Winter Park Home, Volume 7 / Issue 1, 2009Short sales reflect the current downturn in real estate valuations - they are real estate closings in which there are insufficient sales proceeds to pay off the outstanding liens and closing costs of the seller. They typically occur because the outstanding balance due on a mortgage is greater than the current market value of the property. The buyer typically will be told in advance that the seller has contacted or will contact the lender in an attempt to have the lender accept less money than the outstanding mortgage balance.
There are three primary options that a seller needs to consider when presented with a contract offer which will result in a short sale. First, he/she can take a loss on the sale of the property and pay the difference from other funds. Although this represents an economic loss, this approach will not impact the seller’s credit rating, and the seller will not have to deal with the fallout of a lowered credit rating or potential bankruptcy proceeding.
The second option is for the seller to ask the lender to accept less than the amount currently owed. The lender may agree to cooperate with the seller’s request, if the partial payoff is likely to be preferable to the alternative – i.e. the costs involved in a foreclosure action, the associated costs in holding the property, and the reality that the amount realized by the lender when selling the property after a foreclosure (especially in today’s market) may be less than the offered partial payment. However, most lenders will not even consider this request unless the seller is already significantly behind in his payments – generally a minimum of three monthly payments.
Prior to entering into any short sale agreement, the lender will require additional proof from the seller relating to the seller’s overall financial position and the current value of the property, together with other requirements. Lenders will not readily grant permission to accept less money than owed, so the documentation provided by the seller will be carefully scrutinized. If, for example, the lender determines that the information provided on the original loan application was “inaccurate,” the seller could also expose himself to charges of mortgage fraud. Before requesting a short sale agreement, the seller must carefully consider all potential ramifications of this action. Our law firm always recommends that the lawyer meet with the client to review his or her options, consider the tax consequences of the sale, and the impact on the seller’s credit rating before proceeding with a short sale.
If a seller is able to obtain permission from the lender for a short sale, he/she still needs to address the tax consequences of the transaction. The lender will either forgive the additional indebtedness, or require the seller to execute an additional promissory note for the amount that is not paid off at the closing. In other words, the debt does not merely disappear. A forgiveness of debt will most likely result in an additional tax obligation to the seller – the IRS will treat this forgiveness as additional income. The only exception to this rule is if the property in question that is being considered for a short sale is a seller’s primary residence. The tax laws currently provide that the debt forgiven by a lender during the sale of a debtor’s primary residence is exempt from being treated as taxable income (up to $2 million of forgiven debt is eligible for the taxable exclusion, and $1 million if married and filing separately). A new promissory note, on the other hand, does not relieve the seller of the existing financial obligation, and the seller can still be sued for non-performance under its terms.
Both the contract seller and the contract purchaser need to be aware that the process of obtaining an approval by a lender for a “short” payoff is a difficult and time consuming process. This article is only intended to outline some of the issues, and is not intended to fully explain all the steps and hurdles that may occur. Each party needs to obtain his or her own experienced real estate counsel to fully understand the ramifications of the short sale contract. The seller needs to thoroughly understand each of his/her options.
When our firm represents a buyer in this situation, we not only initially advise our client of the steps that are involved prior to closing, but we also recommend that our firm, as buyer’s counsel, hold the escrow deposit. A Short Sale Addendum to Purchase and Sale Contract should always be included as part of the contract under these circumstances, which provides that the contract is contingent upon: 1) each of seller’s lien holders approving the purchase price and the terms of the contract and HUD-1 Settlement, and confirmation that these lien holders will satisfy or release the liens for the reduced payoff amounts; 2) timely notice by the Seller that the lien holders have approved these terms; and 3) acknowledgment by the buyer that the lenders/lien holders are not obligated to approve the contract. The buyer of course must not be related to the seller, and the contract must be a good faith – arms length transaction.
The third option, of course, is for the seller to stop making payments altogether, and to allow the property to be foreclosed. This will have a significant impact on the owner’s credit rating, and may prevent the owner from obtaining financing to purchase other property for years to come. It is noteworthy that borrowers often file bankruptcy to halt the foreclosure process. This is a stalling tactic only, and most likely will not prevent the foreclosure from ultimately being completed.
Short sales represent significant hurdles for a seller, and a recognition by a buyer that the seller will not be obligated to complete the transaction in the event that the seller is unable to obtain the necessary consents from the outstanding mortgage and lien holders. Both the buyer and the seller should retain their own legal counsel to represent them through this potential closing quagmire, and to realize that there are many potential issues involved for both the buyer and the seller.
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Frank Pohl founded Pohl & Short, P.A. based upon the belief that a high quality small commercial law firm was needed in the Orlando, Florida area as an alternative to the large commercial law firms. He still believes that client responsiveness and satisfaction has a place in a fast changing legal profession. Frank has been involved in the Central Florida community for more than twenty-five years. He has been a dedicated past board member of many local organizations over the years. Frank graduated magna cum laude with a B.G.S. Degree from the University of Miami in Coral Gables, Florida; attended the University College at the University of London as an undergraduate studying British literature and British history; obtained his Juris Doctorate Degree in 1979; and obtained a Masters of Law and Letters Degree (LL.M.) from New York University School of Law in 1980. Frank is a member of The Florida Bar, the California Bar, and the District of Columbia Court of Appeals. He is also admitted to the U.S. Supreme Court. He has served on the Orange County Bar Association Real Estate Committee and is a member of the The Florida Bar’s Real Property and Corporation and Business Law Section. He has also served on the Florida Bar Grievance Committee.
