BROKER RISK MANAGEMENT
WEEKLY PRACTICE TIP
SHORT SALES – AN UPDATE
BACKGROUND: A “Short Sale” is a sale where a lender agrees to take less than the full amount due on the loan on the property. If there is more than one lender, it is the junior lender (as measured by time of filing of the deed of trust) who is in the greatest danger and should be willing to take less than the full amount due. The reason for this is that, if there were a foreclosure by the holder of the most junior lien, they would not get the full payment. If there were a foreclosure by a senior lender, such as the holder of the first, the junior lien holder(s) could get foreclosed out, potentially getting nothing.
Institutional lenders understand this, and usually do not want to take a property back as a foreclosure into their Real Estate Owned (“REO”) department, since this is an expensive process and looks bad on their record with the regulators. They will usually work with you, but you have to find the right person to talk to, usually a vice president or department head.
If the junior lienholder is a hard money lender, friend or family member, you may find it difficult or impossible to negotiate with them. You may not have a saleable listing. One phone call to that junior lienholder may make that clear.
Listing and selling agents should be aware that:
1. Lenders are under no obligation to agree to a short sale; although most institutional lenders will actively try to avoid a foreclosure by working with the seller/borrower on a short sale.
2. Lenders are under no obligation to process a request for a short payoff within any particular timeframe. So sellers, buyers and agents must be prepared for a process that may take weeks, or even months, regardless of the time frames in a Purchase Agreement.
3. Lenders are under no obligation to agree to a short payoff demand that will allow brokers to be paid a commission. However, most institutional lenders will agree to a payoff demand that will allow brokers to receive a commission, if not necessarily the full commission agreed to by seller.
PRACTICE TIPS:
LISTING AGENTS:
1. To avoid the problem of a short sale, or at least anticipate it, at the time of taking a listing, go over the existing financing and indebtedness on the property with every seller. Ask about any liens, judgments or attachments. Get the Preliminary Title Report (“PTR”), or a Property Profile, from escrow early and review it to see if there will be enough proceeds from the sale to pay off all recorded liens, judgments and attachments – as well as your commission. If not, discuss with the seller before you proceed. Start early to resolve the problem.
2. PREPAYMENT PENALTIES: Be sure to calculate any prepayment penalties into your calculation, since this can take a significant amount out of seller’s proceeds.
3. CASH TO CLOSE: Discuss with your seller whether they have the ability, and whether it might make sense, to bring cash to close the escrow to avoid having to do a short sale. If your seller states that they are willing to do so, document that in writing since: (a) technically, this will not be a Short Sale; and (b) there will be enough cash to close the sale and cover all closing expenses. Advise your seller that, based on his/her representation that they will be bringing sufficient cash to close the escrow, you are not advertising this as a short sale. A good idea would be to actually put this in the Additional Terms of, or in an Addendum to, the Residential Listing Agreement.
4. SELLER ALTERNATIVES: A seller has other options to a short sale, such as: (a) the seller/borrower may be able to negotiate a “Short Payoff” without a sale of the property; essentially a restructuring of the debt; (b) the seller/borrower may ask the lender to accept a “Deed in Lieu,” wherein the lender agrees to accept a conveyance of the property in satisfaction of the loan; or (c) a seller/borrower may even prefer to allow a foreclosure under some circumstances. Do not advise sellers regarding these alternatives: sellers must be sent to their legal and tax advisors in making these decisions.
5. REALITY CHECK: Before proceeding with taking a short sale and expending your time and expense, assess the likelihood of actually being able to accomplish a short sale given the amount of indebtedness, who the lenders/creditors are, and the market for this property at the projected list and sales price.
6. LISTING FORM: When taking the listing, be sure to add the CAR Short Sale Listing Addendum (WinForms form SSL) to your listing agreement.
7. If you choose to help your seller negotiate a short sale with a lender (you have no obligation to do so but most sellers don’t know what to do), some lenders will not talk to you without written authorization.
FORM: You can get that authorization using CAR form “Authorization to Receive and Convey Information” (WinForms ARC).
8. Advise your sellers that the lender will want documentation, which may include: a “hardship” letter, tax returns, W-2’s, pay stubs, a list of other assets, etc. Remind your seller that this information must match the information on the loan application. If the loan application was wrong, the lender might charge that there was lender fraud when the loan was taken out.
9. If the seller/borrower has other assets or an income stream (i.e., a steady job), the lender might not do a short sale but instead do a “compromise short sale.” This is where the lender will place a short demand into this escrow to allow the sale to close, but will require a note from the seller for the balance. This note may be secured by other real property, if the seller has any; or it may be a personal, unsecured note.
10. Lenders will usually report the short sale to credit reporting agencies, which will reflect negatively on the seller/borrower’s credit report for seven years. If the lender is agreeing to a short sale, ask them if they are willing to show the file as the more favorable “paid in full.” Most will not, so discuss this with your seller and get their approval before proceeding with the lender.
11. You may be able to negotiate even with senior lenders for removal of penalties and other added fees, to help get the total of the demands into escrow reduced. It’s worth a try.
12. If sellers have any questions about the above, they should be sent to their tax advisor or attorney. Be careful not to refer your seller clients to mortgage foreclosure consultants; many of these are less than honest and you could incur liability if these consultants damage your clients.
13. The fact that this is a short sale must be disclosed to a buyer. This can be done, of course, in the purchase agreement; however, good practice would be to alert a prospective buyer and the buyer’s agent prior to the writing of an offer so they are not taken by surprise at the time of the contract ratification.
14. The purchase contract must state that this will be a short sale, and that close of escrow by seller is conditioned on the successful negotiation with the lender(s) to demand not more collectively than the sale proceeds, net of closing expenses including commissions.
15. Sellers should be advised that there can be adverse tax consequences to seller as a result of a short sale to the extent that seller receives relief from mortgage debt by the lender in a short sale unless the property loan qualifies for the federal exclusion from this tax as a “Qualified Principal Residence Indebtedness,” which is defined as debt incurred in acquiring, constructing, or substantially improving the residence (up to $2 million). California state law is expected to follow suit. Send your sellers to their tax advisors for advice on this subject.
FORM: CAR form Short Sale Addendum (WINForms Form SSA) covers items 14 and 15, above and should be incorporated into every short sale purchase agreement.
FOR FURTHER INFORMATION: See the CAR Legal Memorandum entitled: “Taxation of Foreclosures, Deeds in Lieu of Foreclosure and Short Sales” at: http://www.car.org/index.php?id=Mzc3MDM
16. COMMISSIONS: If you anticipate that the sale will or might be a short sale, place a conditional offer of compensation in the MLS broker comments, such as:
“Short sale — subject to lender approval. Any reduction in total commission received will be split evenly between Listing and Selling Brokers.”
Or, alternatively, you can propose some other arrangement as to who absorbs any shortfall in total commission received. It would appear, however, that an even split between listing and selling brokers would be most equitable.
FOR FURTHER INFORMATION: CAR has good information online entitled “Short Sale Advertising” at http://www.car.org/index.php?id=MTc5MA
17. SUBMITTING OFFERS TO LENDER: Once you have submitted an offer to the lender for consideration of a short payoff by them (and the contract is contingent on lender’s approval of a short payoff as it should be), continue to market the property. With your seller’s permission, if you receive another offer, or offers, you should submit those offers to the lender for their consideration as well. The lender has the right, for example, to choose to reject the first offer on their desk and accept a later, better offer. In such a case, the first offerer’s contract is cancelled, based on the Short Payoff contingency, and the second offer accepted by the lender for a short payoff proceeds forward. A higher offer price may benefit your seller by making the lender more willing to participate in the short sale and/or reduce or eliminate a compromise short sale.
BUYERS’ AGENTS:
1. CHECK FOR SHORT SALE: Prior to writing an offer, review the MLS remarks to see if the listing agent has indicated that this property is, or may be, a short sale.
2. DISCUSS WITH BUYER: Upon learning that this is a short sale, discuss the situation with your buyer. Your buyer is taking a bit of a risk since your buyer could spend hundreds or thousands on inspections and loan applications, only to have the deal cancel because the seller could not negotiate a short sale with their lender. Make sure your buyer understands the risks and is making a conscious decision to proceed. Document your transaction log and/or confirm the decision in an e-mail or other correspondence with your buyer.
3. PURCHASE AGREEMENT CLAUSE: Be sure that the Short Sale Addendum is a part of the purchase agreement (CAR form SSA). This form can protect your buyer in the event the lender does not respond to a request for a short payoff in a timely manner by allowing your buyer to cancel the purchase agreement and get their deposit returned, if the lender does not approve the short payoff within the time specified. It does allow the seller to cancel as well in that situation, so buyer should be aware of that eventuality. It also allows for the parties to agree as to whether the time for contract performance and contingency removal will commence at the time of ratification of the contract (the default mode), or upon the approval by the seller’s lender of the short payoff.
4. REVIEW PRELIMINARY TITLE REPORT: Immediately upon getting the PTR, review the liens on the property. If the total liens and encumbrances start to approach the purchase price, and listing agent has not advised you that this may be a short sale, discuss the situation with the listing agent.
5. OTHER OFFERS: Your buyer should also be advised that the lender may entertain other offers from other buyers, agree to work with another buyer, and reject your buyer’s offer. Even if your buyer’s offer has been accepted subject to the existing lender’s approval, the lender may accept another, better offer even though your contract has been submitted for quite some time. Your buyer should be advised that if they expend funds on inspections and on obtaining a loan, they could lose these funds if their contract is rejected by the lender.
6. COMMISSIONS: Check MLS comments re broker compensation. If you are a buyer’s agent concerned about getting paid on a short sale, you can enter into a Buyer-Broker Agreement with your Buyer. (CAR form BBE or BBNE)
FOR FURTHER INFORMATION: CAR has an excellent legal memorandum on-line entitled “Short Sales” at http://www.car.org/index.php?id=MzY3OTc=
This Weekly Practice Tip is attorney-client privileged and for the exclusive use of clients of Broker Risk Management and their agents. It may not be reproduced or distributed without the express written consent of Broker Risk Management. The advice and recommendations contained herein are not necessarily indicative of standards of care in the industry, but rather are intended to suggest good risk management practices.
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