Short Sale Qualification
The qualifications for a short sale are slightly different than for a traditional listing. The major difference is that in order-for a bank to accept a short sale, the borrower must have a demonstrable financial hardship. They 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 the financial situation of a homeowner that is or will affect their ability to pay their mortgage.”
The seller must have a hardship in order to qualify for a short sale. Examples of acceptable financial hardships are:
- Loss of job
- Business failure
- Damage to property
- Death of a spouse
- Death of family members
- Severe illness
- Inheritance
- Divorce
- Mandatory job relocation
- Medical bills
- Military service
- Payment increase or mortgage adjustment
- Insurance or tax increase
- Reduced income
- Separation
- Too much debt
- Incarceration
Insolvency Requirement
You must not be able to Pay Down his Mortgage. A short sale client has to be financially insolvent. For the purposes of a short sale this means that he has to owe more than he has or that you do not have liquid cash or assets that could be used to buy-down your mortgage.
If they do have liquid cash or assets, they will be expected to use them to pay down their mortgages. We have seen cases where a homeowner made a contribution towards the sale of his property but was still short and the lender covered the remaining shortfall.
A short sale is not a way to just get out of a mortgage. It is a tool for a borrower to use when they truly can't pay their mortgage.
Actual Short Sale Scenarios
You have to determine how much a property will be short and what chance you have of getting a short sale approved. There are simple calculations you can use. In order to negotiate a short sale fully, you or your title company will be required to prepare a preliminary HUD-1 statement, as follows:
SCENARIO 1: ONE MORTGAGE MINOR LIEN
| Property details: | |
| Client owes mortgage: | $200,000 |
| Minor lien: | $3,000 |
| Market value: | $200,010 |
| Sale calculation: | |
| Sale price: | $200,000 |
| Commissions: | ($12,000) |
| Closing costs: | ($4,500) |
| Lien payoff: | ($3,000) |
| Net sale price: | $180,500 |
| Potential amount short: | ($19,500) |
| % Short | 9.75% |
The short amount works out to about 6.25% of what the client owes (Short Amount ÷ Amount Owed). This is an excellent potential short sale if the client meets the other qualification criteria.
SCENARIO 2: ONE MORTGAGE, LOWER SALES PRICE
| Property details: | |
| Client owes mortgage: | $200,000 |
| Market value: | $185,000 |
| Sale calculation: | |
| Sale price: | $175,000 |
| Commissions: | ($10,500) |
| Closing costs: | ($3,397) |
| Lien payoff: | ($3,000) |
| Net sale price: | $160,563 |
| Potential amount short: | ($39,437) |
| % Short | 19.72% |
The short amount works out to about 19.72% of what the client owes (Short Amount ÷ Amount Owed). This is a good potential short sale if the client meets the other qualification requirements.
SCENARIO 3: TWO MORTGAGES, ONLY SECOND IS SHORT
| Property details: | |
| Client owes 1st mortgage: | $140,000 |
| Client owes 2nd mortgage: | $60,000 |
| Market value: | $185,000 |
| Sale calculation: | |
| Sale price: | $175,000 |
| Commissions: | ($10,500) |
| Closing costs: | ($3,397) |
| Lien payoff: | ($3,000) |
| Net sale price: | $160,563 |
| Potential amount short: | ($39,437) |
| % Short | 34.72% |
| (Second Only) |
In this case the negotiating will be with the second mortgage holder. The first mortgage will be satisfied at closing so you are only shorting the second mortgage. In this case-the second mortgage will be 65.73% short (Short Amount ÷ Mortgage Amount Owed). This is an excellent potential short sale if the client meets the other qualification requirements. Most second mortgage companies would accept this deal since if the property goes into foreclosure they get nothing.
SCENARIO 4: TWO MORTGAGES, SHORT GREATER THAN SECOND BALANCE
| Property details: | |
| Client owes 1st mortgage: | $140,000 |
| Client owes 2nd mortgage: | $60,000 |
| Market value: | $185,000 |
| Sale calculation: | |
| Sale price: | $135,000 |
| Commissions: | ($8,100) |
| Closing costs: | ($3,037) |
| Net sale price: | $123,863 |
| Playoffs: | |
| 1st Mortgage: | $121,863 |
| 2nd Mortgage: | $58,000 |
| % Short: | |
| 1st Mortgage: | 12.96% |
| 2nd Mortgage: | 96.67% |
This scenario is becoming more and more common. The amount short exceeds the second mortgage balance and therefore both mortgages will be short. In most cases second mortgage companies are fully exposed and will end up having to accept very close to nothing to settle as shown in this example. It is not uncommon for a large second mortgage to accept a payoff of less than $5,000.
Notes for these Scenarios
- A commission rate of 6% was assumed.
- This is just an example of closing costs. They will vary in your area. This calculation assumes 2.25% including taxes and all closing costs.
- This calculation is based on the lowest priced comparable property in the neighborhood. This calculation is done at about 5% less than the price at which we think the house will sell
Private Mortgage Insurance - PMI
Private Mortgage Insurance is a monthly fee charged to the borrower on loans that are originated over 80% of value. This fee is to insure a portion of the loan should your client default; this is usually some percentage of the total balance of the mortgage. A good rule of thumb is that the top 20% of the loan is covered. If you owe $200,000 on a 100% mortgage loan chances are the lender has PMI covering $40,000. This applies to the "top" of the mortgage so the amount from $160,000 -$200,000 is covered.
In order to verify if you have PMI, take a look at your statement. The charge will be shown as a line item. If you purchased your property with a single loan for over 80% loan to value then chances are you have PMI. If you purchased your property with two loans where the first mortgage was over 80%, then the first most likely has PMI. PMI does not exist on second mortgages; lenders absorb the risk through higher interest rates on seconds.
If you have PMI and the property is less than about 20% short, you need to contact the lender immediately and see if they will even consider a short sale. Many lenders will tell you at that point what their policy is. Also the PMI policies with a given lender may change, so don't assume that what they told you once holds true for the next. Policies may change depending on how many claims have been made by the lender against their master policy. Remember they still have to foreclose and that carries costs.
It has also recently been reported that many of these PMI companies are at risk of becoming insolvent and going bankrupt. This is why it is suggested you submit to the bank for final approval.
A Note on Lender Paid Mortgage Insurance or LPMI
Lender paid mortgage insurance is like hidden PMI. You have probably seen 100% financing loans advertised with 'no PMI'. The reality behind these loans is that the lender was paying the PMI and passing the cost of the insurance on to the borrower in the form of higher interest rates. The issue is that you cannot verify that there is or is not PMI by looking at the mortgage statement.