the buyer can get out of the contract and get his earnest money back. There will be no repairs on the property, but at least the buyer will know what it will take to bring the property back to livable condition.

But in a recent training course which I attended on “distressed” properties, the instructors recommended that buyers take the inspector with them when they view the property even before making their first offer. If there is a major issue which will require extensive repairs, the inspector (without a written report and at a lesser price than a normal inspection) may be able to give an indication of what is wrong with the house before even making an offer. This would influence the offering price, while taking into account the cost to fix the problem.

Another aspect of foreclosures having to do with problems financing the foreclosed home, especially if it needs extensive work to make it livable and thus make it possible for the buyer’s loan to be approved. Banks and other financial institutions, who own the properties in question, do not want to make repairs, so if a home needs work, there may be a problem to get the buyer’s loan approved.

Normally mortgage loans permit buyers to purchase homes in livable condition. If the foreclosed home needs extensive repairs to put it in livable condition, there are a number of alternatives. If the home is a Fannie Mae owned home it may be eligible for Homepath Financing which will allow financing for the repairs. Freddie Mac has a program called Home Steps financing for homes owned by them.

If the home is not Fannie Mae or Freddie Mac owned, the FHA 203K program may provide a solution. This type of loan allows for funds to make repairs and bring the home into livable condition. However, most banks do not do this type of loan, so make sure the loan originator is familiar with the new “streamlined” version of this loan and can get it closed. Your realtor can help with recommendations in this regard.

The current real estate market situation is extremely complicated for sellers, especially those with problem mortgages. Often it depends on who “owns” your mortgage if you are having a problem. The people you make your payments to may not own your mortgage, but rather only be the “servicer”. If you are a seller wanting to sell your home, check with your realtor and your lender, especially if you are having problems.

The easiest solution ultimately (if you are a buyer) is when you can find a “normal” property, which is priced to compete with short sales and foreclosed properties. Normal properties at excellent prices are available and the buyer is less apt to run into title or other problems that more frequently rear their ugly heads on foreclosed properties or lengthy negotiations with lenders involved in a short sales.

The important thing is to have a buyer agent, knowledgeable about the market. Your agent can do a market analysis of recent sales in the area so you don’t pay too much and check on the history of the home to determine “wiggle room” for a potential offer.

And if you are a seller who does not have to sell and can continue to pay your mortgage, it is best that you do so and not put your home on the market now. This market will not last forever.

It’s a great time to purchase a home now, but not necessarily a great time to sell—except if you can save more money on the buying side compared to what you are losing on the seller’s side. And if you are an investor, there are some phenomenal “deals” out there now.

Your experienced real estate agent can guide you through the pitfalls of the current complicated market whether you are a buyer or a seller.

Look for a new forthcoming section about foreclosures and short sales on my main website at www.JudyLuna.com. I hope to have it up in a week or two. There will be more detailed information there.

For more information:

http://online.wsj.com/article/SB124104990739271023.html
http://www.fanniemae.com/homepath/homebuyers/buying_fanniemaeowned.jhtml
http://www.freddiemac.com
http://www.hud.gov