First off, many lenders and servicers will require that the borrower be in default in order to be eligible for a short sale. For example, FHA requires that Mortgagors must be in default, or soon to be in default, as a result of an adverse and unavoidable situation. Mortgage Letter 2008-43 notes that “Mortgagees may exercise their discretion to accept applications from mortgagors who are current but facing imminent default.” However, they must be at least 31 days delinquent on their mortgage by the date the short sale closes.
In the government’s HAFA program, there is a provision that the mortgage must be delinquent, or that default is reasonably foreseeable. This is to prevent homeowners from strategically defaulting and still receiving government assistance. Please note however, HAFA also has a provision that the owner may have to make mortgage payments up to 31% of their income, as outlined in their Short Sale Approval (SSA) with their lender.
That said, at Seattle Short Sales, Inc. we have submitted a number of short sales to lenders where the borrower has been current throughout the process. We have found that in those situations, the lender may ask for a substantial promissory note in exchange for the short sale approval. We can always submit a short sale while the borrower is current, and simply see what the lender says. If the borrower needs to be in default, the lender typically tells us right away.
Here is what typically happens to borrowers who stop making their mortgage payment: Within one to three months, a Notice of Default is mailed to the borrower. This states that a local trustee has been retained and serves as official notice to the borrower that the Trustee Sale will commence unless the arrears are paid promptly. Then, within the next 30 days or so, the Notice of Trustee Sale is presented to the borrower. This Notice is a matter of public record. It states the exact principal and arrears owing, and sets the Trustee Sale date and location. The date is 90 days from the time of Notice. Overall, if things move along quickly after payments are curtailed, an auction of the property can happen within 5-6 months. On the other hand, many borrowers have found themselves living in their property for almost two years now with no mortgage payments being made during the entire time.
The borrower should expect that the lender will immediately begin reporting late notices to the credit bureaus. This doesn’t always happen however, and typically, this isn’t a huge issue for our clients, as they expect their credit to suffer already from the short sale itself.
One additional concern is whether the missed payments will affect the lender’s decision regarding the short sale. In our experience, the lender is typically not focused on the total amount of debt. They are mainly trying to determine how best to recoup the most money from the distressed asset. That means they are focused on whether the net proceeds from a short sale are going to be greater than the net proceeds from a trustee sale, or as a bank-owned property.
Homeowners do have to very careful about the decision to stop making payments. In our experience, most homeowners who stop making payments either sell their house via a short sale, or lose the house to foreclosure. It is very unlikely that a homeowner will be able to hold onto the money and catch up on the arrears and reinstate the loan if the short sale is denied.