At the Law Office of Linda C. Garrett, an online, Solano County, California-based consumer, bankruptcy and family-law practice, I receive a consistent stream of calls from homeowners, calling because they are worried about their distressed property. Some homeowners are solely looking for options in the event of imminent default, while others are looking for options because they are in active foreclosure in connection with their distressed property. One option that frequently comes up is the California short-sale.
The purpose of this blog post is to provide the reader with a realistic look at the short-sale--looking at the benefits of a short-sale, inherent risks involved in the California Short-Sale, and the enactment of recent legislation affecting California short-sales. Let's proceed with understanding what a California short-sale means to a homeowner.
What Is a Short-Sale?
In the case of a short sale, the borrower (working with his or her legal or real-estate professionals) is given permission by the lender (or lenders) to sell the property at fair market value with the lender(s) forgiving the remainder of the loan. In other words, the lender agrees, in writing, to consider the final amount paid as the loan pay-off, essentially forgiving the difference in the amount owed and the amount received. While this option may sound too good to be true, it makes a great deal of sense to the bank when the cost of foreclosure is weighted against the loss incurred by the bank on a short sale.
The Benefits of a Short-Sale
Before 2010, there were many benefits of a short-sale as compared to a foreclosure.
No Risk of Embarrassment: For many homeowners, the thought of their neighbors and friends knowing their home was being foreclosed upon them, was too much for them. Short-selling the home provides an alternative solution.
Especially helpful when homeowner had more than one loan on the property--such as a second mortgage or Home Equity Line of Credit (HELOC) as these loans were non-money purchase loans; and/or when the homeowner has refinanced the home several times. This means if lender #1 were to foreclose on the homeowner's home, lender #2 (and lender #3) could sue the homeowner on the entire amount owing on his loan! A short-sale hopes to eliminate this risk. By all parties working together (homeowner , real-estate agent, lender 1 and lender 2), they agree to allow the home to be sold in a short-sale and also agree that the proceeds will be divided between lender 1 and lender 2, resulting in no deficiency judgments against the homeowner.
The homeowner is leaving his home on favorable terms.
Problems with Short-Sale
Most real-estate agents will tell a consumer that short-selling their home is better than foreclosure. Examples given are:
1. Less impact on your credit score
2. No worry of deficiency judgments
3. Better for the community
4. Avoid stigma of the "F" word--foreclosure
If you are careful to note the source of the person advocating short-sale over foreclosure, you will quickly note that the advocate is a Realtor or real-estate agent.
The Credit Score dilemma: a consumer's credit score is primarily impacted by how well he or she pays their debts. So, if a consumer is 6+ months in default and has not paid his mortgage, and then seeks to short-sale his home, the damage is already done to his credit score--because it will show 6+ missed payments! The consumer's credit score has already "bottomed out."
No Worry of Deficiency Judgments: In an ideal world, this would be true. Pre-2010, many lenders required the seller (homeowner) and/or buyer to pay extra money out of their pocket for the deficiency and/or require the borrower to sign a promissory note for the difference owing! Many times, when asked, the consumer assumed there will be no deficiency judgment payments once the short-sale was completed. In a few cases, I have instructed the homeowner to confirm that there would be no deficiency post-short-sale and learned, to their horror, that the second lender expected the homeowner to sign a promissory note.
The Better for the Community Argument: This translates to better for the real-estate agent. Bottom line: the short-sale has to be in the best interest of the homeowner.
Avoiding Stigma of the F (foreclosure) Word: There is no stigma. For most hard-working consumers, they have tried for months, if not years, to work with their lender to achieve a loan modification. Only after countless delays by their bank, harassing calls by their lender (asking for bank statements for the umpteenth time), and/or unjustified denials by their lender for a loan modification, does the homeowner contemplate foreclosure. From a legal perspective, it is the real-estate agent attempting to make the homeowner feel shameful for considering foreclosure. There is no shame in the homeowner doing what is right for the family. The majority of the time, the right thing for the distressed homeowner to do is to save him money --in order to prepare for foreclosure.
Senate Bill 931 requires a lender that has approved an agreed-upon short sale payment to accept that amount as full payment for the outstanding balance of a loan secured by real property, prohibiting the lender from pursuing a deficiency judgment against the borrower. The deficiency protections in this measure apply only to first (senior) liens, junior liens are not affected.
Passage of California Senate Bill 458, known as the "No-Recourse Short Sale Bill" was passed on July 15, 2011. SB 458 extends the protections of SB 931 to junior liens effectively providing that any lender that agrees to a short sale must accept the agreed upon short sale payment as full payment of the outstanding balance of all loans. In addition, this measure will clarify that this rule applies only to residences.
The Unexpected Fallout from the Passage of Both Bills
The passage of SB 931 and SB 458 were designed to protect the consumer. The problem, however, is that the two bills combined, in essence, eliminate the motivation for the lender to want to enter into a short-sale agreement. Before the passage of the two bills, the lender(s) could require the homeowner to sign a promissory note and thereafter sell the promissory note to a debt buyer; or, the lender could require the homeowner/seller and/or buyer to pay additional sums to offset the deficiency judgment.
The 2007 Mortgage Forgiveness Debt Relief Act and Debt Cancellation Act
and the 2010 California Debt Relief Act reflect that forgiven debt arising from a short-sale is not taxable income so long as the homeowner meets eligibility requirements.
With the passage of SB 458, there is no forgiven debt because the lender must accept the short-sale payment as "payment in full"; thus, there is nothing to forgive.
Before the passage of SB 931 and SB 458, the senior and junior lienholders could pursue deficiency judgments against the borrower. With the passage of both bills, the senior and junior lienholders can no longer pursue deficiency judgments against the homeowner regardless of the type of loan they took out with the lender, e.g. refinance (of money purchase, home improvements) or HELOC.
Prior to the passage of both bills, only foreclosures were protected by the California Anti-Deficiency Statutes (California Code of Civil Procedure section 580(a), 580(b), 580(c), 580(d) and 580(e)).
How Can I Help?
1. Undertake a complete financial history of your situation.
2. Work with you to identify the types of home loans you have--in order to assess risk of deficiency judgments and/or taxation issues.
3. After having undertaken a complete history of your finances and various home loans, provide you with all possible options in connection with your distressed property, with the underlying goal of helping you make an informed decision regarding the next steps that should be undertaken regarding your distressed property.
Contact me to schedule a consultation.