The goal of a short sale is to obtain a full and complete release of all liability from the lender(s) and an acknowledgement by the lender(s) that any loan obligations have been paid in full or fully satisfied. Releases with these terms were something that lenders were providing in the last economic downturn in the mid-1990s. In this economic downturn, releases with these terms have been few and far between. Most lenders today, if they approve a short sale, do so with language in an approval letter or term sheet that either expressly reserves the right to pursue the seller for any shortfall or is silent on the issue, therefore leaving the seller potentially exposed to such a claim. There are several factors that explain why this is taking place.
First, the magnitude of this economic downturn is far more significant than the last one in the 1990s. Second, the loan products utilized in the last eight to ten years and the risks inherent in them are far different. These loan products (stated income, no documentation, option at ARMs, etc.) have demonstrated that they are capable of abuse. At times, this abuse translates into misrepresentations being made to the lender(s) regarding, among other things, the income of the seller/borrower, bank accounts with inflated balances, or accounts that the seller has never maintained. Many sellers don’t even realize that this erroneous information has been submitted to the lender(s) on their behalf, because many sellers were asked to sign loan applications in blank.
Another trend revealed in this last economic downturn involved the investor/purchaser. Many such investors represented, knowingly or otherwise, that the property that they were purchasing was to be owner occupied in order to obtain a more favorable loan rate. However, many of these purchases were actually intended to be rentals rather than owner occupied.
All of the foregoing has created a much different economic landscape than that of the 1990s. Lenders are more in tune with these issues and recognize that there may be an opportunity to pursue seller/borrower(s) who have made misrepresentations of these kinds. Reserving their rights against a short sale seller for any shortfall is a way of preserving their claims based on any of the foregoing. Lastly, given the magnitude of this economic downturn and the fractionalization and securitization of many of these loans, many lenders may just be unwilling to absorb the losses that they are otherwise facing.
Irrespective of the motivation, these issues raise a number of concerns for a potential short sale seller. These concerns, and several others outlined below, should be evaluated by a short sale seller before any contact takes place with the lender(s):
First, ask the seller “is there any inaccurate or untruthful information contained in sellers loan application or any other documentation submitted to the lender(s) or signed by seller?” It’s necessary for the Seller to review their loan application, the occupancy provision of their deed of trust, and any occupancy rider to the deed of trust. This potential must be evaluated before any short sale package is submitted to the lender(s). If not, then Seller is providing the lender(s) with the potential evidence to demonstrate that misrepresentations or untruthful statements were made to the lender(s) and induced the lender(s) to make the loan.
Second, “Are the loans recourse or non-recourse?”
Third, “What are the tax consequences of a short sale versus letting the property go into foreclosure?”
Fourth, “Is the Seller candidate for any loan modification or any other relief under a federal program?”
Fifth, “Is the Seller a candidate for bankruptcy?”
Sixth, “If multiple loans, are the junior loans recourse ones?” If so, what is the amount of that loan and what is the likelihood of that lender accepting a significantly reduced amount based on the approval terms of the senior lender (typically, anywhere from $3,000.00 to $8,000.00)?
Also, “What is the impact of these various decisions on the Sellers credit?”
Finally, “What is the Sellers exit strategy from this property?” In other words, “Where is the Seller going to be living? Will They need credit in order to be able to complete their next move, and does the seller want to accomplish that move before stopping any payments on their loan?”
All of these issues should be evaluated before making the decision to embark on a short sale. Many of the answers will be in conflict with each other. Unfortunately, a short sale today typically results in a seller choosing to swallow the least unpleasant of several distasteful medicines. The key is recognizing that even if you have worked through all of the foregoing issues, in today’s short sale environment, you are still going to be faced with a lender who typically is unwilling to release you from all claims and liabilities related to the note and deed of trust. The contract that you sign must contain language which gives you the right to evaluate the approval letter/term sheet that the lender provides. That review should take place with an attorney. The choices that the seller faces at that time are to accept the terms set forth by the lender(s), attempt to negotiate with the lender(s), or cancel the transaction. The decision that each seller makes ultimately turns on a balance of all of the foregoing factors and the status of any pending foreclosure. The key is recognizing what the issues are, evaluating them, and giving the seller flexibility to make the best decision.