Financially distressed borrowers may think that a foreclosure or a short sale means their mortgage troubles are over. That’s simply not the case.
The Washington Post reported last week that “over the past year, lenders have become much more aggressive in trying to recoup money lost in foreclosures and other distressed sales [e.g. short sales], creating more grief for people who thought their real estate headaches were far behind.” Also, the Los Angeles Times recently reported that “Fannie Mae gets tough on homeowners” explaining that the government-controlled mortgage company said that it would instruct the companies servicing its loans to recommend when it should sue a defaulting borrower for the unpaid portion of their loan.
In many circumstances, lenders have the right to pursue collection of the deficiency (the amount left unpaid post foreclosure OR POST SHORT SALE). In California, a lender may have as long as 4 years to commence legal action against the borrower after the original default. This means the borrower is in jeopardy for years after foreclosure or short sale.
In a typical situation, after the foreclosure or short sale has concluded, the original lender will sell the right to pursue the legal action to a company that buys and collects upon bad debt. It is that collection company that will call the borrower 2 or 3 years after the short sale demanding payment of the outstanding balance on the loan along with default interest, costs of collection and attorney fees. They have the right to sue the borrower for the amount unpaid, and they have an excellent chance of winning the case. At that point, they have a deficiency judgment against the borrower and can start legal collections procedures such as garnishing wages or clearing out bank account balances.
So what can you do if you are a borrower facing default or foreclosure? Your best option is to explore an alternative to foreclosure which will give you the ability to negotiate the deficiency issue with your lender. Currently, the most successful foreclosure alternative is a short sale. A short sale allows you or your attorney the ability to negotiate with your lenders to have them waive any and all deficiencies.
If you are pursuing a short sale, make sure you have representation that understands recourse & nonrecourse loans, judicial & non-judicial foreclosures, the California anti-deficiency laws (CCP 580b, CCP 580d, CCP 726) and their application to your loan(s), along with the difference between a simple “release of lien” and a “full satisfaction of debt.” It is not good enough that your lender agrees to release its lien in the short sale, you must get a waiver of the deficiency or have language of full satisfaction in your approval letter. Silence in the approval letter on the issue IS NOT AN OPTION.
Additionally, contradictory language is not good: An approval letter which “reserves the right to pursue the deficiency” and also contains language that the lender will “issue a 1099-C in the current tax year,” creates a serious legal ambiguity. There are cases on record where lenders successfully argued that the issuance of a 1099-C was a mistake, and the lender was allowed to pursue the deficiency. Thankfully, the Home Affordable Foreclosure Alternatives (HAFA) program directly addresses this issue and provides incentives to the lenders to compete the short sale with a full wavier of deficiencies. In fact, the HAFA program allows a relocation incentive of up to $3,000 to be PAID TO THE BORROWER for participating and cooperating in the short sale. Hopefully, more lenders will follow the lead of the HAFA program even for those loans which do not fall within the HAFA guidelines.
PLEASE BE AWARE: You only have one chance to negotiate the deficiency issue with your lenders. A short sale provides the best opportunity to address the issue and receive a full waiver of deficiencies. It is also the one time where “new money” is coming into the transaction via the new buyer, which allows for some leverage against the lenders (especially with a second lien holder who would otherwise be very aggressive against a seller post-foreclosure). Homeowners who do not proactively pursue a short sale and who simply wait for a foreclosure to occur are foregoing a significant opportunity to limit their financial burden. As stated in other articles, you must also be aware that a waiver of deficiencies is a cancellation of debt by your lender which can raise serious taxation issues. Please seek tax advice prior to making any decisions on pursuing a short sale.
For more information, please watch our webinar “Foreclosures & Short Sales: Navigating the Minefield” at www.LawyersRealtyGroup.com.
ABOUT THE AUTHOR:
Derik N. Lewis is a California real estate broker and a practicing real estate attorney. Derik graduated magna cum laude from Boston University School of Law. He has 20 years of real estate experience and has served as legal counsel for some of the world’s largest lenders. During the current real estate downturn, Derik is applying his knowledge and experience to help homeowners, investors, and developers find alternatives to foreclosure. Borrowers facing default or foreclosure can get a skilled broker and experienced real estate attorney by contacting www.LawyersRealtyGroup.com.