The Sellers Guide to Short Sales in Sonoma County

Simple definition of a Sonoma County short sale

Five years ago, the term “Short Sale” was only used at the local clothing store to kick off the spring season. Very few real estate agents knew anything about a short sale and even fewer consumers understood the concept. Not so today. Today in Santa Rosa and Windsor, the term “Short Sale” is being used in so many real estate listings that to practice real estate and NOT understand the dynamics of a short sale is a sign of an unprepared agent. Even agents who don’t participate directly in short sales need to understand them and the impact these properties have on the market as a whole.

The simple definition of a Short Sale is when the owner of a home can no longer afford the monthly loan payments on the home AND the market value of the home is lower than the money owed to the lender(s). The owner therefore sells the home for the best price they can get, and the lender(s) agree to release their liens against the property so it can be transferred to a new owner. The current owner no longer has the overwhelming monthly payment which they cannot afford, and the current lender does not own a property they have to manage and dispose of. Note: there is a common misconception that a borrower who uses a short sale to get rid of their home will walk away from the deal with no debt. That is not necessarily true. Read the section “Major Issues with Short Sales” at the end of this article.

In Sonoma County, there are only two successful ways to sell your home for less than you owe the lender. The first way is if YOU plan to pay the difference at the closing. This is not called a short sale, but rather a “Seller brings cash to closing” sale. For some people, and for some types of property, this is the best way to go, but for many, this is not financially possible. The other way is to get the lender’s approval for a short sale.

How did we get here?

There are many contributing factors that have set the stage for the rash of short sales in Sonoma County today, but (in my opinion) the predominant factors include;

  • Easy money and lending practices that pushed risky financing onto unqualified buyers
  • Huge annual increases in homeowner equity that many people used as a source of cash for their lifestyles
  • An unrealistic belief that the real estate market would always go up
  • The reality that the market does NOT “always go up” and in fact has dropped significantly in the last three years.

Some homeowners faced with this situation may consider using a short sale to solve the problem

But wait, the Short Sale is only one answer out of many

Before I go into the details of the Short Sale, I need to mention that there are many other options available to people in the above situation. The Federal Government has introduced new rules and options for lenders with the hope this will encourage lenders to let owners modify their loan payment amount. Lenders are now MUCH more willing to extend the length of the loan, modify the rate, or allow interest only payments for a while so people can get back on their feet.  The government is in the process of writing “Cram Down” legislation which would give the courts the ability to re-write loans for certain homeowners. Things are changing fast, so educate yourself on the options before you choose a path.

In addition to these new and evolving options, there is also the old standby option of foreclosure which, for some people, may be a better solution than a short sale. For anyone in Sonoma County with unmanageable home debt, I strongly recommend consulting with any one of the MANY support organizations that have sprung up in the last few years. I have posted links to some of these at the end of this article. Furthermore, talking to an attorney and/or tax consultant is HIGHLY recommended so that whatever solution you choose, your solution has the most favorable impact on your future.

So, the bottom line; Look around, learn, and make an informed decision.

Why would a lender agree to a short sale?

Lenders on property in Sonoma County DO NOT want to own your home. This is especially true if you can show that even if they DID foreclose on your home, they could not sell the home for the value of the loan amount. In this case, not only would the lender get less than the loan amount anyway, they would also spend considerable time and expense in going through a foreclosure.  Assuming no payments from the borrower, the lender must carry the entire loan amount for the duration of the foreclosure process. In addition, there are legal fees, maintenance costs of the property, liability exposure once they own the property, and additional reserve amounts they must maintain as required by the Federal government.

The foreclosure process in Sonoma County is between four and five months after the borrower defaults on the loan. The total cost of a foreclosure to the lender is quite high, some estimates for a California foreclosure in a declining market exceeded $60,000. Honestly, most lenders (not all) have figured out that for some homes in today’s real estate market, taking less than the loan amount for a home WITHOUT a foreclosure is much better than going though one.

This said, you may want to read my article: Problems with Short Sales because the banking industry has really created a mess out of the short sale process and recent statistics show that only about 12 percent of short sales in Sonoma County successfully result in a closed transaction. That means that 88 percent of the attempted short sales in Sonoma County were a waste of time.

Short Sales are a race against the clock

In most cases, a short sale is a race against the clock. The big hand ticking is that your lender may decide they don’t want to wait and they may just record a Notice of Default to begin the foreclosure process. The other hand ticking is your own ability to continue to make your loan payments.

To beat this clock it is often best to price your home slightly below current market value so you can get quick buyer interest and be able to submit an offer to your lender before they pull the plug. This is especially true in a declining market, because even if you do price below market, it may be a short time before “Market Price” has dropped below your asking price.

I used the term “slightly below market value” because the lender wants the highest price possible and in some cases is unrealistic in their appraisal of the property. Short Sales are a fine balance between time and competing needs.

Short Sale advantages to the Owner of the property

I spoke above about why a lender would consider a short sale, but why might a home owner in Santa Rosa or Windsor want to consider a short sale?

If a homeowner cannot afford their loan payments, has an eminent foreclosure in the future and has exhausted all avenues for re-financing and debt management, their choices quickly boil down to a foreclosure or a short sale. In a foreclosure, the borrower’s credit rating gets hit pretty hard. Current lending practices suggest a foreclosure will downgrade your FICO credit score by 250-280 points and this negatively impacts your ability to get a decent loan for as long as seven years.

A short sale, on the other hand, has much less of an impact. Current lending practices suggest a Short Sale may lower your FICO score by 80-125 points and will impact your credit for perhaps three years, and maybe less depending on how your lender reports the sale. Also, remember that in today’s economy, your credit score may impact not only your ability to get a new loan, but may also determine the availability of health insurance and job offerings.

The theory behind all this is that in a short sale, the borrower has shown a strong effort to make the situation better by helping to sell the property. The foreclosure is viewed by lenders as the borrower simply walking away from the mess. Future lenders will look much more favorably on the Short Sale than a foreclosure, and their lending rates should reflect this.

The current economic problems are still unfolding and pretty much everything I am writing here could change, so be sure to read as much CURRENT information about short sales and your options BEFORE you make a decision on how to proceed.

Who might qualify for a short sale in Sonoma County?

One of the first misunderstandings people often have about the short sale concept is that you are NOT a candidate for a short sale just because your home isn’t worth the loan amount. With current lending practices, to be considered a candidate for a short sale you must have some kind of a hardship that has changed your financial situation such that you can no longer AFFORD your current home.

In some cases, a homeowner has decided that they just want to get rid of the house because it was a bad investment. Well guess what; the bank doesn’t want that bad investment either. Therefore, the first thing the lender will do is to determine if the property owner truly cannot make the current loan payments. They will require all the paperwork and financial documents from the property owner as they would from a new borrower. This is exactly the opposite of when you had to show you COULD afford the loan. They want PROOF you cannot make the payments. If you do not pass this first hurdle, the lender will simply say “No”, and not accept a short sale condition.  Also, even if the monthly payment is now unaffordable, do you have other assets like savings, stocks, a well-paying job, etc., which “could” be used to pay the short-fall on the sale of your home. If you do, many lenders will require that you do so.

This is not entirely unlike playing “Chicken” on the highway, because if the property owner really does not want to keep the property, they will eventually go ahead and allow the lender to foreclose. The lender knows that in a foreclosure, they will probably loose more money than they would with a short sale, so they certainly hope you will NOT go to foreclosure. The lender hopes that you may value your credit rating enough that you WON’T allow a foreclosure and since (in this case) they determined you really COULD pay off the loan with other assets, they keep driving in the middle of the highway at high speed hoping that you do. The key to this high-speed chicken-disaster is to present enough good information to the lender to convince them that the home is not worth what is owed on the loan and that you really CAN’T make the payments, and you don’t have the resources to make the deal whole.

Word of caution – Short Sale promissory notes

You should look very carefully at whether or not your lender will require you to sign a promissory note for the shortfall that occurs from a short sale. You may be trading a non-recourse loan for a recourse loan and the difference is very significant if you cannot repay the promissory note.  See “Major issues with short sales” below.

Who are the players in a Short Sale – Senior and Junior lien holders, PMI

So if you decide to attempt a short sale on your Santa Rosa or Windsor property, who has to approve the conditions of the short sale? The answer is; “It depends”.  Every home loan has what is called a “Senior lien holder”. This is the first lender to provide money for the purchase of the property and record a lien. In many cases, this is the only lender involved and in such cases, this is the lender that needs to approve the short sale conditions.

Many homeowners in trouble with their loan payments have problems because in addition to the first lender on the property, they took-out secondary loans. These may be for a HELOC (Home Equity Line Of Credit), or may have been a second loan to reduce the amount of the down payment. The lender(s) that have this “second” (or even third) position are called a “Junior lien holders”.  Depending on the amount for each loan and the short-fall of the sale, short sale approval may need to come from Junior lien holder(s), or BOTH the senior and junior lien holder(s).

Another player in the short sale scenario is the Mortgage Insurance Company. Many loans in Sonoma County are made with a requirement for mortgage insurance. Mortgage insurance is designed to help reduce the impact of borrower default on the lender. A short sale typically qualifies as borrower default and therefore the lender may be able to reduce their short sale loss by making a claim against this Mortgage Insurance Company. Often a short sale will require approval from the mortgage insurance company. This adds a whole new layer of effort and complexity onto the short sale scenario.

The Short Sale process in Sonoma County

1) Get tax and legal advice

You should base your decision to pursue a short sale on the advice from qualified tax and legal professionals, NOT a Realtor© or any other source. The laws and options are changing all the time and each person’s situation is unique. Take the time to protect yourself with qualified advice, it will be well worth it in the long run.

2) Find a great Realtor©

In Sonoma County, many lenders require borrowers to use the services of a real estate agent if they want to do a short sale. The lender wants this involvement because the lender does NOT have the human resources to help counsel a borrower through the short sale process. The lender figures that if a real estate agent is involved, THEY should be able to help the borrower with all the issues during the process. Another reason that lenders may require a real estate agent is because they want to be sure that the property was exposed to the entire market to insure the highest price. To do this the property must be listed in the MLS. Finally, the lender requires an “arms length” transaction which means you cannot sell the home to a relative or close friend. The involvement of a Realtor© helps insure the sale conforms to the lender’s requirements.

While a lender in Sonoma County may require a real estate agent be involved, the lender is typically going to be looking around to see who else is willing to “feel their pain”. This means they may require the seller to pay for some expenses without reimbursement. They will also frequently require the real estate agents involved in the sale to reduce their normal fees. Your agent should already be on-board with this possibility, but you should ask your agent about this before you sign a listing agreement with them.

Be sure to use a fully competent Realtor© as your representative to the lender. You want a Realtor© that the bank feels is highly qualified and the information they receive from the Realtor© is accurate and well documented. The Realtor© is essentially your representative to the lender and the better this relationship, the higher your chances for getting the lender to agree to the short sale. Also be sure to provide the lender with a signed letter allowing them to share information about your loan with your Realtor©. Without permission from you, the lender is prohibited from discussing your loan with others. 

2) Contact your lender

The lender has many different departments and each department has a specific goal. Short sales are most often managed by the “Loss Mitigation” department and a conversation about a short sale with any department OTHER than the loss mitigation department is pretty much a waste of time. Start your conversation with the right department.

I think it is important to contact your lender about a possible short sale as soon as you think this is the correct solution for you. Your Realtor© will ask for the lender’s “Short Sale” package and requirements and determine what their procedures are for a short sale. In the current Sonoma County real estate market, lenders are coming up with new ways to help borrowers avoid foreclosure. A short sale may only be one possible avenue your lender would consider, they may have others. Be sure to find out if the lender will pay the junior lien holder(s) any money as an incentive to release their liens.

When your Realtor© contacts the lender, it is possible the lender will say that they only work with borrowers that are in default. They may also say they only work with borrowers that have a signed offer from a buyer ready to buy the home. Even if the lender will only work with you AFTER you meet these conditions, it never hurts to start early. If nothing more, you at least know who to talk to and have reduced the amount of time required to get your package in front of a reviewer.

A great Realtor© will negotiate with your lender for how they will handle the short sale. In some cases, it is possible to negotiate for removal of late charges and fees that may have accrued prior to the sale and negotiate how the lender will report the short sale to the credit reporting agencies. It is also very important to determine if the lender will require a promissory note and what escrow fees the lender will pay. Much of this may depend on how well your lender package was put together.

3) Sell your Sonoma County home

Pricing the property is a big deal. Remember, it really doesn’t make any difference what you OWE on the home; the only thing that matters is the value of the home in TODAY’s market (market value). The lender knows that they cannot sell the home for MORE than market value. In fact most buyers in Sonoma County are only interested in short sale properties because they believe they can get the home for LESS than market value. The home has to be a good deal before a buyer gets interested. Your Realtor© will run a complete Competitive Market Analysis (CMA) for your property. This will be one of the key documents for the lender’s decision to do a short sale.

The property must be listed in the local MLS to prove that it has received full market exposure. Also remember that in a short sale, some lenders will not allow you to sell your home to a relative because the lender will assume the sale was a “sweetheart deal” and was not sold for the maximum value possible.

Because the short sale process with the lender can be demanding on your time and energy, sellers sometimes forget that they still need to NEGOTIATE any offer received from a potential buyer. Your Realtor© will be a great aid in this and will help remind you to negotiate the amount of the offer, date of possession, earnest deposit, anything that would be negotiated with a typical offer to buy. If you receive a low-ball offer from a buyer, be sure to counter offer for a higher price. A low offer with several counter offers which result in a higher price actually looks better to the lender than a single offer for the same amount. Counter offers help show that you have tried to get the maximum value for the home. Remember; you are not trying to push the price up to market value, you just want to try and avoid “Crazy Lowball” offers.

If your buyer has a substantial down payment and can do a quick close, the bank will be MUCH more likely to approve the sale than if the buyer had a low deposit and long escrow. Great Realtors© who represent the BUYER know how to help their buyer clients prepare and submit a short sale offer that is more attractive to lenders. Even though the home sale is a legal agreement between the buyer and YOU (not the bank), the fact of the issue is that many lenders will act like they own the home.

Word of caution: Many sellers (and, sadly, many real estate agents) think the contract is between the buyer and the BANK. This is NOT true. The legal agreement of sale is between the Seller and the Buyer. The seller is legally obligated to any and every clause in that document. If you default on the Purchase Contract, YOU are the one the buyer could sue, not the bank.

Make sure your buyer is pre-approved. Lenders are not interested in sitting on a property while a possible buyer goes through the approval process. Most lenders won’t even consider an offer from an unapproved buyer. The approval may be a typical loan approval form a lender, or proof of funds for an all-cash offer. If the offer is all cash, the proof of funds must be in the name of the buyer.

It is critically important that your purchase agreement with any buyer must state that the sale is contingent on the lenders approval of the short sale conditions. While this is a common contingency for the BUYER, the short sale process makes this an important contingency for the seller as well. The California Association of Realtors© (CAR) has developed special documents that support the unique requirements of a short sale and your Realtor© should be familiar with these forms.

4) Prepare the short sale lender package

One of the most important things to getting a short sale approval in Sonoma County is the “Lender short sale package”. This is all the information your Realtor© will help you prepare and submit to your lender. This package identifies you as a borrower and will convince your lender of three things; 1) your home is not worth what you owe on it and 2) you have had a hardship that caused this situation and 3) you can’t afford to pay the difference between the current value of your home and what you owe (the shortfall).

Components of the package often include;

  • A cover letter with your name, address, loan number, contact info, etc.
  • A letter authorizing your lender to provide information about your loan to your Realtor© (if not already done).
  • A Broker Price Opinion (BPO) or Competitive Market Analysis (CMA) showing the value of the home in today’s market.
  • Some lenders may require an appraisal in addition to, or instead of the CMA.
  • If the home has declined in value due to damage or neglect, an independent inspection report should also be included that shows the reduction in the value of the home as a result of these conditions.
  • A “Hardship Letter” explaining why you now find yourself unable to make the payments and documentation to support the hardship claim.
  • All the paperwork required to “not” qualify for a loan (W-2s, bank statements, two years of tax returns, and the financial documents outlining income and debt obligations, etc) – you have to prove that you do not qualify for your current loan.
  • If you submitted financial statements to your lender at the time you originally listed your property, you should submit new current documents along with any purchase offer that you ask them to approve. In many cases a fair amount of time may have passed since you listed the property and many lenders require current information before they will consider an offer.
  • A complete copy of the listing agreement. Your Realtor© should include their showing log, any advertising done for the property, any sales price adjustments, etc. Include anything that helps demonstrate to the lender that a real effort was made to get maximum value for the property. I suggest if you receive multiple offers, that you should submit these along with the “highest and best” offer that you are asking the lender to approve. These lower offers help support your claim that the highest offer truly represents the current market value of your home. Also, if you have counter offers showing you worked to increase the amount of the buyer’s initial offer, this looks good to the lender. It shows you were working for their best interests rather than simply dumping the house. This will increase the chance that the lender will accept the sales amount.
  • A complete purchase order signed by both parties and all addendum and riders.
  • The buyers proof of funds (cash) or lender approval
  • Your Realtor© and perhaps the title company will help you create a settlement statement (Hud-1) showing all closing costs and who will pay these. This will help you avoid a surprise at the closing when you learn that the lender will not allow certain expenses or fees. There are some fees the lender may consider paying. These often include the Owners title policy, City or County transfer fees, customary seller’s escrow fee. Not all lenders will pay these fees, but it is important to check with YOUR lender to know. Be SURE the HUD-1 correctly reflects the fees you believe your lender will pay, and that these fees are computed accurately. The HUD-1 must also be accurate when compared to the offer to purchase. It should include the correct name of the buyer, date of the offer, etc. Details like these that don’t match can often derail a short sale approval.

5) Wait, Wait, wait…

Short sales in Sonoma County take time. Sometimes a long time. It is not uncommon for lenders in Sonoma County to take anywhere from three to five weeks simply to accept or reject a purchase offer in a short sale scenario. This means your buyer (if not properly coached by their real estate agent) may decide to quit waiting. The purchase agreement will normally allow either party to cancel the agreement if the lender has not responded in a certain amount of time. It is also entirely possible that the lender could file a “Notice of Default” against the property while you are waiting for a response. With the large amount of distressed properties for sale in Sonoma County, the lenders are trying to get faster at processing short sale requests, but their progress has been slow.

Keep a complete record of any conversations you or your Realtor© has with your lenders representatives during the entire process. Include the date and time of the conversation, person’s name you spoke with and their phone number. Don't expect logical decisions to happen. Your lender may very well be swamped with short sale issues and the decision requirements are not always clear.

Any subsequent offers that you receive while the lender is making a decision on your first offer should be submitted to the lender as back-up offers. Lower-priced offers help support the offer you have previously submitted and higher-priced offers increase the chance the lender will accept the new offer while at the same time reducing your exposure to a lender-requested promissory note. If you are submitting any secondary offers to the lender AFTER the initial offer was submitted, your Realtor© should create a complete new package to support the offer. This includes documents that you know the lender already has such as your financial docs, etc. This is especially true if there has been more than a month since the first offer was submitted; often lenders will require current financial documents before they review the new offer.

It is completely amazing how fast paperwork gets lost by the lender during this process. Personally, I think they throw some of it away. Do not get mad when they ask for a document again, or again and again. Just give it to them and keep pushing the deal forward.

Be sure that your Realtor© helps to prepare the buyers for a possible rejection from the lender. The key here is that a rejection is usually the lenders way of saying they want a higher price. Try to prepare the buyer for this possibility and encourage them to re-submit another offer at a higher amount. They may just go to another property, but then again, they may really want YOUR property.

Major issues with short sales

Loan Fraud

When submitting your current financial documentation to your lender, be honest. Don’t try hiding assets or income to make your situation appear worse than it really is because this could be defined as loan fraud. Lenders are pretty anxious to identify loan fraud because it gives them more tools to collect their money.

You also have to be careful in explaining your current income. If the amount of your income is dramatically lower than the income you showed to get the current loan, there must be a good reason. Part of the problem in the current real estate mess in Sonoma County is that many people lied about their income so that they could qualify for a loan. This is loan fraud. Lenders are looking for this possibility with short sale requests and if they find loan fraud, they may have other avenues to collect from the borrower. So if your income is much lower than your original application, be sure to document why. You should always get the advice of a financial advisor and/or attorney.

Promissory note required by lender

California's anti-deficiency laws (California Code of Civil Procedure Section 580(b)-(d)) protect homeowners by limiting the ability of the lender to recover bad debt. Most homes in Sonoma County are purchased with what is referred to as a “Non-Recourse” loan. Non-recourse means that the ONLY money a lender can get in a foreclosure is from the sale of the property. If the property sells for less than the amount owed on the loan, the lender has no other recourse.

This is VERY important because some lenders will not allow a short sale unless the borrower agrees to sign a promissory note to cover the short-fall from the sale. If you sign a promissory as part of your short sale (rather than allow them to foreclose), you then may be giving up this “non recourse” protection because with the new note, the lender may be able to sue you for the amount of this new note should you later default. A promissory note usually gives the lender the ability to attach other assets of yours, if you default on the note. This may be a very big deal, depending on your ability to actually repay this new note. In some cases, an owner may be completely unable to pay this shortfall and would be better off allowing for a foreclosure. You should always get the advice of a financial advisor and/or attorney.

Junior lien holders

Having more than one lender involved makes things quite a bit more complicated. If you do have more than one lender, it is often the second lender (the “junior” lender) that will take most of the loss. Remember that a borrower normally cannot transfer ownership of a home unless ALL prior liens are removed from the home before the transfer. Therefore, a short sale cannot happen without consent from ALL lien holders both junior and senior. The junior lien holders are often the most difficult to deal with in a short sale because they often have little or no incentive to do so. Even if the junior lien holder has a lien for $100,000 the senior lien holder may only offer a small “token” amount when asking the junior to release their liens so a short sale can occur.

While junior liens will often receive as little as $1,000 to $5,000 to release their lien rights, this is NOT the same thing as forgiving the debt; the junior lien holder is simply releasing the collateral for their debt. In California, if the junior lien is a non-recourse loan, they cannot pursue the seller for a deficiency. Once they release their lien, that’s all the money they will get. However, if the junior lien holder has a recourse loan, they still have the right to seek repayment of the loan from the seller in other ways. While a foreclosure does wipe-out the junior lien holder’s claim against the PROPERTY, if they have a recourse loan, it does NOT remove their right to collect from you in other ways. They simply loose their lien position on the property. You should always get the advice of a financial advisor and/or attorney.

Taxation

There may be tax effects that result from a short sale. If the lender forgives a portion of a borrowers debt, the government considers this “debt forgiveness” similar to income and may tax the borrower on this amount. While it may seem totally unreasonable for a person to pay taxes on “income” that they never see, especially during the stress of a short sale, this is the sad fact. In 2007, the President signed the “Mortgage Forgiveness Debt Relief Act of 2007” which changed the IRS tax code to exclude taxation of short sales. This was long overdue and California was very slow to enact a similar law in regards to State taxation. There are differences between these two laws, so as always,… “Professional tax advice should be sought by anyone considering a short sale”.

Buyer Links for Short Sale info.

The US Department of Housing and Urban Development has tips for homeowners in distress: Click Here

The Consumer Federation of California has a section of their website devoted to articles on predatory lending and bills before California lawmakers: Click Here

The State of California has information about  the Mortgage Forgiveness Debt Relief Law: Click Here

The State of California has information about home mortgages and lenders: Click Here

The HOPE NOW is a cooperative alliance of governmental offices, lenders and counselors and has information on how to avoid foreclosure:Click Here

The Federal Trade Commission has general information on ways to ease foreclosure pressures: Click Here

The National Association of Consumer Advocates has information about Predatory Lending Practices: Click Here

Click Here to learn more about the author of this article

If you have any questions about this article, or would like additional information, please Contact Me and I will be happy to help you in any way possible.

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