Short Sales: Not Always A Shortcut

style=’font-size: large’>A short sale – like a loan modification, a repayment plan and a deed-in-lieu of foreclosure – is a loss mitigation option that is gaining popularity. According to the National Association of Realtors, foreclosures and shorts sales accounted for almost half of real estate transactions in the first quarter of 2009, with short sales accounting for 10% to 20% of sales nationally. However, as simple as a short sale may seem on the surface, it is not without its complications. A short sale, as the name implies, is a real estate transaction that falls short of the amount due on the mortgage or mortgages on the property, whether the shortage is a few thousand dollars or over $100,000. The mortgage company, based on a detailed analysis of the underlying circumstances, agrees to accept less than the full amount due under the terms of the note and mortgage in order to resolve a defaulted mortgage. While it is often assumed by the seller that the difference between the sale price and the actual amount due on the mortgage will be forgiven, this is not always the case. It is common practice for mortgage holders to require that sellers in short sales sign a promissory note for the debt. In the alternative, as permitted by state law, the mortgage company may file an action to collect on the deficiency remaining due on the mortgage account after short-sale funds are applied. Given the current sluggish real estate market, short sales are becoming an increasingly popular method of resolving delinquent mortgage loans. In better economic times, if a mortgagor's financial circumstances took a downturn or the mortgagor had to relocate, the sale of the property for the full payoff amount or a refinance were commonplace. Not so today. {OPENADS=float=left&zone=32} Stricter financial requirements and tightened lending pools mean fewer opportunities to refinance. Terms like ‘underwater’ or ‘upside down’ are commonly used to describe borrowers who owe more than their property is currently worth. This type of scenario, combined with property values that have generally declined, makes it difficult to obtain buyers willing to purchase properties for an amount that covers the current debt on the property. In short, borrowers are stuck with a piece of property that they can no longer afford nor liquidate. Short sales, as with most types of loss mitigation, have their advantages and disadvantages from the perspectives of the seller, the mortgage company and the purchaser. Sellers view short sales as an appealing option because they are seen as a way to avoid the negative impact of a foreclosure. Further, a short sale ends what is often a frustrating marketing of the property for a price that is not compatible with the current market value of the property. However, some sellers are surprised to learn that they may still be liable for the difference between the short-sale price and the total amount due on the mortgage. Clauses pertaining to the deficiency may be buried in the sales contract or not clearly understood by the sellers, contrary to the sellers' assumption that the mortgage company has forgiven the remaining debt. Even if sellers are aware that a mortgage company retains the right to pursue the difference between the sale price and the actual payoff, some sellers assume this will not happen. If a deficiency judgment is pursued, it will affect the seller's credit report the same as any other judgment, making the seller's attempt to avoid a negative mark on his or her credit report by avoiding a foreclosure unsuccessful. In some cases, a deficiency judgment or other short-sale liability may ultimately lead the seller to file for bankruptcy relief. In other situations, the seller may be asked, as part of the short-sale agreement, to sign a promissory note for the remainder of the debt. This may be a deal-breaker for the seller, who would prefer to let the mortgage company take the property through foreclosure proceedings rather than be saddled with a new debt for the sale deficiency. Short sales are appealing to mortgage companies because they are guaranteed a partial return on the amount due without some of the pitfalls of a traditional judicial or nonjudicial foreclosure action. According to the Joint Economic Committee of Congress, while losses by lenders vary, studies show that the lender loses more than $50,000 for every foreclosed property. The time and costs of a protracted foreclosure action can be avoided through a short sale. Also, the eviction process can be obviated in addition to the post-foreclosure marketing of the property. In short, the lender, while agreeing to take less than a full payoff, is able to cut its losses sooner than it would with a typical foreclosure. Of course, this loss is often covered by requiring that sellers sign a promissory note for the remaining balance, or the mortgage company may take steps to file a deficiency judgment against the seller, which allows for collection activities. Buyers, naturally, hope to score a great deal on a property at a reduced price through a short sale. However, buyers are at the mercy of the lenders and must wait through what is often a lengthy process for approval. According to a November survey by Campbell Communications, it takes, on average, over eight weeks to get an answer from a lender on whether or not a short sale will be approved. Advantages and disadvantages aside, the ultimate decision on whether to accept a short sale resides with the mortgage company. As with any other loss mitigation option, considerable financial and other valuation information is required. A short-sale review starts with a call by the seller to the mortgage company, usually when the account is in default and when loss mitigation that would allow the borrower to retain the home, such as a repayment plan or loan modification, is not an option. Mortgage companies require an estimated closing statement showing the expected sales price. Cash from the sale to the seller is virtually always going to be a deal-breaker; if the mortgage company is taking a loss, the seller should not be making a profit. A hardship letter is also required, explaining that due to the seller's financial situation, a short sale is the only feasible loss mitigation option on the account. Proof of income, a statement of assets and bank statements are also required to provide the mortgage company a clear picture of the seller's current financial situation. The mortgage company typically engages in comparative market analysis, as well as a broker price opinion, to determine the current market value of the property. Finally, the purchase and listing agreements are needed. Once all of this information is collected from the seller, the mortgage company must decide whether or not to accept the short sale, all the while motivated by the challenge to protect investors and shareholders from losses. The mortgage company must also determine whether or not it will pursue a deficiency or require that the seller sign a promissory note for the payoff shortage. Factors that the mortgage company will review include the amount of the unpaid mortgage (the bigger the loss, the more likely the mortgage company will seek to record a portion of that loss); whether the property was an investment property or the primary residence of the seller; the assets and income of the seller (if sellers have the ability to pay the difference, they will be expected to be responsible for the difference); the hardship of the seller (whether the seller is walking away from a property he or she can no longer afford versus just wanting to walk away from a property that has suffered a steep decline in value compared to the mortgage amount due); prohibitions or limitations on deficiencies under state law; and the costs of collection compared to anticipated returns. Additionally, the mortgage company's actions are dictated by the policy of the investor or mortgage insurer. These factors are then balanced against the costs and time of proceeding with a foreclosure. Another inducement for increasing the number of completed short sales is coming from the federal government. In May, the Obama administration included a provision in its housing rescue plan to make it easier for homeowners to sell houses that are worth less than the current amount of their mortgages. This initiative provides for a standardized process, as well as incentives for short sales designed to help those homeowners who are not candidates for loan modifications due to their total amount of debt or lack of income. Under the new plan, the government will pay servicers up to $1,000 and borrowers up to $1,500 for successful short-sale transactions. It will also spend up to $1,000 to defray the costs of getting second-mortgage holders to release liens so that the short sale can be completed. The government's objective is to encourage lenders to clear the ever-growing number of distressed mortgage loans. Given the current economic situation, the number of mortgage loans currently in default and a continued push for alternatives to foreclosure, short sales will be an increasingly utilized loss mitigation tool. As with any other type of alternative to loss mitigation, there are many factors to be contemplated, from the initial sales offer to the feasibility of collecting on a deficiency. In short, there are no shortcuts with short sales. [i]Patricia K. Block is an associate at Lerner Sampson & Rothfuss LPA, a foreclosure and bankruptcy law firm with offices in Ohio and Kentucky. She can be reached at patricia.block@lsrlaw.com or at (513) 241-3100

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