A LAWYER’S PERSPECTIVE ON SHORT SALES
by Michael A. Starvaggi, Esq.
For better or worse, short sales will be a common part of the real estate transactional landscape for the foreseeable future. It makes sense, then, to understand why they exist and how, exactly, they work. A short sale occurs when the value of a property is less than outstanding balance on the mortgage or mortgages affecting it and the mortgage holder(s) agree to accept less than the amount owed to them in order to facilitate the sale of the property.
Why would a mortgage lender agree to take less than the outstanding balance? For one reason, very often the homeowner is in default or foreclosure when the short sale takes place. Therefore, the lender’s only choices are to pursue the foreclosure or strike a deal to allow the property to be sold. Foreclosure is costly and time consuming, and the auction sale price often does not cover the mortgage debt anyway. Furthermore, if the lender cannot sell the property at auction, it ends up as another REO (“real estate owned” by the bank) and the lender must incur the cost of maintaining the property which is not a profitable enterprise. So it makes sense that the mortgage holder would consider reducing its payoff so that the property can be sold privately.
Should you find yourself involved in a short sale transaction, there are several things you must keep a lookout for. Here are the main ones.
First, remember that there are other choices for a distressed homeowner who wishes to remain in their home. Mortgage modification programs abound these days. Many are backed by the government (such as the HAMP programs) and others are private. So if the homeowner is considering a short sale only because they cannot afford their payment, be sure all other avenues are explored first.
If the sort sale does proceed, it must be understood that listing a property, or even entering into a contract with a buyer for a short sale, does not prevent the lender from foreclosing on the premises. Often, the lender or its counsel will give the homeowner ample opportunity to sell the home if there is a contract in place, but they are generally not obligated to do so. Thus, even if the lender knows that that a private sale is pending, they can proceed to sell the property at auction. In some cases, federally insured lenders must forego foreclosure proceedings while a short sale is pending, but this is not a universal rule and should not be relied upon. Always insist upon written confirmation that the lender has temporarily stayed its foreclosure proceedings and be keep active communication with the lender’s attorneys.
In addition, it must be clear to all parties that it is strictly in the lender’s sole discretion whether or not to allow a short sale. Thus, any contract of sale must reflect the contingency that the sale is subject to the approval of the mortgage holder or holders. Buyers should be aware that the process may take much longer than a traditional transaction and should be guided accordingly when locking rates and making arrangements to sell any real estate of their own.
Even if the short sale is approved, the lender may pursue the homeowner for the difference between the amount they accept at closing and the balance owed to them. This difference is called a “deficiency” and a judgment can be entered against the homeowner for this amount. Thus it is crucial for the seller to negotiate this point with their lender in advance and to have a written agreement as to whether or not the lender will pursue a deficiency judgment.
And the pitfalls don’t end there. If the lender does not pursue the deficiency amount, that amount may be taxable income to the seller. Currently there are laws that relieve taxpayers from claiming such amounts as income, but these laws may expire or may not apply to a particular transaction short sale. It is important to discuss this potentiality with a tax professional.
There are also numerous rules about the structure of the short sale transaction that must be borne in mind.
First, the seller will not be entitled to keep any money from the short sale and there must be no “side deals” or other arrangements with the buyer that attempt to circumvent this rule. If you sense that there is something amiss, do not proceed.
Second, the short sale must be an “arms length transaction.” This means the buyer and seller may not be friends, family members or any other parties who have had a previous relationship.
Third, it is advisable to steer clear of sale and leaseback arrangements. Any transaction wherein the buyer is agreeing to rent the premises back to the seller and eventually reconvey the premises is suspect and should be avoided, as it may run afoul of New York’s Home Equity Theft Prevention Act. For more information, see my article at http://www.starlawpc.com/index.php?page=blog_detail&blog_id=2.
Fourth, the short sale must be an as-is transaction, as the lender will not allow repair credits or the like to be part of the deal.
Although there is no uniformity to the short sale process, there are guidelines being promulgated that will provide similar treatment of for the short sale of all Fannie Mae/Freddie Mac loans as well as for all FHA/HUD loans.
As always, it is essential to seek legal counsel if you are considering the sale or purchase of real estate. Be sure to discuss all of these points with your legal advisor.
Michael A. Starvaggi is an attorney admitted to practice in New York and New Jersey. To contact Mr. Starvaggi, please call (845) 589-9456, write to mstarvaggi@starlawpc.com or visit www.starlawpc.com.
This article is intended for informational purposes only. Please discuss your particular situation with an attorney of your choosing.
The article is written by a professional and is intedened for general use. Always contact your advisors before making a decision. The Smart Investor, or Ken Mahoney does not agree or disagree with the above article. The article is provided as a 'starting point' for your research.
