Posts tagged ‘Short Sale’

Deed in Lieu of Foreclosure

The “deed in lieu of foreclosure” is the foreclosure alternative in which the property owner turns over the property to the lender and avoids the formal foreclosure process. As in a true short sale, the borrower’s goal in a “deed in lieu” resolution is to avoid liability for the deficiency that results if the property is worth less than what the borrower owes on the debt. The general idea is that the borrower saves the lender the expense of foreclosing by giving the lender the deed to property. In exchange the lender waives the deficiency.

Most lenders in the states where I practice law, Connecticut and New York, require the borrower to list the property for sale for a certain time period (usually at least 90 days) before they will consider a taking a deed in lieu of foreclosing. Whether the lender actually accepts the deed, or waives the deficiency, after the time period expires is an open question. I have not been involved with any deed in lieu transaction in Connecticut or New York nor have I heard of any completed deed in lieu transaction in Connecticut or New York. I think this is largely for three reasons. First, the bank would much prefer that the borrower sell the property rather than the bank have to add the property to its inventory of unsold, “bank-owned” properties. The bank has carrying costs on the properties it owns and there is no reason to increase those costs in a terrible real estate market. Plus, real estate agents will tell you that it is generally easier to sell a property that is occupied than it is to sell a property that is vacant. If the bank takes the deed, the property will be vacant.

Second, Connecticut and New York are judicial foreclosure states. By the time the borrower starts considering a deed in lieu in transaction, the bank has already commenced the foreclosure lawsuit. For residential foreclosures, the parties will spend time in Connecticut’s Foreclosure Mediation program or New York’s Foreclosure Settlement Conference program trying to agree to a mortgage modification. If the programs fail to achieve a modification, most banks believe completing the foreclosure is a foregone conclusion. The bank has less incentive to consider a deed in lieu because it has already initiated and, in its view, can expeditiously complete, the foreclosure without having to waive the deficiency. Contrast this with a nonjudicial foreclosure state where a deed in lieu can avoid commencement of the foreclosure process.

Finally, banks don’t like to waive deficiencies. In a judicial foreclosure state, where the foreclosure lawsuit has already commenced, the borrower gets no real benefit from a deed in lieu if the bank will not waive the deficiency. This is essentially the flip-side of the bank’s viewpoint discussed above: the bank has little incentive to consider a deed in lieu when the foreclosure action is pending and neither does the borrower.

That being said, if a borrower is resigned to losing the property, it cannot hurt to explore the deed in lieu possibility with the bank. At the least, it might provide the borrower with some flexibility in vacating the property.

Short Sale May Not Be All It’s Cracked Up to Be

Lenders may be touting short sales as a foreclosure alternative but the sale may not be truly “short” or even possible. In this post, I discuss how short sales are supposed to work, how they have been (not) working and why they might not work.

How A Short Sale is Supposed to Work

Think of real estate title as a ship. Think of the mortgage as a barnacle that is put on the title when the borrower takes a mortgage loan. The real estate buyer wants to buy a title that is free and clear of all barnacles. This means that the borrower-seller must scrape the mortgage barnacle off the title before she can complete a sale. The normal way to scrape the mortgage barnacle is to use the sale price to pay off the loan associated with the barnacle. If the sale price is insufficient to pay off the underlying debt, the borrower-seller has to ask the lender or mortgage servicer, who often are responsible for foreclosure and short sales, to release its mortgage barnacle even though the sale price is too “short” to fully repay the debt. The difference between what the borrower-seller owes and the net sale proceeds is the deficiency. With a true short sale, the lender takes all of the net proceeds of the sale, releases its mortgage and waives any claim to collect the deficiency from the borrower-seller.

Of course, before the lender or servicer will agree to a short sale, it has to be satisfied that the borrower-seller cannot pay the mortgage and the proposed sale price is reasonable. The borrower-seller demonstrates that he cannot pay the mortgage the same way he does when seeking a mortgage modification: he submits income and expense information and documentation to the lender or servicer, together with an affidavit explaining the hardship. The lender or servicer confirms the reasonableness of the proposed offer with its own appraisal or broker’s price opinion.

How Short Sales have been (Not) Working

Many mortgage servicers have been unwilling to waive the deficiency. The reason for this isn’t entirely clear but probably has something to do with restrictions imposed by mortgage securitization. In a mortgage securitization, the issuer pools mortgages and sells mortgage backed securities, or “MBS”, to investors. The MBS entitles the investor to receive a share of the pooled mortgage payments. The mortgage barnacle, and the personal liability of the borrower, gives the investor security that it will actually receive its proper share of the pooled payments. If the servicer waives the deficiency, the investors may claim that they had a right to that deficiency and the servicer harmed them by the waiver. It is safer for the servicer to refuse to waive the deficiency.

The refusal to waive the deficiency may be a distinction without much of a difference. Though the deficiency still exists, it is an open question whether any lender or servicer would actively attempt to enforce it. Doing so would most likely require a separate lawsuit because a foreclosure deficiency presumes a foreclosure of title. In a short sale, title is not foreclosed; it is sold with the servicer’s consent. A separate lawsuit to obtain a judgment on the unpaid portion of the debt is another expense for the servicer and one that is unlikely to yield a benefit because the borrower-seller is not likely to have the financial resources to pay it. In such circumstances the borrower-seller is said to be “judgment proof.” The added expense, without any added benefit, may be enough to deter the lender or servicer from pursuing a separate lawsuit based on the deficiency.

A short sale without a waiver of deficiency may be preferable to a foreclosure and deficiency judgment in any event. In a foreclosure lawsuit where the property value is less than the debt, the foreclosing party can obtain a judgment for the deficiency, or deficiency judgment, as part of the foreclosure lawsuit. There is virtually no added expense for the foreclosing party since the foreclosure and deficiency judgment are accomplished as part of the same lawsuit. Though the risk to the borrower of anyone actually trying to collect on the deficiency judgment remains remote, the judgment itself remains viable for a long time — 15 or 20 years in many jurisdictions. That means someone could show up to collect in year 14, after the borrower has righted her financial ship. Contrast that to the short sale with no waiver of deficiency; statutes of limitation can protect the borrower-seller from attempts to collect a long unpaid debt.

Why Short Sales Might Not Work

Going back to mortgage barnacles, a real estate title can have multiple barnacles. For example, many borrowers have a first mortgage and a home equity line of credit, or HELOC. The HELOC is another barnacle. All barnacles have to be removed to sell the property. The first mortgage is usually the largest and the first mortgage lender usually wants all of the net sale proceeds (assuming the net proceeds aren’t enough to fully repay the first mortgage). The HELOC, and any other mortgages or liens, can prevent the sale by refusing to release their barnacles unless they get paid something too. If they can’t agree with the first mortgage on who gets how much, the property can’t be sold. If it takes too long for them to agree, the borrower-seller may lose the buyer, who can’t wait around forever.

The possibility of bickering barnacles and lost buyers makes it imperative for anyone considering selling a property via short sale to use a real estate broker experienced in short sales. From what I’ve seen, an experienced short sale broker can be the difference between a completed short sale and a completed foreclosure.