Short Sales and Deficiency Judgments
As declining residential property values are starting to stabilize, mortgage lenders are approving more Short Sales as an alternative to foreclosure. A homeowner may elect to pursue a Short Sale when the fair market value of the property is less then the amount of the loan, and the owner cannot cover the mortgage payments. Some homes are encumbered with two or more loans. All lien holders must approve before a Short Sale can occur. If the loans are generated with different lending agencies, then the Real Estate Agent must contend with different business practices when assisting with the Short Sale application. For example, lenders have different procedures regarding Short Sale applications. Some lenders require submittals of offers. Often the Seller must disclose his financial records and explain his financial hardship. Financial information must be accurate and honest. Otherwise, the Seller and his Agent could be liable to the lender for fraud.
If the lenders approve of the Short Sale, a lender “Approval Letter” will follow. More often than not, the Approval Letter will specifically state that the lender reserves its right to pursue a deficiency judgment against the borrower for the difference between the loan balance and the price received from the Short Sale. This language is often overlooked by the Agent and the Seller, because they either do not understand the legal ramifications, or they are rushing to complete the sale. Sometimes the Approval Letter is silent and the lender does not mention it is reserving its rights to recoup the deficiency. The lender’s silence on this issue usually does not constitute a waiver of its right to do so. Unless the Seller receives a written release directly from the lender, an unsophisticated Seller will be exposed to a possible deficiency judgment. This means that, after the property is sold, the Seller may receive a demand letter from the lender to pay the difference between the sale and loan amounts.
Agents must advise the Seller of government programs that may prevent lenders from going after the Seller for deficiency. For example, in the last few weeks the Homeowners Affordable Modification Program (“HAMP”), through the Home Affordable Foreclosure Alternatives (“HAFA”), came out with a new law that prevents lenders from going after the Seller for the deficiency. If the Seller meets the HAFA requirements, and proceeds with the Short Sale through HAMP, then the lenders must release borrowers from the obligation to repay the difference between the sales price and the loan amount. No deficiency judgments are allowed for a first or second loan. You can learn more about the HAFA requirements here.
Agents usually are not attorneys, nor are they Certified Public Accountants. When their clients receive a demand letter from the lender, the Agents are sometimes just as bewildered as the Seller. The Agent should advise the Seller, in writing, of the importance of speaking to an attorney or CPA about whether the borrower will remain liable for the deficiency. If so, the Seller will want to reserve the right to cancel the Short Sale without penalties or pursue negotiations with the lender to obtain a written waiver of the deficiency and general release of all claims against the borrower.
Agents assisting Sellers with Short Sales use the Short Sale Addendum (C.A.R. Form SSA 11/07). Section F of Form SSA broadly advises the Seller that he can incur credit or legal consequences, or taxable income from a Short Sale. It states that the Seller should “seek advice from an attorney, CPA or other expert regarding such potential consequences of a Short Sale.” However, the language is ambiguous, and can create confusion about whether the Seller can cancel the sale after the lender approves of the Short Sale but does not release the deficiency.
In addition to using Form SSA, Agents and Brokers should also prepare a more detailed Addendum to the Purchase Agreement, permitting the Seller to meet with a lawyer or CPA to discuss the lender’s agreement, and thereafter allowing a five day window to cancel the sale, if necessary. Such an Addendum to the Short Sale Purchase Agreement should include 1) the Seller’s right to terminate the Short Sale (within a limited period of time); 2) notice that the Seller may have negative tax, legal or credit consequences which result when the funds due at the close of escrow are insufficient to fully satisfy a loan secured by the property; 3) notice that the lender may agree to take less than the full amount of the loan without releasing the deficiency; and 4) advise the Seller that there are government programs that may assist the Seller with avoiding a deficiency judgment.
Essentially, the Agent should address Short Sale issues more directly, and bring to light the possibility of the lender “approving” the Short Sale, but not releasing the Seller from any deficiency. Since proper documentation of the Short Sale process is necessary to maximize the Seller’s legal protection, an attorney should be consulted to guide the Seller through this process. In addition, Agents should be advising the Seller of new HAFA programs that are being implemented to protect homeowners.
The real estate attorneys at Kring & Chung, LLP, some of whom also maintain a real estate broker’s license, are knowledgeable and ready to assist both the Seller and the Agent through the Short Sale transaction, and any other real estate related legal matters.
Anna Greenstin is an Associate at Kring & Chung, LLP‘s Irvine, CA office. She can be contacted at (949) 261-7700 or [email protected] .