Sweeping generalized statements (“I predict we are at the bottom!”) regarding the current state of the Southern California (or even just the Santa Clarita Valley) residential real estate market may work to grab a reader’s attention (and this is a blog, after all), but their value in terms of providing useful information that is worthy of your consideration is minimal, at best.
That said, it is simply beyond dispute that many Southern California homeowners, including some who put as much as 20.0% down in cash at closing, now find themselves owing more money to their first and second lien lenders than the mortgaged property is worth. Many of these homeowners may also find themselves to now be struggling, or flat-out unable, to satisfy their mortgage payment obligations each month.
Often, such homeowners and their lenders will have already tried at least one prior unsuccessful loan modification under the federal government’s Home Affordable Modification Program (HAMP). At this point, as borrowers, the homeowners may be faced with a threatened or pending non-judicial foreclosure sale of their property.
Under these circumstances, a Short Sale — a pre-foreclosure sale in which the lender allows the borrower to sell the distressed property for less than (i.e., “short” of) the amount currently owed on the mortgage loan — may seem to offer an attractive, workable, and ultimately beneficial solution to a distressed homeowner’s financial woes.
And, it is certainly an option worthy of careful review and consideration by the distressed homeowner, together with a licensed realtor and independent legal and tax advisors. Beware the unlicensed “short sale negotiators” and the real estate agents who relinquish control over the bank negotiations to them. There are certain issues which may arise in the course of a short sale transaction that can only be properly addressed by a licensed and experienced realtor, attorney or CPA, respectively.
Once such issue, and one that is of critical importance to the seller of the home, is what happens regarding the amount of the shortfall of the sale proceeds applied against the secured loan(s). This shortfall amount is commonly referred to as the “deficiency” amount, and proper handling of the issues which surround it will require the unique expertise of the realtor, the lawyer, and the accountant in their respective fields.
The need for this expertise is generated by the interplay of two rules governing secured real estate transactions within the State of California. These are the One-Action Rule, set forth in Section 726(a) of the California Code of Civil Procedure, and the Anti-Deficiency Laws set forth in Sections 580(a) through 580(d) of the California Code of Civil Procedure. The interplay between these two rules raises important considerations involving the homeowner’s exposure to potential liability for the amount of the shortfall of the sale proceeds to be applied against the outstanding balance of the mortgage loan.
In particular, the One-Action Rule provides that a creditor must choose and pursue only one form of legal action seeking recovery of any debt secured by a mortgage upon real property (i.e., out-of-court foreclosure under power of sale contained in the deed of trust; judicial foreclosure of the real property security; or suing for recovery of the underlying debt). In addition, a creditor is required to proceed in the exercise of its remedies against the real property collateral before suing for recovery of the underlying debt.
One effect of the One-Action Rule in California is to induce most creditors to proceed with an out-of-court (or “non-judicial”) foreclosure sale of the mortgaged property before seeking a personal judgment against the debtor. Now, enter the Anti-Deficiency Laws, and in particular Section 580(b) of the Code of Civil Procedure, which prohibit a deficiency judgment against the debtor in any case in which the real property security has been sold by the creditor under power of sale contained in the deed of trust.
As a result, if a mortgage lender exercises its foreclosure remedy against a defaulting borrower in respect of a loan used to pay all or part of the purchase price of a dwelling intended to be occupied by 4 or fewer families (including the purchaser) — a typical owner-occupied, single family home — the homeowner is protected from a deficiency judgment.
This protection against a deficiency judgment is not available in the case of a consensual short sale transaction. Recently proposed legislation to extend the application of California’s Anti-Deficiency Laws to first lien lenders who have consented to short sales of mortgaged residential properties failed to receive the Governor’s approval prior to September 30th of last year, falling victim to the ignoble “pocket-veto”.
Lenders will often include the following acknowledgement (or one very similar) of borrowers’ exposure to liability for the deficiency amount in their short sale approval letter: “[Bank] may pursue a deficiency judgment for the difference in the payment received and the total balance due, unless agreed otherwise or prohibited by law, if the short sale closes on the loan referenced above.”
In such instances, the services offered by an experienced local realtor are therefore essential in order to help maximize the sale price received for the distressed property (and thereby reduce the amount of the deficiency judgment which may be pursued). However, realtors are not licensed to comment on the sufficiency of short sale approval letters, and will not themselves be able to negotiate to obtain more favorable language from the bank waiving any rights to pursue a deficiency judgment against the seller.
Only a licensed attorney may act to provide this important protection of the seller’s interests. And, if successful, the seller will have been well-served to have consulted with a licensed CPA prior to close of the transaction to understand the tax implications of any “debt forgiveness” obtained as a result of the short sale transaction.
A properly handled short sale requires a professional team effort. Each player needs to understand his or her respective role, and then be quite good at performing it.
The authors wish to acknowledge two highly informative articles published by the California Department of Real Estate: CONSUMER ALERT: Warning Regarding Residential “Short” Sales (April 2010); and Update to DRE Issued Consumer and Industry Alert(s) Regarding Short Sales Fraud, and Related Issues (September 2010)
