I’ve read many stories about how we got into the current financial crisis. However, there is a series that Ira Glass is producing for NPR’s This American Life that tells the story in much more understandable, insightful, and entertaining terms than I’ve seen anywhere else. I would encourage you to check out the following programs, which you can either download as transcripts or you can stream them to your computer:

The Giant Pool Of Money – May 9, 2008

This Peabody Award winning show explains how Wall Street and homeowners are connected by a chain of middlemen and tap into a giant global pool of money and how this setup led to the current crisis.

The Watchmen – June 5, 2009

Who was minding the store when all this was going on? This show is very interesting in that it connects events that took place in the 1930s with today’s events and it becomes clear that for every fix the government can come up with there are eventually unintended consequences down the road.

Suppose you read my earlier post on why you should consider a short sale. What needs to happen in order to pull it off? Here is a short overview of the process.

Get The Right People Involved

It definitely helps to have a realtor involved in this process because there is a lot of back and forth, coordination, and information transfers. It’s really helpful to have someone handle all that for you – especially if they’ve been through this process before. A realtor can also help convince the bank that the property value warrants a short sale.

You will want to consult with an attorney because they can be helpful at several steps in this process, starting with getting your lender’s attention. One way to get your lender to consider a short sale is to stop paying your mortgage. However, I hear that is no longer the only way to get their attention and I wouldn’t recommend doing this without first consulting with an attorney. Then you will want your attorney involved again later in the process when your lender presents you with different settlement options so that you can understand the implications of them. For instance, you can sign a 0% interest note for the deficiency or the bank can just forgive the debt. Each of these alternatives has specific implications for your credit history, your future liabilities, and your taxes. You will probably want your attorney negotiating the terms of your deal for you, though your realtor will negotiate the offer with the lender.

Because of the tax consequences you’re also going to want to involve your accountant. For instance, under certain circumstances, when a sale is completed, you may receive a 1099 C from the lender that documents how large the deficiency was. As debt forgiveness, this would normally be taxable except that there is the Mortgage Forgiveness Debt Relief Act of 2007 that provides for this phantom income to not be taxable if the debt forgiveness is related to your principal residence and the debt is forgiven during 2007 – 2009.

Contact The Lender

Once you believe your lender is ready to consider a short sale someone needs to contact the lender to start the process. This is something your Realtor can actually do for you. The first step is to figure out who to talk to and to document the process. In general, you want to be dealing with the Loss Mitigation department, not customer service. They can outline the steps and the required documentation.

Prepare The Documents

Before the lender will have any discussions with your realtor that are specific to your case they are going to want to have an authorization on file that explicitly gives your permission for the lender to talk to the realtor. After that, the lender will need a short sale package on file. Every lender has a different process but in general the following documents are required in the short sale package:

• Copy of the listing agreement with any amendments
• A hardship letter, written by you, explaining your circumstances that require a short sale. If there is any supporting documentation such as medical bills or termination letters, those should be included.
• Financial information request form, which provides a summary of your income and expenses
• Copy of pay stubs
• Copy of income tax return
• Copy of property tax bills

Pricing The Property

Once your lender is in receipt of your short sale package and they have been authorized to talk to your realtor your realtor should call your lender to discuss pricing and the lender’s process for responding to offers. This is where a realtor can really add some value by figuring out what the lender’s targets are and how flexible they are. In addition, by understanding the process your realtor can set the appropriate expectations with potential buyers and possibly even expedite the response. The last thing you need is a realtor who just lets fate take its course.

Next Time

In another post I’ll cover what happens after an offer is made. In the meantime, if you would like some additional perspective on the short sale, check out this Atlanta based realtor’s blog.

Unfortunately, it looks like the NAR’s lobbying efforts are paying off since the US Treasury is now reported to be considering buying more mortgage backed securities in an effort to drive mortgage rates down to 4.5%. While this may be good news for buyers and sellers in the short run, it’s not the right policy for the country.

I almost choked during Paulson’s speech on Monday when he said “And we continue to look for additional ways to make mortgage credit more affordable, which will stimulate purchases, help to stabilize prices and end this housing correction.” Excuse me? If it’s a correction, how can you end it before it’s corrected? Why would you want to? What is Paulson thinking?

The only thing they can hope to accomplish with this initiative is to keep the housing bubble inflated just a bit longer. In the end, they can’t subsidize mortgage rats forever (I hope). When they finally take the punch bowl away prices will continue their slide and all the people that were enticed into buying will be underwater. In the meantime, the taxpayer will be footing the bill for this party.

What these folks seem to be ignoring is that the country is operating under an enormous debt level and there is no escaping the fact that we must deleverage. All I hear about are plans that involve adding more debt. I think someone needs to find the pods that are almost surely outside the office windows of our government officials before any more of them get snatched.

Short sales have become huge. Lawrence Yun, the eternally optimistic NAR economist, now estimates that short sales and foreclosures comprised 35 – 40% of all nationwide real estate transactions in October. They’re certainly becoming more common throughout the Chicago area – even in the more upscale neighborhoods. That’s one way to deflate a real estate bubble.

So what exactly is a short sale?

A short sale is a home sale where the proceeds of the sale are not going to be sufficient to pay off the mortgage. Consequently, the sale contract requires the bank’s approval. Exactly how a short sale is executed and how the payoff shortfall is resolved is something I’ll address another day.

So why should a seller pursue a short sale?

First and foremost a seller will want to consider a short sale when it becomes clear that they are not going to be able to sell their home at a price which will allow them to pay off the mortgage in its entirety and they don’t have the money to make up the difference. While the decision to conduct a short sale should only be reached after seeking appropriate legal and tax advice, generally it is seen as preferable to going through foreclosure. It can certainly be resolved faster, since it can be pursued prior to the lender completing the foreclosure process. The other way that it is seen as preferable to foreclosure is that it is believed to have less of a negative impact on your credit record, though I find conflicting information on exactly what the difference is:

• The NAR refers its members to the CBS News site (isn’t it odd that the supposed authorities on real estate refer people to CBS?), where they claim:

While in both cases, short sale and foreclosure, the delinquent mortgage will negatively affect their credit rating, at least short sellers avoid having a “debt discharged due to foreclosure” on their credit reports. Mortgage and credit experts say that, after bankruptcy, having a foreclosure on your credit report is the worst result and will reduce your credit score by over 250 points. You could also have to wait up to three years to qualify for a mortgage at a reasonable rate.

Short sales show up on a credit report as a “pre-foreclosure in redemption” status and can result in a credit score reduction of 100 points or less. After the sale, the mortgage may show up as “discharged.” People who successfully complete a short sale may also qualify for a mortgage at a reasonable interest rate in as little as 18 months. So, if buying a home is a future goal, then a short sale is the better option for many.

• Unfortunately, About.com indicates that the credit score impact is the same on a short sale as it is on a foreclosure, though they seem to agree with the CBS report on the other aspects of the differences.

And why should a buyer pursue a short sale?

Short sales can offer great values because the property is heading towards foreclosure, which is an expensive process for the lender. Consequently, the rational lender should be willing to accept a bargain price. Of course, we do not live in a rational world. If we did we wouldn’t be deflating the housing bubble right now. I hear countless stories of banks turning down short offers one day to only end up foreclosing many months later for even less money than they originally turned down.

Then there are the realtors who don’t even want to mess with short sales because it often takes forever to get an answer from the lender and sometimes commissions get cut. In fact, one national, discount real estate brokerage will not “support short sales” because “the chance of success is extremely low.” While there are elements of truth in all these concerns it’s not really right to short change a buyer by ignoring 40% of their opportunities.

Of course, the less that rationality prevails in the short sale world the better the values are for the rational players. I know of some exceptional values out there right now.