Get Your Sellers Released from Deficiencies
by Brandon Brittingham
From an agent’s perspective…
There has been a lot of controversy recently (and even a CNN news story) about sellers not being fully released when they sell their property through short sale.
I think, for the most part, a majority of the information that I have read has been accurate, but there is a major glaring issue that no article or blog has touched on. As agents we can get our sellers released from deficiencies!This is all part of the negotiation, and I think there is a huge lack of education when it comes to this subject.
First off, in some states (depending on state law), the bank cannot pursue the seller for a deficiency, so check your state law to see if you are in a state that qualifies…I think a lot of agents assume that if the bank accepts the short sale, they are automatically letting the seller off the hook for the deficiency. This, unfortunately, is far from the truth. If the terms are not clearly spelled out in the approval letter with language such as, “seller shall be fully released from all further liability or debt, and we, “XYZ”, shall not pursue a deficiency judgment”, then you, as an agent, should be negotiating to have that language in the approval letter. On a principal residence this is a lot easier because most banks (not all) take the IRS perspective of letting the seller off the hook, but only if you make that part of the negotiation.
If you are unfamiliar with the IRS perspective, The Mortgage Forgiveness and Debt Relief act passed in 2007 brought relief to sellers in this position. In most cases on a principal residence, this legislation relieves the buyer of any taxable “gain” on their home through short sale. In the past, the seller would receive a 1099 for the difference of the mortgage balance vs. what the property sold for at short sale (i.e., if the balance was $200,000 and the property sold for $150,000, the seller got a 1099 for a $50,000 gain) and they were taxed on that difference as income…
Banks would certainly rather perform a short sale than perform a foreclosure, and if you are involved in a short sale it should be a requirement that your seller is fully released. If not, you’re not negotiating for the seller’s best interest, and if you’re not acting in the seller’s best interest, then what really are you negotiating? Yes the bank will accept the sale, but if they reserve the right to pursue your seller later on, that doesn’t sound too much like a negotiation to me. Banks are more prone to doing this on principal residences and I have found that is fairly simple to get my sellers fully released when it is their principle residence. When they have balked at doing this, I simply went over all the factors with them, and reiterated the amount of money they would lose along with the other factors I had presented with my package, and got it in the approval letter that they would release my seller!
Please note that with any approval letter, you and your sellers should consult with an attorney to know the ramifications of the letter once received. I suggest never attempting to interpret an approval letter, no matter how versed or experienced you are, without a lawyer’s interpretation first. The reason behind this is the simple fact that as agents, it is not our job to interpret law, and with a lot of approval letters, state and federal law can get drawn into the equation. If you interpret something the wrong way, you could find yourself facing a law suit.
Second homes, investment homes, and second liens take a bit of a different approach. These are tougher situations to get your sellers fully released, but they’re not impossible. With these three cases make sure your seller talks to a short sale versed accountant, because these types of sales may have some tax ramifications. Second liens are the easiest of the three because the bank is in a second position, and, in almost every case, if the property goes to foreclosure, they get absolutely nothing. Second lien holders will usually require some type of payment from the first, and they will generally fully release the seller on a primary residence. (but only if you get in writing to get them released).
Even in a second position, on second homes and investment homes the situation can be tougher though. In a perfect world every second lien holder will be easy to deal with, but we’re talking about banks here! Principal residence or not, sometimes you come across that second lien holder that is going to try to hold the seller to some type of promissory note, or will not fully release them without some kind of debt repayment. There are going to be some cases where the second’s loss is so great they cannot stomach the small payment they are getting from the first. Again, if they are in a second position and the property goes to foreclosure, then they get nothing. Please keep this in mind when negotiating.
So what do you do if they won’t budge? If a second lien holder simply will not budge (though in almost every case I have been able to get them to…), then whatever promissory note they hold the seller to should be a minimal amount with very favorable terms. Then of course, your seller has to agree to the terms which they may not want to do, so they have to be favorable to the seller not the bank.
Out of the 265 short sales I have closed, I have only had two in which my sellers had to sign a promissory note. Both were under $10,000 and in both cases the notes were zero interest payable over ten years. In both these situations the second lien holder’s loan loss was over $150,000. Now, if your seller agrees to this, they have to be fully released from any other future liability. (If you run into this, please consult with an attorney as this can get complicated, and you and your seller need to have a full understanding of the situation before moving forward).
With second homes and investments, you will have a harder time getting your seller fully released. Banks think of second homes as “luxury” items, and try not to let sellers off the hook as easy. Investments are often treated the same way, because the all-knowing banks think your sellers should be able to rent or sell the property (Obviously, if they could they wouldn’t be performing a short sale!). In both of these situations, remember—if they foreclose, their probable loan loss could be in the six figures, and depending on your state’s law, they may not get the property back for over a year! Keep this in mind, and just make sure whatever the bank throws at you to get your seller released, negotiate on your seller’s behalf!
Regardless of what the banks tell your or what you read in the media, you can get your sellers fully released, and successfully close short sales to your sellers benefit…
Brandon Brittingham is Realtor with Long and Foster in Salisbury, Maryland.