By Charlene D. Moody, Deputy Legal Counsel
With the decline in the economy over the last several years, the “short sale” transaction has increased in popularity. Licensees are listing a larger number of “short sale” properties and buyer-clients are seeking supposed bargains.
Brokers and buyers must remember that a seller is always free to sell their property for less than the remaining amount due on the seller’s mortgage loan as long as the seller is able to come to closing with the difference in order to extinguish the mortgage lien. In general, that is known as a “short sale”, but it does not require approval or participation by the seller’s lender. For purposes of this article, a “short sale” transaction occurs when the seller’s lender agrees to extinguish the lien for less than the amount due, allowing the seller to sell the property free and clear of the mortgage lien but without paying off the full balance due on the loan. There are several issues of which licensees should be aware in order to avoid short sale pitfalls.
THE LENDER MAY RELEASE THE LIEN BUT STILL HOLD THE SELLER LIABLE FOR THE REMAINING AMOUNT DUE ON THE LOAN (THE “DEFICIENCY”). Sellers in short sales must be made aware that they may be on the hook for any deficiency and just because a bank will allow the sale of the home does not mean that they will be left without owing the debt. A lender may accept the short sale amount and release the lien but refuse to consider it a full and final settlement of the debt. Brokers working with sellers should make certain the seller determines whether or not the lender will hold them liable for the deficiency before the short sale is completed. Conversely, if the lender agrees to forgive the remaining debt, the seller may face tax consequences because this debt forgiveness may be treated as income for tax purposes. Finally, a short sale transaction may affect the seller’s credit score and ability to purchase another home for a period of time. Licensees should encourage sellers to discuss these issues in detail with their attorney and tax advisor before deciding to do a short sale. An attorney may be able to assist an owner in pursuing options other than a short sale (such as a loan workout, refinance, deed-in-lieu of foreclosure, bankruptcy, or loan modification).
AT WHAT POINT DOES A CONTRACT IN A SHORT SALE BECOME A BINDING CONTRACT? The North Carolina Association of REALTORS® has created a short sale addendum for both the standard form listing agreement and offer to purchase and contract. When these forms are used, lender approval is simply an additional contingency to the contract. At the point that both the buyer and seller have signed the contract and the seller’s acceptance has been communicated to the buyer, the parties are in a binding contract subject to the contingency of the lender’s approval of the short sale. Brokers representing sellers in a short sale situation where the standard form is NOT being used should advise their seller clients to have an attorney review the contract before they sign and be sure the seller can be released if the lender does not approve the short sale.
LENDER APPROVAL IS REQUIRED AND CAN BE COMPLICATED. Each lender may have different document and eligibility criteria to determine whether a short sale transaction will be allowed. Generally, a lender will require proof that the borrower is incapable of paying off the loan and that the lender will fare better through a short sale than through the foreclosure process. Sometimes, being upside down on the loan (owing more on the loan than current fair market value) is enough, but the lender may still choose to evaluate the seller’s financial circumstances to confirm that his or her resources are truly insufficient to cover the loan amount. Additionally, all debt and costs must be ascertained in order to determine the feasibility of a short sale. These debts include the amount of the delinquent loan, any home equity or other loans recorded against the property, past due HOA fees, and unpaid property taxes. The costs of the sale include any agreed closing costs (if allowed by the lender), escrow fees, and brokerage commissions. If a seller has more than one lien against the property, a short sale may require the approval of other lenders.
BROKERS SHOULD TRY TO IDENTIFY POTENTIAL SHORT SALE SITUATIONS PRIOR TO TAKING THE LISTING TO AVOID SURPRISES ONCE THE PROPERTY GOES UNDER CONTRACT. Listing brokers must remember that it is a material fact that a seller cannot complete a transaction without doing a short sale and this must be disclosed to a buyer prior to contract even if the information may harm the seller’s bargaining position. Similarly, if the listing broker learns a short sale is required after the contract is signed, or if the property goes into foreclosure while under contract, the listing broker has a duty to inform the buyer. Brokers should also remind sellers and buyers that short sales are uncertain. A lender is not obligated to approve a short sale transaction and may choose not to involve the seller or his listing broker in the decision-making process.
SELLERS AND LISTING BROKERS SHOULD BE ON THE LOOKOUT FOR SCAMS INVOLVING SHORT SALES. These may include the buyer retaining a third party to negotiate a short sale, requesting that the seller execute a power of attorney for another party or not contact the lender themselves, large upfront fees, and guarantees to stop foreclosure. “Flopping” is a newly coined word for certain scams involving short sales. “Flopping” occurs when a seller or buyer (and/or his broker) convinces a lender to accept a short sale transaction while concealing from the lender the fact that another offer at a higher price is already lined up. The buyer then quickly resells the property for a profit. New regulations have been created to prevent flopping, including 90 day bans on resales.
LENDERS WHO AGREE TO A SHORT SALE TYPICALLY TRY TO HAVE A SAY IN THE AMOUNT OF BROKERAGE COMMISSION PAID AND MAY NOT ALWAYS BE WILLING TO APPROVE A SHORT SALE IF BROKERS TAKE THEIR USUAL FEE. Listing brokers should be careful to accurately represent the commission they will pay to cooperating brokers and disclose that the amount of compensation may be adjusted based on the lender’s requirements for approval of the short sale.
BUYER BROKERS SHOULD ADVISE BUYER-CLIENTS ABOUT THE PROCESS AND CONSEQUENCES OF A SHORT SALE. A buyer broker should remember that just because the asking price of the property is below the payoff amount of the loan, there is no guarantee that the property is worth even the asking price. Brokers should take special care in assessing value in declining markets. In addition, a lender may not consider a short sale until a contract has been signed by buyer and seller. Once the parties submit a contract, the lender may take a long time to make a decision and may reserve the right to change the terms at the last minute. Moreover, a seller in a short sale transaction may not be financially able to make any repairs so the transaction is likely to be “as-is”. The listing broker is allowed to continue marketing the property and may receive other offers which must be communicated to the seller and the seller’s lender. Remember that the lender has a financial interest in the property and is being asked to take less than the amount owed. The lender therefore has the right to full disclosure of all offers. If another offer is more attractive in price or terms, the lender may not approve the first contract and require the seller to accept the later offer. Buyers must be patient, willing to wait, and understand that they could lose the property at any time before closing.
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In summary, short sales involve significant risk to both sellers and buyers. Sellers may face many financial issues before, during and after the closing. The buyer must understand that not all short sale are bargains, short sales are generally not short transactions, and just because the parties have signed a contract does not mean that the buyer will get the house. Brokers should be well versed on these types of transactions before engaging in a short sale and should fully disclose all potential issues to their clients.
This article came from the May 2011-Vol42-1 edition of the bulletin.