Clearing the myths and misconceptions of Short Sales

7 Jul

For anyone who is contemplating or negotiating a short sale, it is important that several myths and misconceptions get “debunked”, and that some information gets demystified.  Read on, and then contact your real estate attorney with questions.

 
What is a short sale?  In simple terms, a short sale is a lender or creditor’s approval or a sale of your home for less than the amount owed.  Where the value of the property is less than the debt balance, people often talk about or consider doing a “short sale” to get out from under the debt, in an effort to avoid foreclosure.  That’s where the myths and misconceptions often begin.

 

No automatic right to short sale

First, it is important to recognize there is no automatic right or entitlement to be able to sell your property in a “short-sale” situation.  Banks or creditors are not obligated to allow a short sale to proceed, and they will do so only if it makes economic or practical sense for them to do so (which it does in many instances). 

 

How a short sale works

For a concrete example, let’s assume you have a home that is worth $125,000, and you owe $150,000 (first mortgage only, no other debt against the home).  If you receive an offer for $125,000, you cannot sell the property unless the mortgage gets released.  The lender holding the mortgage would have to approve the release of the mortgage, or you would have to bring the $25,000 that remains unsatisfied from the sale in order for the sale to close.  Otherwise, the sale would have insufficient proceeds to satisfy the debt owed, and the home may be foreclosed if you can’t make payments on the mortgage.

 

Release v. satisfaction

In the example above, I only mentioned that the lender would have to approve the sale and release the mortgage.  If the mortgage is released, that does not mean the debt is satisfied.  A mortgage is the security instrument securing the lender for the amount owed by you, using the home as collateral.  The amount you owe is based on your contractual obligation to repay the lender through the terms of a Prommissory Note. 

 

If the mortgage is released, with nothing more, you may remain obligated to pay the outstanding/unsatisfied amount of the Note.  In the example above, then, the home may sell for $125,000, but you may still owe the lender $25,000 after sale.  In some instances a lender may ask you to reaffirm the debt at closing, and in other instances they may not even mention it.  Either way, you could end up owing the money, which the lender may call due immediately, or could perhaps delay and require you to pay weeks or months down the road.

 

 Avoiding repayment of unsatisfied debt

With the above in mind, it is clear that a “short sale” does not automatically mean “satisfaction of outstanding debt”.  In other words, if you go into a short sale thinking the bank will simply forgive the amount of debt you contractually agreed to repay, you may be in for a dramatic surprise. 

 

There are certainly instances when a bank will make a financial decision to forgive all, or a portion of the debt, depending upon factors such as the amount of debt between sale value and debt owed, whether there are additional lenders, creditors, tax liens, and other financial obligations recorded against the property that must be negotiated, and your financial picture.  In my experience, I have seen lenders be more accommodating when your financial picture (and their ability to recover from you) is bleak, and the amount of debt that will be unsatisfied is small.  They tend to be less accommodating where a large amount of the borrowed money will be unsatisfied by the proposed sale, where the borrower has investments, income, or other property that could be accessed to satisfy the amount owed, and related circumstances.

 

 Proactive planning

Before you enlist the help of a real estate agent or other professional to list your property for sale or to negotiate a short sale, you should spend some time upfront with a knowledgeable attorney or financial advisor to discuss some of the issues identified above, and how these issues may impact your own personal financial goals, expectations, and circumstances. As you may now understand, lenders with whom a borrower is negotiating a short sale do not treat all borrowers alike, and each property, each proposed sale, and each result is different. 

 

You should approach this type of transaction with eyes wide open, ideally with the assistance of your attorney who may help identify pitfalls, ensure the appropriate agreements confirm your expectations regarding the release of the mortgage, the satisfaction of debt, and ensuring the related legal consequences and financial outcomes meet with your expectations. 

 

Clients of mine sometimes are uneasy paying money to an attorney to advise them of the risks and assist them in the process of negotiating a short sale.  However, it is far easier (and less expensive) to address such issues proactively, as they arise, then to react to and try to correct any surprises or problems that could have been planned for or circumvented.  If you are facing or contemplating a short sale, be sure to speak with your attorney.  If you aren’t already working with an attorney, feel free to contact Brad Boyd at Thomsen & Nybeck. 

 

This blog entry is written by Brad Boyd, Shareholder at Thomsen & Nybeck, P.A. Brad’s practice focuses primarily in Real Estate, Real Estate Brokerage, Business and Corporate law, and Wind Energy Law.  Brad works regularly with real estate buyers, sellers, and investors, real estate brokerages and agents, and he provides advice, guidance, and representation related to risk management in a wide variety of real estate matters.  For more information about Thomsen & Nybeck’s Real Estate practice, please visit http://www.tn-law.com/CM/Real-Estate/Real-Estate-Law.asp.

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