At their best, short sales are complex transactions where the lender that holds the current mortgage on the home has the final say on the deal the buyer and seller agree upon. But things can get even more complicated if the lender wants additional cash from the seller to settle up beyond what’s covered in the real estate contract.
As the buyer in the transaction, you might think this twist doesn’t affect you, but it absolutely could. If the seller doesn’t come up with more money, the entire deal could be derailed.
What should you do if your short sale requires a cash contribution? We’ve researched the topic thoroughly and discovered some possible options to help you see your short sale deal through to the finish. If you’re considering making an offer on a short sale, it’s a good idea to be prepared for such a scenario.
What is a short sale?
A short sale occurs when the homeowners owe more on their mortgage than the home is worth and are in danger of being foreclosed on. Instead of foreclosing, however, the lender agrees to let the homeowners sell the house. It’s a “short” sale because the lender may settle for the proceeds even if they fall short of the remaining amount due on the mortgage.
Lenders agree to short sales because it saves them the cost and trouble of foreclosing on the home and maintaining the property until they can sell it. However, in a short sale, the lender will insist on approving the deal between the seller and buyer.
The lender’s goal is to be sure it gets the most money possible out of the deal and to limit its losses. That can slow down the homebuying process and complicate it because more parties are involved in the sale — the buyer, the seller, and the seller’s lender or the company that currently owns the mortgage.
Sometimes more than one department at the lender has a say in the deal, and those departments may not communicate well with each other.
What causes short sales?
Short sales were common during and after the Great Recession, tapering off after 2010. That recession involved a housing bubble; home prices fell, and some people found their homes were worth less than the mortgage on them.
While you don’t hear as much about short sales these days, homeowners can still find themselves in that situation, especially when they take out a no- or low-down-payment loan and get overleveraged.
Kelly Hollowell, an agent in the Chesapeake, Virginia, area, who works with 75% more single-family homes than the average agent in her area, expects fewer short sales to come out of the economic downturn the COVID-19 pandemic has caused.
Hollowell, who has 26 years’ experience as a real estate agent, noted that home prices went up during the 2020 downturn, rather than dropping as they did in 2009. Rising prices give homeowners more equity in their houses, so they’re less likely to be underwater, owing more than the home is worth.
So far, short sales don’t seem to have increased because of the economic downturn caused by the pandemic. Homes in preforeclosure, which would be likely candidates for a short sale, were down more than 80% in November 2020 from 2019, according to RealtyTrac. The decline in preforeclosures is likely tied to loan forbearance rules included in the pandemic relief CARES Act that was enacted early in 2020. However, there is no way to predict how much relief homeowners will receive in the future, or if the low numbers of preforeclosures will continue once the law’s protections end.
What’s a cash contribution in a short sale?
Sometimes, the lender in a short sale will ask the seller for more than the proceeds of the sale as a way to reduce their loss taken on the loan. This is known as a cash contribution.
In some cases, the seller might have a second mortgage on the house, and the lender holding that second mortgage is the one seeking a cash contribution.
The size of the requested cash contribution varies, depending on several factors, including details of the mortgage and the seller’s financial condition. It could be as much as several thousand dollars, although the seller may be able to negotiate the amount down.
When might a lender ask for a cash contribution in a short sale?
The lender is most likely to ask for a cash contribution when they know that the seller has liquid assets, such as money in a bank account. Fannie Mae — a government-sponsored entity that purchases and securitizes mortgages in the United States — lists two instances in which the mortgage servicer must request a cash contribution.
- The seller has cash reserves of more than $10,000, not including money in retirement funds.
- The seller’s housing expense-to-income ratio is less than 40%. In other words, the mortgage costs — including principal, interest, property taxes, and homeowner’s insurance — add up to less than 40% of the seller’s income.
While you, as a buyer, don’t know the details of the seller’s financial condition, a few situations provide a clue that a cash contribution is likely.
For instance, if the property was an investment or vacation home instead of the seller’s primary home, the lender may want a cash contribution. (You may be able to do some research to see if the house was ever a rental, indicating it was an investment property.)
Another situation where the lender might require a cash contribution is if the seller refinanced the house to pull money out of equity.
Other clues that the lender might require a cash contribution include:
- The seller has maintained a good credit score
- The seller doesn’t have a lot of other debt
- The seller was able to keep up with mortgage payments
What are your choices when it comes to making a cash contribution?
If you’re lucky, as a buyer, you won’t have to deal with the seller’s cash contribution issues at all. In fact, Hollowell says she’s never had to deal with the problem. Neither has her manager, who has 30 years in the real estate industry.
So, in the best-case scenario, the buyer never even hears about the cash contribution.
Likely, the seller will follow one of these options:
- Make the cash contribution the lender requested
- Convince the lender to reduce or waive the amount altogether, possibly by sending the lender a hardship letter
- Give the lender a promissory note — basically, an IOU — stating that they will pay the amount later
- Borrow the money from family or friends
What if the seller asks you to put up some cash to help with the contribution?
Your first step should be to suggest the seller exhaust all their other options, from writing a hardship letter to seeing if a relative will loan them the money.
But if it comes down to you, what should you do?
Don’t act hastily. “It can take months to get approval on a short sale,” Hollowell notes, and if a buyer thinks that throwing in some more cash will get the sale done, they might want to jump on it. However, adding more money to the deal could disrupt your financial picture or even disqualify you for the mortgage you’re approved for. Talk to your lender to make sure you’re not jeopardizing your mortgage before agreeing to spend more.
Also, carefully consider whether you can spare the money. Short sale homes often need repairs, and if you were saving that money for a new roof or maintenance issues, think about whether those home improvement projects can wait.
If you do decide you’re willing to provide the cash, Hollowell suggests you first learn whether raising the sales price on the house would work. Otherwise, you’ll have to make sure the lender will allow you to provide the money as a gift to the seller, with documents that clarify it’s not a loan that must be repaid.
Consider a short sale negotiator
Short sales are complex deals that can easily take several months to complete. Working with a qualified real estate agent who can guide you through the process is a smart move.
Some attorneys specialize in short sale negotiations. Sellers who want to get out of their mortgage with a short sale may hire these lawyers when they start negotiating with the bank, but both buyers and sellers benefit from working with a specialist, says Hollowell.
She suggests that you and your agent might want to “look for short sales that are being handled by attorneys that specialize in short sales. You’ll cut your time and frustration if you’re working with a professional negotiator.”
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