A short sale is the sale of a home when the owner owes more on their mortgage(s) than the property is worth on the open market. The owner must obtain approval from all impacted mortgage holders to allow the sale.
Impact (also called deficiency) is calculated by lien position, starting with the most junior lien. Consider the following scenarios:
Scenario 1
1st Mortgage: $400k balance
Closing Costs: $25k (this includes agent commissions)
Home Market Value: $350k
Under this scenario, the homeowner is “selling short” by $75k. This is calculated by adding up all of the mortages and closing costs ($425k) and deducting the market value ($350k). The 1st lien holder would have to be approached to approve a sale and take a $75k loss.
Scenario 2
1st Mortgage: $400k balance
2nd Mortgage or Equity Line: $50k balance
Closing Costs: $25k (this includes agent commissions)
Home Market Value: $350k
Under this scenario, the homeowner is “selling short” and is deficient by $125k. This is calculated by adding up all of the mortages and closing costs ($475k) and deducting the market value ($350k). Since the 2nd lien is only $50k and we start deducting with the most junior lien, the 2nd is completely wiped out and the 1st will take a $75k hit. Both lien holders will have to be approached for short sale approval. In actual practice, the 1st lien holder will take a bigger hit than the basic math calculates as the 2nd lien holder will not release the lien without some payment. Typically, this amount ranges from $1k – $10k and is negotiated to come out of the amount going to the 1st. If the 1st lien holder allows a $5k payoff to the 2nd lien holder, then the 2nd really takes a $45k loss and the 1st takes a $80k loss.
Scenario 3
1st Mortgage: $250k balance
2nd Mortgage or Equity Line: $100k balance
Closing Costs: $25k (this includes agent commissions)
Home Market Value: $350k
Under this scenario, only the 2nd lien is under water. Total costs are $375k including loans and closing costs. This leaves a deficiency of $50k and the 2nd is owed $50k. The 1st would be completely paid off and the 2nd would have to be approached to approve the sale with a $50k payoff.
Other Considerations
These scenarios are portrayed in a very simplistic manner to help understand the basic concept. In reality, a short sale is a very delicate negotiation complicated by a variety of factors:
- Negotiating agreement between multiple lenders when applicable
- Approval of All Closing Cost Items
- Unpaid Property Taxes
- Back-HOA Dues
- Child Support of Alimony
- Mortgage Insurance on the Loan
- Moving Market Prices from Time-of-Offer to Time-of-Approval
- Having to Replace Buyers Who Do Not Stay Until Time-of-Approval
How the offer is initially negotiated and written up can have a serious impact on how the bank negotiations unfold. Negotiating the wrong factors or approaching the negotiator inappropriately will have your file pushed to the bottom or denied altogether. This is a “chess-game” and rushing down the board without first having your pieces in position can be disastrous. You have to live with the results, so don’t hire just any agent and leave it to chance!
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