Short Sale vs. Foreclosure: The Foreclosure That Wouldn’t End
Can a foreclosure go on and on? Unfortunately the effects of it can linger. Right now in California, we have very favorable anti-deficiency laws protecting home owners from being pursued after a foreclosure or a short sale. However, there are still limits to those protections. Homeowners weighing their options should consult with a competent attorney and CPA before deciding on bankruptcy, short sale, loan modification, deed in lieu of foreclosure, or a foreclosure.
Recently, I met with a prospective buyer who had a foreclosure four years ago and would like to buy again. Most lenders I chatted with said that given the time frame it would not be a problem as long as everything else was in order. However, everything else was not in order because the details of that foreclosure were still being drug along behind him. At some point, he refinanced the second loan he used to buy the home into a HELOC and took out a small amount of cash. (Of course, he was not informed that he likely lost some anti-deficiency protection when he did that – but that’s whole different blog post.) When he fell onto financial hard times and wanted to consider his options, he was advised by an attorney to simply walk away from the home. So, he packed up and moved out. This former homeowner was not made aware that that HELOC loan could continue to drag behind him. I personally think a short sale would have been more beneficial for him than walking away. Even though a short sale does not guarantee a deficiency release from a junior lien holder under current California law, the short sale process would have allowed him an opportunity to negotiate up front with the HELOC lender, instead of wondering if they will attempt to pursue him. (* July 2011 Update – California Senate Bill 458 now gurantees that if a second lien holder accepts the short sale, the deficiency is waived as a matter of law.)
In a short sale with two lien holders, it is typical for the first lender to make a small contribution to the junior lien holder in order to secure a lien release for the short sale. It is not guaranteed that they will do that, but in my experience, it frequently happens. The homeowner can then negotiate paying the remainder of the amount demanded by the junior lien holder, or they can also agree to sign a note for a smaller negotiated amount, in exchange for a deficiency release. (Importantly, any payments to the junior lien holder made as a part of the short sale must be disclosed to the first lender.)
So, say for example, a person purchased a property for $500,000 that is now worth $250,000, and they apply for a short sale. They owe $400,000 on a 1st mortgage loan, and they have a refinanced HELOC second for $110,000. If the HELOC demanded $10,000 to resolve the $110,000 balance, and the first lender contributes $5,000 toward that lien as a part of the short sale, a homeowner may be able to obtain a full deficiency release by paying the remaining $5,000 to the HELOC lender as a fully disclosed cash payment at closing or by signing a note and making payments on that $5,000. It could all be handled as a part of the negotiations. There are no guarantees that the junior lien holder will negotiate fairly or favorably, but in my mind, you at least have the possibility of a much better result than by just “walking away.”
Why is this more advantageous? Well, if this potential buyer had settled this debt (with a deficiency release) from their HELOC lender, either as a part of a short sale (or even after a foreclosure), they would likely now be in the position to buy a home again. If the first mortgage lender made any contribution to that junior lien holder as a part of the short sale it helps the homeowner — if he were to now negotiate a settlement of the debt for $10,000, he would be responsible for the full $10,000. And since he chose to just “walk away” instead of dealing with the debt, the effects of this foreclosure will likely continue to linger negatively on his credit for an additional 2-3 years. He could also be sued and experience wage garnishment, etc. And, if he cannot reach a debt settlement now, he may have to head back over to that attorney’s office to declare bankruptcy to truly discharge this debt.
Those considering foreclosure, short sale or bankruptcy should solicit the advice of a competent attorney and tax professional before deciding on a course of action. The issues presented in this article should be discussed in full with your attorney and CPA; these are generalizations of very complex topics that require a much deeper inquiry. The information offered on this blog does not constitute legal advice or tax advice. If, after that inquiry, you, your attorney, and your tax advisor determine that a short sale is the best course of action for you, I will be happy to assist you through that process.
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*Nothing in this article is intended to solicit listings currently under contract with another broker. Those considering a short sale are advised to consult with their own attorney for legal advice, and their tax professional for tax advice prior to entering into a short sale listing agreement – this article does not offer legal and tax advice. A short sale approval cannot be guaranteed. Mint Properties is not affiliated with the government and my services have not been approved or endorsed by the government or any particular lender.
Copyright © Tni LeBlanc *Short Sale vs. Foreclosure: The Foreclosure That Wouldn’t End*