If you owe more on your home than it's worth, you may be hearing a lot about short sales.
That's when you sell your property for the current market value, even though that's less than your mortgage. Your lender agrees to take the proceeds, and you walk away from the house.
Since the foreclosure frenzy began last year, many consumers who have embarked on short sales have found the process complex and time consuming. Lenders can delay decisions for months on whether to accept the process. In many cases, potential buyers have walked away from the deal because they wanted to buy a house quickly and not lose a favorable mortgage.
In an effort to smooth out the process, the Obama administration on May 14 unveiled new incentives and uniform standards and procedures for parties involved in short sales.
The changes, announced by Housing and Urban Development Secretary Shaun Donovan, are structured as an extension to the government's main foreclosure prevention program, called Making Home Affordable. They offer cash incentives to lenders and borrowers to encourage them to participate.
Donovan said the program should reduce "the damage that foreclosures impose on borrowers, financial institutions and communities."
The plan -- to go into effect when the government issues standardized documents -- does not cover everyone. To be eligible, the home must either be owner-occupied or a one-to-four unit property. Condominiums, cooperatives and mobile homes are eligible.
First trust loans must have an unpaid principal balance of $729,750 or less, before including arrearages. (Amounts are higher for multi-unit buildings.)
Here are some highlights:
-- There will be a standard "Short Sale Agreement" and an "Offer-Acceptance Letter." The lender must independently evaluate and establish the market value and determine the minimum acceptable price that it will accept.
-- The borrower must list the property with a licensed real estate agent who has experience in the area where the house is located. Lenders must allow at least 90 days for the property to be marketed and sold, although more time can be allowed depending on local market conditions.
-- The short-sale process can proceed even if the lender has started the foreclosure process, but the foreclosure sale cannot take place until the short-sale timelines have been exceeded.
-- The real estate agent is entitled to receive the usual commission, which can be deducted from the selling price. This is a significant change from the way short sales have been conducted. Until now, real estate agents often had to significantly reduce their commission to obtain lender approval. Under the new guidelines, the lender must agree not to negotiate a lower sales commission after an offer to purchase has been received.
-- The government will provide financial incentives for lenders and homeowners to participate. Lenders may receive up to $1,000 for completing a successful short sale. Homeowners may receive up to $1,500 to assist with moving expenses.
One of the most significant barriers to a short sale comes when there is a second mortgage on the property. The first lender may be willing to engage in the short sale because it is less expensive than a foreclosure. More important, many times, no one buys at the foreclosure auction, and the lender ends up stuck with the house -- and the associated costs of upkeep.
Though the first trust lender is taking a hit, it will get some cash from the sale. The second trust lender, however, will often be completely wiped out. Typically, these second-place lenders object to this.
The new plan attempts -- in a modest way -- to satisfy these concerns. The Treasury Department has agreed to share the cost of paying junior lien holders to release their claims, and will match $1 for every $2 paid by the senior lien holder, up to a total government contribution of $1,000. In effect, the junior lienholder will get a minimum of $3,000.
Clearly, this will not make these lenders happy. But they also face an unpleasant reality: If they block a short sale and the home goes to foreclosure, second trusts are by law eliminated. And although that second lender has the right to sue the borrower, as a practical matter such a lawsuit is meaningless against an insolvent debtor.
Although borrowers cannot be charged a fee for engaging in a short sale under the government plan, the plan unfortunately is silent on whether the lender can require the homeowner to come up with additional money to cover the lender's shortfall.
HUD must address this important issue when drafting the implementation documents. In my experience, some lenders will waive such payments, while others will demand that a large percentage of the shortfall be paid by the borrower.
This new program also addresses deeds in lieu of foreclosure. This is a procedure where the homeowner says in effect: "Lender, take my house and release me from my loan." If the lender agrees, it saves the cost of foreclosure, including legal fees, advertising costs and auctioneer charges.
This program will run until Dec. 31, 2012. Homeowners should consider it only as a last resort because your credit rating is hurt if you choose a short sale or a deed in lieu of foreclosure instead of going all the way to foreclosure. You should first consider refinancing, if possible, or seek a loan modification from your lender.