Can a Bank Back Out of a Short Sale?

Recent changes in Fannie Mae and Freddie Mack policies can make it harder for banks to back out.

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There’s plenty of blame to go around since the 2008 financial crash gave banks a black eye and consumers reality checks about the U.S. housing market. As a result of the shakeout, “short sales” have become tall real estate news, allowing homeowners to put a house on the market for less money than it’s worth. Can a bank back out of a short sale once the deal starts moving forward? Yes, a bank can back out at any time during the process -- and they do.

What’s a Short Sale?

When a property owner finds himself with a mortgage balance that’s higher than the home’s worth and wants to get out from under the debt, he can go to his bank and ask if it will take less money for the property so the place can be sold at a reduced rate. The process isn’t easy and takes a long time to accomplish, as it’s common for a variety of land mines to crop up during the course of the transaction. Further, since any party -- buyer, seller or the bank -- can back out at any time, the process of going through a short sale is extremely stressful.

The Short Sale Process

Start by contacting the bank. Ask for a short sale or workout packet. Draft a hardship letter explaining why you haven’t made your mortgage payments and bundle it with financial documents requested by the bank. Typically, income tax returns, pay stubs, bank records, a HUD-1 form, sales agreement and property assessments are among documents you may be asked to submit. One of the most frequent reasons banks back out of short sales is due to incomplete packets, but even if the documents you submit are sufficient, the bank can still back out.

Banks Aren’t Obligated to Say Yes

Banks back out of some short sales because the list price may be so high that the bank would lose too much to make it worthwhile to take the risk. Other short sale deals are summarily rejected because the property has multiple loans associated with it. Even if a homeowner manages to find a buyer, that person may not be willing to negotiate with the bank or may not qualify for a mortgage due to credit history problems, unsold residential property or factors associated with the policy of an individual bank.

Bank Review Committees

Even if a short sale looks perfect on paper, a bank can back out while an application is in committee. Banks turn application packets over to committees of negotiators committed to the bank’s bottom line, and the short sale can end at any time during this review. Committee members rarely accept short sale packages as submitted, says Business Insider, so even if things look good during the review process, a counter-offer made on the back end could be deemed unacceptable to other parties, bringing to a halt the short sale’s progress.

Other Reasons

Homeowners getting into serious financial trouble after their homes have lost their value often have second mortgages and other liens attached to the sale of their property, making their case for a short sale difficult. A bank can back out of a short sale if it's unwilling to continue the process as a result of too many liens. Further, banks often have so many foreclosures and short sales in process, a lender may not find out until it’s too late that the bank no longer holds the mortgage because it was sold to another lender.

Changing Short Sale Climate

According to the Wall Street Journal, homeowners could find fewer incidents of banks backing out of short sales thanks to new guidelines issued by Fannie Mae and Freddie Mac in 2012. Beleaguered homeowners won’t have to submit as much documentation in the future and will learn the fate of their short sale application sooner. Further, new measures require banks to examine and consider financial hardship situations more seriously before they back out for any of the aforementioned reasons.