I recently spoke in Brighton, Mich., which is about 45 minutes outside of Detroit. Michigan is experiencing a very difficult buyer’s market. Prices are decreasing. The auto industry is experiencing massive layoffs. Many Michigan sellers lack sufficient equity to close a transaction. As a result, short sales have become an unpleasant fact of doing business. If your market is slowing down, you may be facing some of the same issues listed below.
Who is the decision maker?
Most lenders sell the loans they originate on the secondary market. In fact, it’s common for a single mortgage to be sold and resold several times. When you have a short sale, one of the greatest challenges is locating the person who has the power to approve the short sale. If you are aware that your sellers are going to lack sufficient funds to close their transaction, don’t put the property on the market until you have confirmed that the lender will work with you to close the short sale. If you cannot obtain this confirmation, don’t waste your time or money marketing a property that you will not be able to close.
How to cope with the tax consequences of a short sale
Be adamant that your client seek the advice of his/her CPA or tax attorney before proceeding with a short-sale transaction. In most cases, the amount the lender reduces the seller’s payoff is considered to be forgiveness of debt. This amount is normally taxable. If the seller has little or no income, there may not be any additional tax liability. Only a tax professional can make this determination. On the other hand, failure to report the forgiveness of debt as income may result in charges of fraud and/or tax evasion. If the IRS discovers this, it can file an IRS tax lien on any of the seller’s assets. The IRS has the power to deduct money from any of the seller’s bank accounts without the seller’s consent. Furthermore, IRS tax liens are difficult to expunge from the seller’s credit report and can take months to resolve. Again, do not enter into a transaction until the seller has examined all the legal and financial ramifications of taking a reduction in his/her loan balance.
Should the seller stop making payments?
It seems counterintuitive that most lenders will turn down your request for a short sale if the seller is currently making the payments. The only time they will consider a short sale is when the seller is delinquent. This presents a particularly difficult dilemma. Sellers who keep their payments current are protecting their credit rating. On the other hand, if they cannot do a short sale, they cannot move. Avoid advising them what to do because ultimately it’s their decision. Instead, refer them to a tax attorney or CPA who can advise them of their options as well as what they can do to minimize they negative impact on their credit.
No one realized that the seller wouldn’t have enough money to close
If you originally thought that the seller would have enough equity to close the transaction, and the offer the seller accepts comes up short, be sure to allot sufficient time to negotiate with the lender. Since it can take 90 to 120 days to conclude a short-sale negotiation, don’t begin this process unless the buyers are willing to wait that long to close.
Buyer’s best offer is $10,000 under the amount necessary to close
If the lender refuses to negotiate a short sale, one option that can protect the seller’s credit as well as helping you to close the transaction is to ask the lender to make a $10,000 personal loan to the seller who can pay it off at $100 or $200 per month. While the seller may resist this idea at first, it can actually result in a considerable savings when he/she applies for future loans or credit cards. If the seller has a delinquency on his/her home loan, a much higher interest rate will be charged on future purchases. For example, assume that a borrower with excellent credit pays 6 percent for a fixed-rate loan. The borrower with a foreclosure or delinquent payments may be required to pay 8 percent. On a $200,000 loan, the difference in interest payments would be $4,000 in the first year, or $12,000 in three years. Clearly, it’s better to payoff the difference rather than having a default.
Seller is moving up and doesn’t want to take less for the property
Assume the seller’s present property is worth $200,000 and he/she will be purchasing a property for $300,000. A 10 percent decline in value means that the seller’s current property has declined by $20,000 whereas the property he/she is purchasing will have declined by $30,000. This translates into a $10,000 benefit on the new purchase. A similar strategy works for those who are transferring to an area where there is appreciation. Each month the sellers hold out for a higher price, the properties in the area where they are transferring are increasing in value. Consequently, they will have a double negative — a declining value on their present property and increasing values on their future purchase.
If you’re in a down market, these issues may be on the horizon in the near future. Nevertheless, short sales can be a lucrative source of business, provided you have the negotiation skills to navigate through the maze of difficult issues you will encounter.
(Special thanks to Regina Benson and Nancy Bohlen in Brighton, Mich., for their contributions to today’s column).
Bernice Ross, national speaker and CEO of Realestatecoach.com, is the author of “Waging War on Real Estate’s Discounters” and “Who’s the Best Person to Sell My House?” Both are available online. She can be reached at email@example.com or visit her blog at www.LuxuryClues.com.