When banks become their own worst enemy

24 Aug

As we all know or as most of you have heard throughout the media, the nation (and certainly the Minneapolis / St. Paul market area) face continued mortgage defaults and delinquencies, foreclosures, and the resulting personal and global economic impact of the same.  Unfortunately, in advising individual clients, real estate agents, brokers, and others, we see a variety of successful short sales, mixed with those that are unsuccessful.

Trend – banks stand in their own way and compound their problem. A common and troubling trend is banks who hold a mortgage/lien in a proposed short sale trasnaction become their own worst enemy.  Sparing the many intricate details of a short sale transaction to succinctly summarize the issue – when banks fail to agree to reasonable short sale terms, they lose.  They lose because they ultimately have to foreclose, which has significant cost and delay.  In Minnesota the time between a mortgage default and the time the bank/lienholder recovers a property could be 8-12 months, or perhaps more depending upon the circumstances.  Once a bank/lienholder has the property back, they have to market it for sale, pay holding costs, and hopefully (wishfully) sell it at the minimum loss possible in a depressed and inventory-heavy market.

When does a bank become its own worst enemy? In this writer’s judgement, one of the biggest roadblocks and constant impediments preventing reasonable and appropriate arms-length (i.e. not fraudulent) short sale transactions from occurring is when banks remain silent as to whether unsatisfied debt must be repaid.  Where banks fail to identify whether debt will need to be repaid, borrowers fear the nagging possibility that the lienholder sues for the unpaid balance of the Promissory Note (contract to repay) even after the mortgage is satisfied.  In a situation where the statute of frauds for recovery on a contract may be up to six years (by way of example only), the borrrower could face the risk of having the bank come knocking and attempting to collect unpaid debt years after a short sale has been “successfully” accomplished.

What’s the solution? Having some clarification is typically better than none.  Short sales come with a variety of “approvals” from banks/lienholders.  Some banks are willing to state, in their approval of a short sale, that the borrower will not have a continued obligation to repay the unsatisfied debt.  Ideally, the bank would state in clear and certain written terms that the debt that remains unpaid is deemed “satisfied” or “forgiven” and that they waive the ability to pursue the borrower.  This is obviously the “goal” outcome, although this is not always attainable.

In other instances, the bank approving a short sale will at least identify, with certainty, how much debt will need to be repaid, when, and on what terms.  In that instance, the amount of debt, interest rate, and payment term may all be negotiable.

The least desirable circumstance (and the one where the bank becomes its own worst enemy) is the situation where the bank or its investors refuse to identify any written terms regarding the unpaid debt.  This silence, in and of itself, tends to be extremely unnerving for many borrowers, and will in some instances force a borrower to choose a path other than short sale, which may result in the bank ultimately having to persue foreclosure.  Obviously this result may fail to serve the short sale buyer (who may move on to another property in the meantime), the seller (who may have otherwise have sold but who may know simply walk away) and the bank (who may have lost a finite and predictable amount of money but is now facing the ongoing and unpredictable loss associated with getting the property back, holding it, and reselling it as a foreclosed REO property.

Conclusion and final consideration. For those in a position of influence in public policy, lending institutions, and other areas that may have an ability to shape policy, the issue of how to help banks help themselves in making the short sale process one driven by a greater degree of logic, common sense, and fiscal responsibility is an issue well worth exploring and working on solving, in this writer’s humble opinion.

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This blog entry is written by Brad Boyd, a Shareholder at Thomsen Nybeck. Brad is the chair of the firm’s Transactional Group, and his practice focuses primarily in Real Estate, Real Estate Brokerage, Business and Corporate law, and Wind Energy Law.  Brad provides legal advice, guidance, and representation related to risk management in a wide variety of real estate and business law matters.  He is counsel to the Minnesota Association of Realtors, many individual Realtors and brokerages, business clients and individuals.

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