Short Sale Players

A reader emailed an interesting question asking about the decision makers are in a short sale. My quick answer is that a short sale has at least one extra party compared to a normal real estate transaction. The lender who financed the home to the current owners becomes an important player and decision maker whenever a transaction becomes a short sale.  It’s made more complicated when there are additional loans on the property.

Let’s call the people that bought and live in the home the “owners”. They are real human beings who dreamed about the joy of owning their own home. People who worried about a late payment. People who watched HGTV and spent weekends building decks and fences or installing new flooring. People just like you and me, but whose dream has gone dreadfully bad.

These home owners are among the saddest people we deal with in real estate. A typical short sale owner played by the rules. They trusted that the American dream of home ownership meant rising asset values and a secure retirement. They didn’t know about bubbles and CDO’s and derivatives. They just bought a house to make into their home. Since their purchase or refinance, declining property values have demolished their equity. They are now supporting a mortgage that’s upside down (worth less than the amount they owe). For most of these owners, any offer on their house is fine with them. The sooner their old house is in their rear view mirror, the quicker they can wipe away their tears, pick up the pieces of their life, and move on.

The additional players (compared to a normal sale) start with the holder of the first mortgage (let’s call them “bank” for short). They are the party with the strongest claim on the property by virtue of the promissory note they hold and their “first in line” position. They’re probably going to lose some of the money they invested in the note, but not all of it. (By definition, in a short sale the lenders (however many there are) aren’t going to get back the full value of their note. That’s where the term “short” comes from.) The bank isn’t going to be happy about this. Period. On the other hand, they are in far better position to recover most of their money than the last stakeholder.

The last player(s) in this drama is any second or third mortgage holder. It’s almost certain in a short sale that the person holding the second is effectively wiped out. Theoretically the holder of any second or third mortgage has the same note-based security as the first mortgage, but there are not going to be many crumbs left when the first bank has taken their share. Sadly for owners, the most effective role the second note holders play is “spoiler”. Because they are getting so little from the deal, they are less likely to cooperate and can hinder or block otherwise reasonable short sales.

When you read about lenders trying to persuade real estate agents or buyers to pay money under the table, it’s often the second note holder trying to extract more money from the transaction than they are being offered in the official transaction. Their only leverage is to kill the deal by refusing to cooperate. They will eventually have to yield, but they can cause major headaches during the process of negotiating a sale. When short sales fail, it is often due to the stubborn behavior of the second note holder.

To recap a simplified version of seller motivations in a short sale, the owners don’t care, the second won’t cooperate, and the bank is going along grudgingly. That’s not a recipe for an easy transaction. By comparison, a normal open market sale has an eager buyer and eager seller. It’s the eager seller that’s missing from a short sale.  It takes strong and patient agents and buyers to make up for that lack and to persist through the drawn out short sale process.

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