“My wife and I bought a brand new home in Sacramento in 2005. We paid $515,000, taking out 2 loans, both with Bank of America. Our balance is about $505,000 but our home is only worth $210,000. We have no financial hardship, really. I am still employed with the same company; my wife works part-time although she’s about to be laid off. Still, I make about $150,000 a year. We can afford our payments, yet we’d like to get out from this underwater home. Is there any hope for us? Or will the bank reject our short sale without a hardship?”
Generally speaking, sellers need a hardship to do a short sale, however; there are ways to do a short sale without a hardship. First, understand there is no guarantee that a bank will agree to accept a short sale and release the loan under circumstances that involve a hardship, much less those without a hardship. Every bank is different. Investor guidelines vary. Moreover, some PSAs really run the show.
What is a Short Sale Hardship?
Sometimes a hardship is a matter of perception. A hardship is defined as a condition that is difficult to endure. It may involve a form of suffering. You don’t have to be living in a cardboard box under a bridge to have a hardship. You can be an NBA star like Ron Artest, who bought a home for $1.85 million in Loomis, CA, and later sold it as a short sale for $1 million. His home’s value fell by almost half. Artest was earning $7.5 million when he bought the home. That income dropped to $5.85 million when he sold. Artest lost about 23% of his earning power — that’s a hardship.
Here are sample types of a hardship. Lenders will consider the following conditions, and they don’t have to have happened personally to you. It could be a family member who supports you — financially or emotionally or both — or on whom you rely for support who has suffered a hardship such as:
Unemployment
Reduced income (furloughs, new job, partner’s loss of job, pay cut)
Illness or medical emergency
Job transfer (voluntary or involuntary)
Divorce, separation or marital difficulties
Exotic mortgage terms (an adjustable-rate loan)
Military service
Death in the family
Incarceration
Increased expenses and excessive debt
Unexpected repairs or home maintenance
The Strategic Short Sale Walk Away
The motivation of many sellers who want to do a short sale is the problem that their mortgage balances are generally higher than the value of their homes. They owe more than their homes are worth. These sellers do not want to go through foreclosure for a variety of reasons, and they hope to somewhat protect their credit rating.
The simple solution would be to do a loan modification that reduces the principal balance below the home’s market value. In effect, this would be selling the short sale home back to its owner, thereby letting the owner stay in the home. That would make a lot of sense. But no, that’s not how our system in the United States works.
To do a short sale, the seller must sell and move, rent for a few years and then buy a home very similar to or perhaps even nicer than the home the sellers already had. I know, it’s stupid.
The easiest way to do a strategic short sale is to write a strong and honest hardship letter. Put some thought into it. What may not be a hardship to your son’s English teacher can very well still be a hardship to you. If you owned a home in South Dakota and your job transferred to you Hawaii, that’s a hardship, even though some people might consider Hawaii to be one of the best places to live in America.
Here are other steps:
Hire an experienced short sale listing agent.
Talk to a lawyer familiar with short sales.
Obtain competent tax advice about possible tax consequences on canceled debt or, in the event of a refinance, mortgage over-basis considerations.
Price your short sale in line with the comparable sales, which should be less than your mortgage.
Assemble the paperwork required by the short sale bank.
Will Banks Let Sellers Walk Away Without a Hardship?
The answers are yes and sometimes no. More often than not, the short sale is granted. A hardship is not always necessary because sometimes the bank prefers to dump the property than risk taking it in foreclosure.
In your situation with a Bank of America short sale, unless you qualify for the HAFA short sale program, it is possible that Bank of America could ask for a seller contribution. However, that practice applies mostly to hard money loans and not to purchase money loans. The bank will probably net about $195,000 from your sale and eat the remaining $310,000.
For many home purchasers, qualifying for a mortgage is not only a tough challenge but also one that ends unhappily: They get rejected.
The reasons for the turndowns typically involve multiple factors: below-par credit scores, inadequate documented income, little or no savings.
But a new survey by credit-score giant FICO offers a peek inside the heads of credit-risk managers at financial institutions. Researchers asked a representative sample of them what single factor makes them most hesitant to fund a loan request — in other words, what’s most likely to prompt them to say no.
Tops on the list? Surprise, it’s not your credit scores. And it’s not how much you’ve got for a down payment or what you have in the bank. It’s your DTI — your debt-to-income ratio. Nearly 60 percent of risk managers in the FICO study rated excessive DTIs as their No. 1 concern factor; that’s five times the percentage who picked the next biggest turnoff.
Yet many new buyers have only a rough idea in advance of an application — even for a preapproval letter — about their own DTIs, how lenders view them and what sort of limits they’re likely to encounter.
Debt-to-income ratios for home loans are the most direct indication about whether you are going to be able to afford to repay the money you want to borrow.
Debt ratios for home loans have two components: The first measures your gross income from all sources before taxes against your proposed monthly housing expenses including the principal, interest, taxes and insurance that you’d be paying if the lender granted the mortgage.
As a general target, lenders like to see your housing expense ratio no higher than 28 percent of gross monthly income, though there is flexibility to go higher if other elements of your application are strong. In May, according to mortgage software and research firm Ellie Mae, the average borrower who obtained home-purchase money through investors Freddie Mac and Fannie Mae had a housing expense ratio of 22 percent. Federal Housing Administration-approved borrowers had average housing expense ratios of 28 percent.
The second DTI component, called the back-end ratio, measures your income against all your recurring monthly debts. These include housing expenses, credit cards, student loans, personal loan payments and others. Under federal “qualified mortgage” standards that took effect in January, your back-end-ratio maximum generally is 43 percent, though again there is wiggle room case by case.
Most lenders making loans eligible for sale to Fannie or Freddie prefer not to see you anywhere close to 43 percent. In May, according to Ellie Mae, the average approved home-purchase applicant had a back-end ratio of 34 percent. Even at FHA, which tends to be more lenient on credit matters than Fannie or Freddie, the average back-end ratio for buyers was 41 percent. The average for denied applications was 47 percent.
A good place to learn more about DTIs and to compute your own is Fannie Mae’s “Know Your Options” site, www.knowyouroptions.com, which includes calculators and other helpful tools.
The new FICO survey found that the second-leading cause of concern for loan officers is “multiple recent [credit] applications.” Lenders take them as signals that you are seeking to add on even more debt, which could affect your ability to repay the mortgage money you’re seeking.
In third place as an instant turnoff: credit scores. Most lenders want to see FICO scores well above 700 — Fannie and Freddie averages were in the 755 range in May; FHA-approved scores averaged 684.
Bottom line: If you want to be successful in your mortgage application, be aware of these key turnoff points and take steps to avoid the tripwires. Most important: Wait until your DTI ratios tell you that you can afford the house you want and that lenders won’t reject you out of hand.