How Does a Short Sale Work? Heidi Peterson MNAR In-House Counsel Vice President,
We have received several requests over time from REALTORS® which have related to short sales and the process relating to`the same. As a response, the MNAR Forms Committee has decided to release a short sale addendum through MNAR in early 2009.
The following serves solely as an informational outline pertaining to the process involved with a short sale transaction. A potential short sale may occur when the current market value of the property is not sufficient to pay all debts and obligations secured by any liens on the property. A short sale requires the seller to enter into short sale agreements with each creditor who has a lien against the subject property and the same should include a release of the creditor’s liens for a payment of less then the amount they are owed. A contingency pertaining to short sales must be included within any offer accepted on a property in which the same applies. Lender approval must be included as part of the contingency which must be given in regard to the transaction. A seller may still be liable for any unpaid portion of debt against the property even though the lienholder releases the lien. The amount which is forgiven by a lender in a short sale may be taxed as income. The lender must submit Form 1099C to the Internal Revenue Service. The form must state the amount of forgiven debt. The seller should explain their hardship before listing a property by submitting a hardship letter to the lender. The hardship letter may include job loss verification, medical statements, disability documents or any other information relating to the hardship. The seller may be required to supply requested documentation to the lender’s loss mitigation department which includes financial documents pertaining the seller and the property, accepted offers to purchase, a listing contract, an appraisal or market analysts, or a statement of need or hardship. Lender forms must be completed in a manner which follows exact lender requirements. The broker may assist the seller by providing a market analysis to the lender pertaining to the property. The seller should then submit a letter to the lender authorizing the listing agent to deal directly with the lender if the seller so desires. The seller and/or the listing agent should contact the Loan Mitigation Department of the lender. The lender will send the file to a negotiator at the mortgage company/bank after satisfying the requests from the Loan Mitigation Department, including the purchase agreement and all other related documentation.
The seller and seller’s creditor(s) must finalize a short sale agreement pertaining to the subject property. The lender has the ability to approve, condition, reverse or reject the short sale. The seller shall promptly notify the buyer if the short sale agreement cannot be finalized. The buyer may then, at the buyer’s option, declare the purchase agreement canceled as there has been a default pertaining to the short sale contingency. The buyer and seller shall immediately sign a cancellation of the purchase agreement directing release of the earnest money to the buyer. TERMS AND DEFINITIONS: Bankruptcy - Bankruptcy is a legally declared inability or impairment of ability of an individual or organization to pay its creditors. Creditors may file a bankruptcy petition against a debtor ("involuntary bankruptcy") in an effort to recoup a portion of what they are owed or initiate a restructuring. In the majority of cases, however, bankruptcy is initiated by the debtor (a "voluntary bankruptcy" that is filed by the bankrupt individual or organization). Deed - A deed is a legal instrument used to grant a right. Deeds are part of the broader category of documents under seal. Deeds can be described as contract-like, as they require the mutual agreement of more than one person. Deeds can therefore be distinguished from covenants, which being also under seal, are unilateral promises. The deed is best known as the method of transferring title to real estate from one person to another, often using a description of its "metes and bounds." However, by the general definition, powers of attorney, commissions, patents, and even diplomas conferring academic degrees are also deeds. Deed in Lieu of Foreclosure - A Deed in lieu of foreclosure is a deed instrument in which a mortgagor (i.e. the borrower) conveys all interest in a real property to the mortgagee (i.e. the lender) to satisfy a loan that is in default and avoid foreclosure proceedings. The deed in lieu of foreclosure offers several advantages to both the borrower and the lender. The principal advantage to the borrower is that it immediately releases him/her from most or all of the personal indebtedness associated with the defaulted loan. The borrower also avoids the public notoriety of a foreclosure proceeding and may receive more generous terms than he/she would in a formal foreclosure. Another benefit to the borrower is that it hurts their credit less than a foreclosure does. Advantages to a lender include a reduction in the time and cost of a repossession, and additional advantages if the borrower subsequently files for bankruptcy. In order to be considered a deed in lieu of foreclosure, the indebtedness must be secured by the real estate being transferred. Both sides must enter into the transaction voluntarily and in good faith. The settlement agreement must have total consideration that is at least equal to the fair market value of the property being conveyed. Sometimes, the lender will not proceed with a deed in lieu of foreclosure if the outstanding indebtedness of the borrower exceeds the current fair market value of the property. Other times, lenders will agree since they will end up with the property anyway and the foreclosure process is costly to the lender. Because of the requirement that the instrument be voluntary, lenders will often not act upon a deed in lieu of foreclosure unless they receive a written offer of such a conveyance from the borrower that specifically states that the offer to enter into negotiations is being made voluntarily. This will enact the parol evidence rule and protect the lender from a possible subsequent claim that the lender acted in bad faith or pressured the borrower into the settlement. Both sides may then proceed with settlement negotiations. Neither the borrower nor the lender is obliged to proceed with the deed in lieu of foreclosure until a final agreement is reached. Deficiency Judgment - A deficiency judgment is a judgment lien against a debtor, defendant or borrower whose foreclosure sale did not produce sufficient funds to pay the mortgage in full. [1][2] This option may or may not be available to the lender, depending on whether they have made a recourse or nonrecourse loan. The fuller, New York statutory definition is this: "the whole residue, or so much thereof as the court may determine to be just and equitable, of the debt remaining unsatisfied, after a sale of the mortgaged property and the application of the proceeds, pursuant to the directions contained in such judgment, the amount thereof to be determined by the court as herein provided. The plaintiff's attorney (in other words, the bank's lawyer) must make a motion to receive such a deficiency judgment. Otherwise, the amount gained from the sale shall be deemed the full amount owed, and the plaintiff has no right to collect the additional debt. However, if the parties (mortgagor and mortgagee) have already agreed in their mortgage or promissory note, then the debtor could be liable for the full amount. A debtor who has a deficiency judgment should see an attorney for possible remedies, including bankruptcy, an exemption from creditors, an appeal, or a motion. As with all legal research sources on-line, Internet users should take caution before applying such advice to your own case, and perhaps should consult an attorney, barrister, or solicitor. Forbearance - In the context of a mortgage process, forbearance is a special agreement between the lender and the borrower in order to delay a foreclosure. Loan borrowers sometimes have problems with their payments due to unexpected circumstances. This may cause the lender to start the foreclosure process. To avoid this situation, the lender and the borrower have the option to make an agreement called "forbearance". According to this agreement, the lender delays his right to exercise foreclosure if the borrower could catch-up his payment schedule in a certain amount of time. This time-period and the payment plan depend on the details of the agreement which are accepted by both of the parties involved. Note that forbearance is just for "temporary" financial problems. If the borrower has more serious problems, for example if it is a variable-rate mortgage and the interest rate become high enough so that the borrower cannot afford the payments anymore, then forbearance is usually not a solution. Foreclosure - Foreclosure is the legal and professional proceeding in which a mortgagee, or other lienholder, usually a lender, obtains a court ordered termination of a mortgagor's equitable right of redemption. Usually a lender obtains a security interest from a borrower who mortgages or pledges an asset like a house to secure the loan. If the borrower defaults and the lender tries to repossess the property, courts of equity can grant the borrower the equitable right of redemption if the borrower repays the debt. While this equitable right exists, the lender cannot be sure that it can successfully repossess the property, thus the lender seeks to foreclose the equitable right of redemption. Other lienholders can also foreclose the owner's right of redemption for other debts, such as for overdue taxes, unpaid contractors' bills or overdue HOA dues or assessments. The foreclosure process as applied to residential mortgage loans is a bank or other secured creditor selling or repossessing a parcel of real property (immovable property) after the owner has failed to comply with an agreement between the lender and borrower called a "mortgage" or "deed of trust". Commonly, the violation of the mortgage is a default in payment of a promissory note, secured by a lien on the property. When the process is complete, the lender can sell the property and keep the proceeds to pay off its mortgage and any legal costs, and it is typically said that "the lender has foreclosed its mortgage or lien". If the promissory note was made with a recourse clause then if the sale does not bring enough to pay the existing balance of principal and fees the mortgagee can file a claim for a deficiency judgement. Once the property has been foreclosed on; it is referred to as a Real Estate Owned Property (REO Property). Loan Modification - Loan modification is a process whereby a homeowner's mortgage is modified and both lender and homeowner are bound by the new terms. The most common modifications are lowering the interest rate, reducing the principal balance, 'fixing' adjustable interest rates, increasing the loan term, forgiveness of payment defaults & fees, or any combination of these. Promissory Note - A promissory note, also referred to as a note payable in accounting, is a contract where one party (the maker or issuer) makes an unconditional promise in writing to pay a sum of money to the other (the payee), either at a fixed or determinable future time or on demand of the payee, under specific terms. They differ from IOUs in that they contain a specific promise to pay, rather than simply acknowledging that a debt exists. The terms of a note typically include the principal amount, the interest rate if any, and the maturity date. Sometimes, provisions are included concerning the payee's rights in the event of a default, which may include foreclosure of the maker's assets. Demand promissory notes are notes that do not carry a specific maturity date, but are due on demand of the lender. Usually the lender will only give the borrower a few days notice before the payment is due. For loans between individuals, writing and signing a promissory note are often instrumental for tax and record keeping. In the United States, a promissory note that meets certain conditions is a negotiable instrument regulated by article 3 of the Uniform Commercial Code. Negotiable promissory notes are used extensively in combination with mortgages in the financing of real estate transactions. Promissory notes, or commercial papers, are also issued to provide capital to businesses. Short Sale - In real estate, a short sale is a sale of real estate in which the proceeds from the sale fall short of the balance owed on a loan secured by the property sold. In a short sale, the bank or mortgage lender agrees to discount a loan balance due to an economic or financial hardship on the part of the mortgagor. This negotiation is all done through communication with a bank's Loss mitigation or Workout department. The home owner/debtor sells the mortgaged property for less than the outstanding balance of the loan, and turns over the proceeds of the sale to the lender, sometimes (but not always) in full satisfaction of the debt. In such instances, the lender would have the right to approve or disapprove of a proposed sale. Many Short Sales leave a deficiency balance for which the Mortgagor / Borrower is still liable. In 99% of all cases it is not a settlement-in-full. A deficiency balance will remain while the mortgage broker, real estate agent / broker, loan officers, title and closing agents retain their profit. No regulatory agency governs this hybrid transaction. Extenuating circumstances influence whether or not banks will discount a loan balance. These circumstances are usually related to the current real estate market and the borrower's financial situation. A short sale typically is executed to prevent a home foreclosure. Often a bank will allow a short sale if they believe that it will result in a smaller financial loss than foreclosing. For the home owner, advantages include avoidance of a foreclosure on their credit history and partial control of the monetary deficiency. A short sale is typically faster and less expensive than a foreclosure. In short, a short sale is nothing more than negotiating with lien holders a payoff for less than what they are owed, or rather a sale of a debt, generally on a piece of real estate, short of the full debt amount. It does not extinguish the remaining balance unless settlement is clearly indicated on the acceptance of offer. Short sales are common in standard business transactions in recognition that creditors are not doing debtors a favor but, rather, engaging in a business transaction when extending credit. When it makes no business sense or is economically not feasible to retain an asset, businesses default on their loans (called bonds). It is not uncommon for business bonds to trade on the after-market for a small fraction of their face value in realization of the likelihood of these future defaults. |