The Legal Pitfalls of Short Sales

 

Although short sales represent an enormous opportunity in today’s market, the chief concern for any real estate professional should be protection from the legal risks associated from this specialty niche.

Deficiencies and Loan Forgiveness
Negotiating a deficiency is at once the most critical and frequently overlooked aspect of completing a short sale. Considering the settlement of a deficiency requires legal analysis and specific language, it’s no wonder this all-important part of the negotiation is bypassed regularly when anyone but an attorney is handling the negotiation. Sellers need a legal interpretation and a written analysis of their closing documents to ensure their interests are protected.

Experienced short sale attorneys negotiate for the release of both the property lien and the underlying personal debt secured by the note.   Otherwise, the lender may not forgive the personal debt and begin collection activity. It should also be noted that Federal loan forgiveness law does not grant all sellers loan forgiveness and does not relieve sellers from taxes levied in certain states. 

Issues with Template Listing, Purchase and Sale Agreements
Realtor's form Listing and Purchase and Sale Agreements do not do enough to protect sellers from buyer's Realtor, buyers and lenders.  Realtors are not licensed to suggest improvements to contracts or review closing documents, contracts and escrow instructions.  The language in escrow instructions is vague at best and closing paperwork which is often deceptive and weighted heavily in the lender’s favor.

Misrepresenting Tax Consequences
The federal government passed a law in 2007 directing the IRS not to count mortgage debt forgiven by a lender as income.  But the provision is limited and laws for mortgage debt forgiveness vary from state to state.  A Realtor who tells a client there are no tax consequences could be putting his or her license at risk.  

Misrepresenting How Secondary Debt Is Treated
One of the most common misrepresentations is that debt is forgiven once the primary lender approves a short sale. This is not always the case. Holders of second deeds of trust don’t typically forgive the debt and reserve the right to seek recompense at a later date.   Rather than write off the entire debt, they often sell the balance to a collection agency that aggressively pursues the borrower. In many states, these second loans are recourse, so sellers can be caught by surprise when the collection agency contacts them a year later seeking payment of the debt. 

Lender Requests for Seller Contributions
Lenders are starting to go after money in a seller’s bank or retirement accounts before they approve a short sale request.  Increasingly, banks are asking Sellers (via their Realtors) to sign over a Note for the amount they have in the bank as a condition of sale.  However, in states where mortgage debt is non-recourse, lenders have no right to these funds, and Realtors who suggest otherwise can be liable for negligence.

These are just a few of the legal pitfalls that someone other than an experienced real estate attorney can encounter. For a more complete understanding of these and other legal considerations, download our free eBook, “Secrets of Short Sale Negotiation.”