Ask some real estate agents about a certain type of short sale, and don't be surprised if they make a cross with their forefingers and back away, hissing. Not every real estate agent wants to tackle a short sale. Some agents have no experience, and others don't want to gain experience due to all of the horror stories they have heard about certain types of short sales.
A few bad short sale agents can mess up the short sale apple cart for everybody else. Not all short sales are awful. Some short sales are much easier than others. But the complexity tends to boil down to the type of short sale.
The type of short sale you could be facing -- whether you're buying or selling -- depends almost entirely on the type of mortgage secured to the subject property. The ramifications of that type of loan depend on state laws. A short sale in California, for example, is different from a short sale in Florida, because the laws are different.
The Three Types of Short Sale Loans
How a lender responds to a short sale request varies with the type of loan. There are three basic types of loans that affect a short sale, especially in trust deed states such as California and Arizona.
- Purchase Money Loan: A purchase money loan is a loan taken out to the buy the home. It is not a hard money loan. It can be one loan or two loans. Purchase money loans for owner-occupants typically offer the best interest rates. In some states, purchase money loans carry no recourse.
- Rate-and-term Refinance: This type of mortgage is generally known as a hard money loan. It is a loan that a homeowner originates after the home has been purchased and the sale closed. Another way to say it is, it is not a purchase money loan. The proceeds of this type of loan are used to pay off the existing loan, typically at a better rate of interest and/or term. It can be one loan or two loans.
- Cashout Refinance or Home Equity: This type of mortgage is also a hard money loan. This is basically the worst kind of loan to have on the books. It means the borrower tapped the home for cash and used that cash at the borrower's discretion. The purposes vary for a cashout refinance and range from paying for a college education or emergency medical services to more frivolous expenditures such as to pay for a European vacation or to buy a powerboat. A cashout refinance is generally one loan in the first position; whereas, a home equity loan could take the form of a junior loan in its entirety.
How Short Sale Banks Handle the Three Types of Short Sales
First, know that all banks are different; every short sale is unique. Banks take direction from their investors and the PSAs. However, the type of loan the bank is asked to forgive does tend to govern how the bank will respond. This takes into consideration, of course, that the short sale seller qualifies for the short sale through a hardship. If the premise of a hardship does not exist, the short sale might not get approved, regardless.
- Approval of a Purchase Money Short Sale: These are the easiest short sales for a bank to approve. Especially if the borrower is struggling to make the payments because of a financial hardship. In this instance, none of the money that crossed hands was created at the borrower's direction; it was initially money used to buy a home. However, it doesn't mean the lender will let the owner walk away from the home through a short sale without making a seller contribution. But the contribution, if any, is likely to be fairly small.
- Approval of Rate and Term Refinance Short Sale: This type of loan is almost on par with a purchase money loan except for the fact that in many states it carries recourse. The lender might be entitled to a deficiency judgment. For that reason, and because it's not a purchase money loan, sometimes banks and their investors will require a seller contribution. That's because a short sale can benefit the seller more than a foreclosure. The amount of contribution may depend on how much the bank and its investors believe it can collect, based on the financial information supplied by the seller.
- Approval of a Cashout Refinance Short Sale: No doubt about it -- the bank will ask for some type of seller contribution. In this type of short sale, the hardship matters but not nearly as much as the fact the bank handed out cash it is not getting back. It's almost as though some sellers are penalized by the bank. The seller contributions can be much higher than those requested to release a purchase money loan. Sellers may want to hire a lawyer with short sale experience to negotiate this type of short sale.