Short sales are a big deal in San Diego housing market, a popular option for some of the one-third of county homeowners who owe more on their mortgages than their homes could sell for.
And they could get even more popular. The federal government next month plans to launch a program that will pay banks to approve short sales, and pay homeowners to do them.
The concept of a short sale is simple: A bank approves the homeowners’ request to sell a house for less than is owed on the mortgage, and forgives the rest of the debt.
The homeowners must prove to the bank they are unable to make the mortgage payments and are in some financial hardship.
There are several reasons why the lenders might prefer short sales to foreclosures. The bank won’t have to hire a cleanup or repair crew to fix up the house. Foreclosing and reselling also requires the bank to pay for the costs of selling the property, like putting up signs and hiring a real estate agent to take offers.
But the process is far from simple for any party.
The numbers show it.
In 2009, short sales counted for 18 percent of houses listed for sale in the county. But they only counted for 9 percent of the homes that actually sold in that same time.
Short sales take a long time, because the seller has to find someone who’s not only willing to buy the house but also to wait for the bank’s approval of the ultimate price.
Short sales are often painted as a palatable alternative to foreclosure for banks and borrowers. And there are perks. Homeowners who do a short sale instead of letting a house go to foreclosure often end up with less of a stain on their credit. And the turnaround is quicker to get back into the housing market. Short sellers can wait as little as two years to buy another house, compared to more than seven years after a foreclosure.
But selling — or buying — a short sale has its hazards. They take a long time: Sellers must grapple with hard-to-read banks for months or even years. Buyers must wait around for an acceptance that might not ever come. And even after the deal’s done, borrowers may end up with a tax bill for the forgiven debt.
Mark Dykstra knows short sales well. He finished two last year, and is working on his third.
While he waited for responses from the bank for a year, he kept paying his gardener for his 4,000-square-foot house in Escondido, and watered the orange, avocado and grapefruit trees.
These were Dykstra’s best attempts to leave the home he’d lived in for the better part of a decade in good condition — even though he was leaving under a financial dark cloud.
He’d bought the Escondido house in 2001 for $630,000. When it was eventually valued at more than $1.4 million, he’d taken bad advice to take cash out to buy investment real estate at the top of the market in 2006. At the same time in 2008, he sustained a severe cut in salary at the law firm he worked at. Dykstra declared bankruptcy.
“I’ve never had anything like this in my entire life happen to me,” he said.
But Dykstra, 48, didn’t want to leave the Escondido home in a cloud of smoke.
“It’s a little embarrassing, to say the least, to have to short sell a property,” he said. “We didn’t just want to walk away and leave everything.”
After about a year of negotiating with his lender and finding a buyer willing to pay about $700,000 for the home, Dykstra completed the short sale. The Eastlake investment home he’d paid about $600,000 for also sold short, to a buyer willing to pay about $300,000.
Two of his short sales closed last summer, a relief to Dykstra. But there’s still a shoe that could drop. Dykstra could face tax bills from California for the forgiven debt, though he hasn’t received any yet.
And despite finding a new job in Los Angeles, working on rebuilding his credit score and eyeing the possibility of buying another house as soon as a year from now, Dykstra’s not quite out of the woods.
Dykstra’s still waiting on one last sale for a condo in La Jolla he’s been trying to sell short for over a year and a half. The bank has threatened to sell the home at a foreclosure auction five or six times — and has postponed it each time. Dykstra hopes that means the short sale will go through and he can move on.
There’s a common complaint about short sales: They take a really long time.
It’s not uncommon for one to take eight months, 10 months, more than a year.
The first thing a troubled homeowner has to do is pen a letter to the bank explaining their financial distress. A lost job that halved their monthly earnings, unexpected medical bills popped up, an adjusting mortgage with skyrocketing monthly payments weighed them down.
The banks often take at least two or three months to review the initial application. In that time, a buyer might come on the scene, making an offer. It can be a couple of months before they hear from the bank to see if the buyer’s offer has been accepted.
Sometimes the buyer drops out, tired of waiting for months without any indication. Sometimes the lender tries to ask for more money. The bank gets another real estate broker to give an independent sense of its value.
Local real estate agents blame the banks for not putting enough resources into their short sale departments to handle all of the work.
Many borrowers must negotiate not just with one bank, but with two or three. And they’ve got to convince each one to take a loss.
The first bank to get paid off is the primary lender on the loan — the main mortgage the borrower is holding. It gets the most money. But if the first bank takes a loss, there’s not usually much money to be recouped by the second bank.
Enter a common pitfall to watch for:
In many cases, the first bank allows for the second bank — the “junior lender” — to be given a small amount of money, like $3,000.
But in many cases, the junior lender comes back and demands more money.
And that’s where things can get tricky. There have been cases where the junior lender has demanded more money in a payment that’s kept secret from the first lender. (The California Association of Realtors has warned that this might be illegal.)
That’s not the only potential snag.
Some homeowners who thought they were out scot-free after a short sale have gotten whacked with a surprise: A tax bill from the state.
Forgiven debt can be taxable.
The federal government has excluded forgiven debt from being taxable through 2011, but the state hasn’t.
Now, some homeowners who did short sales last year are getting tax bills from the state for several thousand dollars. Those homeowners, tax preparers and real estate pros are nervously watching the state Legislature work through a couple of laws that might make those bills go away, but as of now, the forgiven debt can be taxable.
In some cases, borrowers may be able to prove they are insolvent and get off the hook. Most real estate agents counsel their clients to talk with their tax accountants or with a real estate attorney before doing a short sale.
Then again, you could still get stuck with the same tax bill for walking away from a home, too.
From Dykstra’s story, you can see why short sales can be favorable from many angles. The buyers who purchased his homes got discounted prices from the peak of the market. The Escondido house wasn’t allowed to fall into disrepair, protecting some value for the lender, who didn’t have to clean up the property or hire an agent to sell it as a foreclosure.
And now, Dykstra is able to move on.
“I guess my story is, there’s light at the end of tunnel,” Dykstra said. “Just hang in there.”
Update: A reference to an individual’s medical condition has been removed.