In this deal, ball is in lender's court

By Dian Hymer

In the recent past, the inventory of homes for sale was pitifully low. Now, the number of homes for sale has increased in many areas. However, there are listings being offered for sale on less-than-advantageous terms. An example is the so-called "short sale."

In a conventional home sale, the buyer usually needs only the seller's acceptance in order to go forward with a transaction. However, in a short sale, the lender's approval is also needed in order for the sale to close.

A short sale occurs when a property sells for a price that is insufficient to pay back the loans secured against it and the seller's closing costs. In such a case, the sellers either have to come up with enough cash to cover the shortfall, or their lender(s) must agree to forgive the amount that the sellers are short in order for the sale to go through.

Short sales have not been a big part of the home sale market since the recession of the early 1990s. At that time, home prices dropped as much as 20 percent in some markets. Some sellers who purchased just before the recession with little cash down were unable to sell for a high-enough price to pay back the amount they owed.

A low cash down payment at that time was typically 10 percent of the purchase price. During the past couple of years, many high-income, low-cash-down home buyers used no-cash-down, interest-only mortgages to complete their purchase. If such a buyer is transferred a year later, loses his job or gets divorced and has to sell, a short-sale situation could occur, even if home prices haven't declined.

Here's why. A buyer who makes no down payment has no equity in the property. With an interest-only loan, the amount borrowed isn't reduced during the first years of the loan unless the borrower makes additional principal pay-downs.

If the mortgage is a pay-option variety that permits the borrower to pay less than an interest-only payment, the principal or amount borrowed could actually increase rather than decrease with each monthly mortgage payment. Couple that with scant home-price appreciation and a seller could come up short even if he sold for the amount he paid, once closing costs such as the brokerage commission and transfer taxes are taken into account.

HOUSE HUNTING TIP: Beware of sellers in short-sale situations who list their properties at below-market prices in order to entice buyers into making offers. Before getting serious, find out the amount of the loans that must be paid off to close the sale. If the loan amounts total more than the sellers' asking price, then you will either need to pay more, or the seller's lenders will need to agree to accept less than they're owed. That is, unless the sellers have savings to contribute to the sale.

Buyers who want to go ahead with a purchase that is subject to the lender's approval should be prepared for a longer-than-typical closing. Usually, the lender won't even take a short sale under consideration until the sellers have accepted an offer. It can then take three or four months before you'll know whether or not the lender will approve the sale.

THE CLOSING: Be sure to include a provision in the contract that allows you to withdraw at any time up until the lender approves the sale. This way you can get out of the contract without penalty if it looks like the transaction has little chance of closing.