TABLE OF CONTENTS
Introduction
A short sale is a sales transaction in which the seller's mortgage lender agrees to accept a payoff of less than the balance due on the loan. A short sale often, but not always, involves a property in foreclosure.
For various reasons, some borrowers may not be able to fulfill their mortgage obligations. When a borrower is no longer in a position to make the mortgage payments, is facing foreclosure, and the current market value of the property - including escrow and closing costs - is less than the loan(s) on the property, the borrower may consider a short sale. This could save the lender the expenses of foreclosure proceedings and from having another REO property on its books. From the borrower’s perspective, the short sale prevents having the foreclosure on the borrower’s credit history, and releases the borrower from an obligation that he or she can no longer afford.
A short sale requires significant paperwork and preparation on behalf of the borrower. Typically, before a short sale is approved, a ready buyer must be found, and all the paper work prepared to present to the lender. The buyer of the property must also be prepared for a protracted time period to conclude the purchase of the property.
For a complete list of forms and paperwork required, read below. For a summary of short sale real estate forms and lender submission paperwork guidelines, click here.
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Lender Options Upon Borrower’s Loan Default
Q 1. What options does a lender have on a debt secured by California real property if the borrower does not make the payments on the loan?
A A lender may foreclose on the defaulting borrower's real property which secures the loan. There are two types of “foreclosures” available to a lender: a trustee’s sale and a judicial foreclosure. Technically, a trustee’s sale is not a “foreclosure” but the term has been used for both a trustee’s sale as well as a judicial foreclosure.
For certain loans, a lender has no choice and must conduct a trustee’s sale. With a trustee’s sale, a lender typically cannot go after a deficiency judgment. A deficiency occurs when the current market value of the property is less than the loan on the property.
The lender may also be able to pursue "guarantors" of the debt who have signed written guarantee agreements (not including the borrowers).
Q 2. What other options may the lender consider instead of foreclosure when the borrower is delinquent?
A Depending on the situation, a lender may consider one of the following:
Loan Workout: Basically, a loan workout is any resolution of a problem loan between the lender and borrower that modifies the original loan agreement. Some of these options include forbearance (e.g. forgiving a portion of the debt or late charges); deferment; renegotiating interest rate, monthly payment amount, principal amount, maturity date; or the enforcement an acceleration clause in the loan.
Deed in Lieu of Foreclosure: After the borrower is in default, the borrower voluntarily delivers title to the lender for consideration and the lender accepts the conveyance of the property in full satisfaction of the mortgage debt. The vast majority of banks are not accepting these in today's market.
Short Sale*: A short sale is a transaction in which a lender allows the real property securing the loan to be sold for less than the remaining mortgage amount due and accepts the proceeds as full payment of the loan. A lender may accept a short sale when the borrower is in severe financial straits and market conditions make a short sale the best choice to mitigate the lender’s damages. This saves the lender the costs of foreclosure and the borrower avoids having a foreclosure on his or her credit report.
Short Payoff*: With a short payoff, the lender accepts less than the remaining mortgage amount as full payment of the loan. The property need not be sold. Like the Deed in Lieu of Foreclosure, the Short Payoff is not often accepted by banks in today's market.
*Note: Some lenders do not differentiate between a short sale and a short payoff.
Q 3. Why would a lender agree to accept a short sale?
A Lenders may have ample incentive to negotiate a short sale with a distressed borrower. For example, should the lender take back a property pursuant to a foreclosure sale, the lender would become responsible for a variety of costs, including property maintenance, utilities, HOA fees, and might risk destruction of the property by vandalism. Furthermore, lender-owned properties (REO) may take a long time to sell, in part because so many REO properties are now for sale.
A lender will typically evaluate the financial situation of the borrower as well as current market conditions to determine whether or not to agree to a short sale. It is really a business decision for the lender to determine whether it would receive more money by accepting the short sale, or completing a foreclosure, reselling the property, and pursuing personal liability (i.e. deficiency judgment against the borrower.)
Effect On Borrowers in Short Sales
Q 4. How does a short sale affect a borrower's credit rating?
A A lender may report a short sale loan as being “Satisfied.” Natalie Lohrenz, director of counseling for Consumer Credit Counseling Service of Orange County in Santa Ana, California, stated in a November, 2007 MSN Money article "Most of the time, a short sale shows simply that a debt is satisfied," says Lohrenz. To view the full article, click here.
A lender may also report the short sale loan as being settled for less than the full balance, such as “Settled,” or “Paid Settled.” This would show up on the borrower’s credit report as a negative mark. However the lender enters the information, a short sale record will be far less damaging to the borrower's credit report than a foreclosure.
Q 5. Suppose the borrower is late with his/her mortgage payments, causing the lender to begin the foreclosure process by filing a notice of default. Before the foreclosure sale occurs, the borrower pays the lender what is owed on the note. Will these activities appear on the borrower's credit report?
A Yes. The lender will report to a credit bureau receipt of any payments made 30, 60, 90 or more days after their due date. This may appear on a borrower's credit report as a "foreclosure in process," "foreclosure proceedings," "current was 30," or in some other way. Any such terms, or other similar reporting comments, harm that individual's overall credit rating.
Q 6. Is the method by which lenders report a short sale a negotiable item?
A Typically, no. The short sale is usually reported to credit reporting agencies as settled for less than the full balance. However, a borrower may try to negotiate this at the time the short sale is being arranged.
Q 7. Are there any risks to borrowers when negotiating a short sale with their lender?
A Yes. In preparing a short sale package, be careful about discrepancies between the seller's income and the income used to obtain the loan. A big gap may indicate mortgage fraud, unless employment circumstances have changes dramatically.
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Q 8. Are there any tax effects of a short sale?
A Maybe. The seller may be obligated to pay taxes on any debt forgiven by the lender. Debt forgiveness may be considered ordinary income and taxable at the seller’s ordinary tax-bracket. This disclosure to the Seller must be in writing. This information is contained in the Purchase Agreement Addendum (PAA) and the Short Sale Listing Addendum (SSL). It is recommended that the borrower seek the advice of a professional tax advisor.
Generally speaking, any relief of indebtedness is taxed as ordinary income. There are however, some exceptions to this rule that may benefit a taxpayer involved in a short sale:
1. Non-recourse debt - If the borrower never refinanced the home, the mortgage is probably non-recourse debt. That means the lender has no right to anything but the value of the home, so there is no debt-cancellation income. If the home has been refinanced, however, the mortgage is generally considered "recourse" debt.
2. Insolvency - Sellers who are insolvent at the time of the cancellation of debt will not have to pay taxes on the forgiven amount. Insolvency would occur when a borrower’s liabilities exceed assets. Note that seller would have to show this insolvency to the IRS when filing a tax return.
3. Bankruptcy - Debts discharged through bankruptcy are not considered debt-cancellation income.
4. The Mortgage Forgiveness Debt Relief Act of 2007 (Public Law No: 110-142) was passed in December, 2007. It provides relief to many people who have lost their home due to a short sale, foreclosure, deed in lieu of foreclosure, or any similar arrangement that relieves the borrower of the obligation to pay some portion of their debt.
The bill - an amendment to H.R. 3648 - amends the Internal Revenue Code to exclude from gross income amounts attributable to a discharge, prior to January1, 2010, of indebtedness incurred to acquire a principal residence. It reduces the basis of a principal residence by the amount of discharged indebtedness excluded from gross income. It limits to $2 million the excludable amount of such indebtedness. It also sets forth rules for determining the allowable amount of the exclusion for taxpayers with nonqualifying indebtedness and taxpayers who are insolvent.
For more information on the tax implications of short sales, see the CAR legal article, Taxation of Foreclosures, Deeds in Lieu of Foreclosure, and Short Sales. The CAR article does not however, contain the updated information on The Mortgage Forgiveness Debt Relief Act of 2007.
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Deficiency Judgments on Short Sales
Q 9. Is the Seller in a Short Sale responsible for any Deficiency Judgments?
A A deficiency judgment is a judgment obtained by the lender in court against the borrower (Seller) for the difference between the unpaid balance of the secured debt and the amount produced by sale or the fair market value of the security, whichever is greater, in a judicial foreclosure.
California has “anti-deficiency statutes” that protect certain borrowers from deficiency judgments. A California lender typically would opt for a trustee’s sale foreclosure which is quicker and less expensive than a judicial foreclosure. A trustee’s sale foreclosure does not involve the courts.
A lender may obtain a deficiency judgment only with a judicial foreclosure. With a trustee’s sale foreclosure, the lender cannot go after a deficiency judgment.
The following are general rules governing deficiency judgments:
- A lender must pursue the security before pursuing a borrower individually for a debt;
- No deficiency judgment is allowed following a trustee's sale;
- No deficiency judgment is allowed when the loan is a seller carry back; and
- No deficiency judgment is allowed when the loan is a purchase money loan for residential property containing one-to-four dwelling units.
Of course in law, there are always exceptions to the general rules and such is the case with the law of deficiency judgments. Click here for more information on Deficiency Judgments and California Law, and when exceptions may apply. Click here to view a legal chart to determine when a borrower may be liable for a deficiency judgment.
Also bear in mind, there are a couple of California-specific legal wrinkles to consider. Most loss mitigators are being trained to ask borrowers to sign a note for any unsecured balance in order to approve the short sale. Say no to such requests and explain to loss mitigators that it’s a non-recourse loan.
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Short Sale Application Process and Other Issues
Q 10. What is the process for applying for a short sale?
A A seller should know the ramifications of a successful short-pay agreement with their lender. An agent considering taking a listing on a short pay should advise the seller, in writing, to seek tax and legal advice before signing the listing agreement. For this purpose, use the Short Sale Listing Addendum (SSL) and the WRG form “Short Sale and Tax Liability Disclosure."
It is always in the best interest of the borrower to keep the lender informed. If the borrower is in default of the loan and is contemplating a short sale, it would be best to let the lender know as soon as you sign the Listing Agreement. The Authorization to Receive and Convey Information (CAR form ARC) provides the seller’s written consent for the Agent to communicate with the lender.
The listing agent should also send a letter to the lender confirming that the agent is not acting on behalf of the lender (Non-Agency Agreement). This helps avoid any claims that the agent is also a fiduciary for the lender. The lender may also grant more time to the borrower to find a buyer.
Short sales are negotiated on a case by case, lender by lender basis. The bank may be receptive to a reasonable offer if the situation warrants it. If the bank does not like the offer, they will counter on items of price, repairs, COE, etc.
In general, the Short Sale Process goes as follows:
- First, the Seller must sign a listing agreement and all required documents, such as the Authorization to Convey Information (ARC) form.
- Next, the Seller should begin to assemble all necessary financial documents.
- The property is marketed and a buyer must be found.
- The purchase offer, along with all the Seller financial documents, must be submitted to the lender.
- The lender will send out an appraiser to ensure the buyer's offer is appropriate.
- The lender will make a determination on whether or not to agree to the short sale.
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Q 11. What documentation will a lender typically require?
A A seller should know that a lender will likely require detailed financial statements from the seller as a condition for approving a short pay. A listing agent may add a statement in the listing agreement obligating the seller to cooperate with the lender’s requests. Lenders will typically require a distressed borrower to furnish a variety of documents, which could include any of the following:
- "Hardship Letter" - Written explanation of the hardship the borrower is experiencing. Click here for sample. Click "File," "Save as," then "Save" to save this to your computer.
- Copy of the purchase contract signed by both the buyer and seller
- Copy of the TDS
- Proof of the buyer's ability to purchase the property. Example: pre-approval by a lender or evidence of cash on hand (bank statement)
- Copy of the certified escrow instructions
- Preliminary title report
- Completed and signed IRS Form 4506, "Request for Copy of Tax Form"
- Completed and signed personal financial statement
- Previous two years tax returns
- Copies of all past due secured and unsecured debt notices
- Copies of the latest mortgage statements
- Copy of current tax bill
- Employment paycheck stubs for the past two months
- Profit and loss statement (if the borrower is self-employed)
- Copy of current bank statements
- Estimated net statement (HUD) by an escrow officer
- Broker price opinion (BPO), recent appraisal, or comps showing an assessment of the property’s condition and worth, an outline of current market conditions, including the number of sales versus listings and the number of distressed properties on the market. You want to show lenders they’re financially better off today with a short sale than they are with an REO later.
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Q 12. What else can be done to improve the chances of a successful short sale?
A There are several things you can do to improve your chances of a successful outcome:
Dealing with Lenders:
- Establish a good working relationship with the person representing the lender. Try to get them on your side and present yourself as a competent real estate agent who is thorough and timely in obtaining any documents they request.
- Whenever possible, try to work in situations where there is just one lender involved, instead of two.
- When you have two loans, you must obtain lender approval from both the first and second. The second mortgage holder often is the one to hold up or even turn down the initial deal. Make dealing with the second mortgage lender a priority.
- Many lenders are ill-equipped for the onslaught of problems associated with subprime borrowers and are short on staff, time, and patience. You could call the lender several days in a row and not get a call back. Consider doing something different to get their attention. For example, send your materials in a brightly colored envelope. The strategy: Staffers will start recognizing that the packages are complete and can be processed quickly.
- Keep an open communication line between you, the buyer's agent, and the lender. Make sure both parties stay current with all relevant updates.
- Contact the lenders and ask for a short sale package, which outlines the given lender’s modus operandi. The aim is to make a plea on behalf of clients by illustrating their hardships. If there are second and third mortgage holders, send the same package to them.
- The lender will tell you exactly what they will want from the seller in order to facilitate their decision, but it helps to anticipate and prepare what they will need at a minimum: a preliminary net sheet, a hardship letter, proof of assets and liabilities, personal financial statement, copies of bank statements, and a comparable Market Analysis. Have these ready to go in advance of their request.
- The hardship letter outlining the homeowner’s crisis is an important component of the short sale package. It is preferable to ask for a hand-written letter from the homeowners. Your goal is for them to write a letter that leaves a tear on the page. After all, human beings read the letter and the words should be moving.
- Develop a broker price opinion (BPO) - an assessment of the property’s condition and worth, and outline current market conditions, including the number of sales versus listings and the number of distressed properties on the market. You want to show lenders they’re financially better off today with a short sale than they are with an REO later.
- Negotiation skills are critical, especially since all aspects of the deal are subject to lender approval. You’ll also have to negotiate with second lien holders and get them to accept the terms. When you present offers to lenders, be prepared for a ‘no’ out of the gate. Youhave to arrive at a price and timetable agreeable to all parties.
- Be accurate on your HUD-1 net sheet statement figures showing what the lenders will net.
- Document, Document, Document - Try to get all communications in writing. Be sure you include, date, time, name of person and details of any phone discussion. Consider confirming the phone conversation with a follow up email or correspondence.
- Use your "activity log" documentation in your correspondence to back up the fact that you have followed through consistently on the transaction and need them to do their part. This may help postpone a trustee sale.
- If you can't get through to the negotiator, but speak with a customer service representative, have them email the negotiator. Give them a message stressing urgency, and have them read the message back to you. Don't let the representative just email the negotiator to email you.
- If you can't get through on the phone, try sending your communication via certified mail. They will have to sign for it and pay attention to your communication!
- If you can't get through to the negotiator through the short sale department, try getting through via a different department - such as loss mitigation.
- When you talk to the Lender, if you are at a critical juncture and you are not getting a timely response, ask to speak with a Supervisor or a person capable of making a decision.
When you communicate with the Buyer's Agent, remind them to:
- Prepare the buyer for possible extensions on the closing date.
- Be certain buyers are fully qualified and pre-approved. Once lenders say "go," closings tend to happen quickly.
- Be careful about locking the loan as the closing date may change.
- Remember there properties are generally sold “as-is.”
- Encourage patience!
When you Communicating with Escrow and Title:
- Inform escrow at the opening that this will be a short sale.
- When requesting an estimated net sheet, give escrow every charge that you anticipate. It is more difficult to negotiate allowable expenditures with the lender later.
- Communicate any and all changes.
- Be sure escrow has the contact information to order all the demands. Allow time for updating the demands at close.
- Ask the seller at the beginning if they have any current or upcoming general liens, tax liens, or judgments you should know about. If there is, it's very important that these are put on the initial net sheet.
- Get a Statement of Information from the Seller UPFRONT. This will allow the title company a chance to check for any undeclared or unknown liens or judgments. If there are any, you can have them addressed in your initial net sheet submitted to the lender.
- Check with the title company at the beginning and throughout the transaction to ensure no new liens or judgments appear on the property title report.
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Disclosure Requirements in Short Sales
Q 13. Must a real estate transfer disclosure statement be given to a buyer in a short sale transaction?
A Yes, if the property being sold is a residential 1-4 unit dwelling and the transaction doesn't fall into one of the regular TDS exemption categories. No exemption exists for a short sale transaction in which the borrower sells the property to an outside buyer, using the sale proceeds to pay off the lender.
Q 14. Must other disclosures be given to a buyer (or seller) pursuant to a short sale?
A Yes. Short sales are treated just like any other sales transaction. See C.A.R. legal article, Sales Disclosure Chart for REALTORS®, for a summary of the disclosure requirements.
Q 15. Should a listing agent working with a distressed seller attempt to negotiate a future listing agreement with the lender?
A Listing agents working with distressed sellers owe them a fiduciary duty. Since in a short sale situation a lender could choose to foreclose on the seller, the lender's interests are potentially adverse to the seller's interests. Be careful about attempting to negotiate a future listing agreement with the lender, because it raises the issues of "to whom is the agent's loyalty devoted" and "has the agent violated the fiduciary duty he/she owes the seller."
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Short Sale Legal Forms
Q 16. What forms do I use when representing a short sale Seller?
A Short Sales can be a mine field of legal issues, so be careful to follow all elements of the law and use all appropriate forms. The Home Equity Sales Act and the Foreclosure Consultant Act both have laws and provisions affecting these transactions.
If you are working with a Seller as an Agent, you will used the following forms, in addition to the standard CAR forms and disclosures:
- Standard Residential Listing Agreement (LA)
- Seller's Advisory (SA)
- Real Estate Agency Relationship Disclosure (AD-11)
- Short Sale Listing Addendum (SSL)
- Short Sale Addendum (SSA)
- Authorization to Receive and Convey Information (form ARC). This form allows the Agent to negotiate with lenders on behalf of the seller. Make sure you get Authorization for each loan on the property.
- WRG/WHL Attorney Accountant Recommendation Disclosure
- All other standard forms and disclosures, including the Transfer Disclosure Statement (TDS).
The listing agreement as well as the MLS information should show the property is subject to short sale. Both the Listing Agreement and the MLS confidential remarks section should contain the statement: “Short sale and gross commission subject to lender approval. Any commission reduction to be split 50/50.” You should also indicate "Yes" in answer to the MLS listing question "Subject to Court/Lender Approval?"
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Q 17. What forms do I use when representing a short sale Buyer?
A If you are working with a primary resident buyer (the buyer intends to occupy the property) and make an offer for a property that is being sold as a "short sale," standard CAR forms and disclosures should be used, including the following:
- Standard C.A.R. Purchase Agreement
- Short Sale Addendum (SSA)
- Addendum to the Purchase Agreement (APA). Complete the form, including checking the box on page 2, item #6, entitled "Short Pay."
- WRG/WHL Attorney Accountant Recommendation Disclosure
- All other standard forms and disclosures
An agent may also represent a primary resident buyer of a residential, owner-occupied property that is a short sale AND has a Notice of Default (NOD) filed on it, if it is going to be the buyer’s primary residence. The standard Purchase Agreement, with all forms and disclosures listed above, should be used for these transactions.
A pest inspection will generally be required by the buyer’s lender (unless it is an all cash deal). A home inspection should also always to done to protect the buyer. All purchase offers should also include a home warranty provision.
Q 18. What forms do I use when representing a short sale Investor?
A If you are working with an Investor Buyer of an owner-occupied residential property that is advertised as a short sale, has an NOD filed on it, and the Investor does NOT intend to occupy the property, the Home Equity Sales Act (HESA) requirements apply.
Until March 2008, the home equity sales contracts (HESA) law imposed a statutory requirement for a buyer's agent to be bonded by an insurer in the amount equal to twice the fair market value of the subject property. Yet, no insurer offered the requisite bond in California.
HOWEVER, Under the March 2008 ruling of Schweitzer v. Westminster Investment, a buyers' agents MAY represent investors without obtaining the surety bond required under the home equity sales contracts law. Buyers and their agents must nevertheless comply with the other requirements of the home equity sales contracts law. Most notably, buyers and their agents should use C.A.R.'s standard form Notice of Default Purchase Agreement (NODPA) revised In the April, 2008 CAR forms release.
Therefore, when an agent is working with an investor buyer who ultimately pursues an offer for an Owner-Occupied residential property that is a short sale AND has a Notice of Default (NOD) filed on it, CAR recommends using:
- Notice of Default Purchase Agreement (NODPA)
- Notice of Cancellation of Notice of Default Purchase Agreement (HENC)
- Short Sale Addendum (SSA)
Q 19. What happens if there is no NOD on the subject property, but one is recorded during the process?
A If during the process, an NOD is recorded and you are working with a buyer or seller, and the buyer is an investor, then the provisions of HESA apply.
All additional disclosures must be given, per state law. The recording of the Notice of Default (NOD) always triggers the provisions and requirements of the Home Equity Sales Act (HESA).
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Marketing for Short Sales
Q 20. How do I find Short Sale Prospects?
A There are several ways to find Short Sale prospects:
- Check the notice of default lists from title companies. Send out letters, postcards, or drop by for a visit. Introduce yourself as a realtor and ask if they know anyone interested in buying or selling. The owner may eventually move the conversation to their own situation when they are comfortable.
- Search for-sale by owner sites and magazines. People often sell on their own because they can’t keep up with payments and believe they’re not able to pay an agent’s commission.
- Check with title companies to find out what ARMs are about to reset in a given neighborhood.
- Advertise your short sale expertise to clients and colleagues. You may receive many referrals from colleagues who don’t know how to work short sales.
- Promote your services to individuals attending credit counseling classes.
- Work your neighborhood. Walk a farm area, chat with people, leave your business card, and ask for referrals.
- Promote short sales to buyers. Tap your pool of interested buyers when a short sale comes up.
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Q 21. How do I Qualify Short Sale Prospects?
A Examine loan terms to determine if there are second or third mortgages and prepayment penalties. Also assess clients’ financial status and whether they meet the criteria for relief.
Lenders will accept job losses, illness, death, and divorce as hardships, but typically won’t offer relief for someone who gambled away assets.
Once NODs are filed, there’s little time (approximately 122 days from NOD to Trustee’s sale) to sell properties before lenders take them back, so the earlier in the process you get started, the better your chances of selling a property at market value.
Most lenders won’t consider a short sale until homeowners are behind on payments, though some are starting to in order to avoid having an REO. But you have to demonstrate homeowners’ inability to meet their payments.
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Q 22. Are there Restrictions on Agents Advertising for Short Sale Clients?
A While it is lawful to solicit these potential customers, licensees should be careful to avoid making false and misleading claims in their advertisements. Also, licensees should be certain not to make any representations that could place the licensee within the definition of a “Foreclosure Consultant.” No promises or guarantees should be included in any advertisements. Click here for more information on Short Sale Advertising.
Q 23. How are Agents affected by the Do-Not-Call and Do-Not Email Laws?
A Telephone calls are an important part of an Agent's business. However, whether it’s calling an individual who was referred to you or soliciting a list of homeowners by cold calling, Agents must be mindful of any applicable do-not-call rules. Click here for a general overview of the legal and practical issues concerning the do-not-call rules.
Click here to review the Watkins Realty Group Do-Not-Call Policy.
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Conclusion
There is a lot of business and money to be made in short sales, and remember you are striving for a “Win-Win” result.
First of all, you are helping the Sellers get out before it is too late. Homeowners benefit by being released from an obligation they can no longer afford, and by avoiding the long-term negative consequences to their credit associated with a foreclosure.
Lenders benefit because they can avoid the substantial expense of a foreclosure proceeding. Most lenders do not want to own the properties used as collateral for their loans, because the maintenance costs and taxes decrease their profitability.
When you help out the homeowner in a short sale, they will tell everyone they know about you, which will in turn bring you more listings. The process will also allow you to get closer to someone with the bank. Putting a deal together successfully can bring you even more work from the bank through REO listings in the future.
Short Sales and REOs are not easy. But for those Agents who have patience and a positive attitude, there is a lot of opportunity!
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Sample Seller's Agent Forms to Download
Sample Buyer's Agent Forms to Download
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