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The above discussion dealt with those sellers desiring to remain in their home. The following discussion deals with owners desiring to dispose of their home and extracting themselves from their loan.

Deed in Lieu of Foreclosure. This alternative is nothing more than a voluntary agreement between the lender and the owner to deed the property back to the bank, rather than (“in lieu of…”) forcing the lender to go through the entire foreclosure process. It benefits the owner, since it is quick; and the lender, since it is cheaper and faster than the usual trust deed foreclosure process, which can take several months. However, caution must be exercised here, since, as will be discussed in the Short Sale Section below, there is the possibility of tax liability for debt forgiveness (if not a primary residence), and for promissory note liability. For this reason, notwithstanding the apparent simplicity of the procedure, scrutiny of the written documentation is essential before finalizing a deed-in-lieu approach.

Foreclosure – Although not a pleasant alternative due to its negative connotations, it should not be discounted as a viable negotiating tool for distressed sellers today. Remembering that banks don’t want the property back as it affects their capital requirements and frequently causes thousands of dollars to rehab, maintain, pay property taxes, and absorb marketing and sales commission expenses. In Oregon, from start to finish, the trust deed foreclosure process can take six months or more.1 Not counting the 3+ months of unpaid mortgage payments, this can mean the lender may go without any income stream from the property for close to a year – and this ignores the time on the market during the re-sale process. Lastly, as discussed below in the New Legislation Section, the lender’s notification to the borrower (the “Notice of Default and Election to Sell” or “NOD”) must now include written notice of an opportunity to apply to have the loan modified. During a portion of this period of time, the foreclosure must be held in abeyance. Thus, forcing the lender to foreclose is a legal decision that the seller should consult with their legal counsel about. This is especially so if the loan is a purchase money trust deed – which is used almost exclusively in Oregon – and the home is a primary residence, since state law prohibits personal liability of the borrower upon foreclosure.2 If the home becomes abandoned, the lender’s expenses are compounded, due to the risk of vandalism, fire insurance coverage, and squatters who may move in during the foreclosure process (sometimes derisively called “bandos” inside the industry).3

“Creative” Financing Techniques – The term “Creative Financing” is not new. In the early 1980s, when interest rates were off the charts and buyers could not afford to purchase even moderately priced homes because lenders were demanding 18%+ interest rates, the only way to sell a home was through what became euphemistically known as “creative” methods. They usually included a transfer of possession to the buyer – privately secured by a short-term contract or trust deed used to “wrap” around the existing loan. The hope was that by the time the balloon payment came due on the wrap, interest rates would be back to normal and the buyer could then afford to refinance. This process did not normally involve the lender’s knowledge or consent, due to the presence of a due-on-sale clause, which could trigger a foreclosure if the bank learned of the transfer. We are now starting to see these techniques again, and there is reason to believe that given the credit crises, many banks would just as soon turn a blind eye to the transaction – since the loan will still be “performing” (albeit in technical default because of the transfer) and therefore might not create increased scrutiny by the regulators. There are even some anecdotal reports that some lenders are considering loan assumptions of existing mortgages, in order to facilitate the orderly transfer of the property without triggering a foreclosure and further inflating the bank’s REO department and capital requirements.

Lease-Options – Simply stated, an option is nothing more than an offer by a seller to a buyer for a fixed purchase price. The offer remains locked in at that price for a certain period of time, during which the buyer can “opt” to buy the property for the agreed price – or walk away with no further obligation. Obviously, there is value to a potential buyer to have this ability to unilaterally buy or not buy, and for this right an option price – or consideration – is normally paid up front. An option agreement differs from an earnest money agreement in several ways, but one of the main differences is that the option price is nonrefundable (assuming the seller does not default under the option agreement), regardless of whether the buyer decides to purchase or walks away. If the option is not exercised by the buyer within the agreed-upon time period, then the right of purchase for the fixed price disappears and the option money is retained by the seller. There are several risks in entering into any legal contract, from sale agreements, to leases, to option agreements, etc. It is for this reason that the use of legal counsel, a lawyer-reviewed form, or a time-tested industry-wide pre-printed form, is always recommended. Oregon Real Estate Forms, LLC (“OREF”), the Realtor® statewide forms provider, has developed a very good Lease Option form – however this should not be used to the exclusion of legal counsel. In today’s marketplace, especially with builders carrying excess inventory and homeowners struggling to sell to get out from under an oppressive mortgage, sellers and buyers are engaging in transactions that invite more risk, simply to move their property. There are many issues that Realtors® need to be alert to when their clients are involved in a lease-option. They range from: (a) When/how will the broker be paid; (b) Is the lender aware of the transaction? (c) Will there be a collection account so the underlying lender gets paid? (d) When will the Seller’s Property Disclosure form be delivered? (e) Will the Lease-Option be recorded4; (f) How is the risk to be allocated between seller and buyer in the event the lender calls the loan because of the transfer? For these and many other reasons, the use of good real estate attorneys on both sides is essential.

Bankruptcy – Although it can take the form of a Chapter 7 or 11, most are the former. Unfortunately, many of these are either borrowers who got in over their heads at the outset, due to bad faith or poor underwriting practices, or sickness, unemployment, or other events that eliminated almost all other viable solutions. Although under federal bankruptcy law it is currently illegal for the court to discharge a lender’s security interest, it is expected that in the not-too-distant future, the government may introduce some form of “cramdown” legislation against junior lien holders, under the theory that the subordinate lien was never supported by the security itself, and was made solely upon the assumption that the home’s value would ultimately catch up with the accumulated liens that had been piled onto the home by lenders with non-existing underwriting standards. There is no question but that an owner who is unable to sell their property because of its high negative equity may find bankruptcy protection useful, even though it can be quite damaging to the owner’s credit for several years. Nevertheless, it is an option that owners/sellers may wish to consider as a part of the decision-making process leading up to disposition of the home.

Short Sales – A “short sale” is a real estate transaction in which the gross proceeds generated from the sale are not sufficient to pay the seller’s mortgage(s), liens, and/or other closing costs. In other words, without a negotiated reduction in the mortgage indebtedness and/or other costs, the seller cannot complete the transaction and convey marketable title. Because a short sale means that the seller is receiving no money out of the transaction, traditional roles become skewed: The seller and his/her listing agent’s goal now becomes obtaining the quickest sale, rather than the best price, but the lender’s motivation is to secure the last and best offer for the most money. Thus, the entire short sale process takes on the appearance of an auction with sealed bids, and no one really knows when the bidding will close. For those representing the seller, a Realtor® or attorney in a short sale transaction, the issue is how to meet one’s fiduciary duty to the seller-client while not committing loan fraud. For example: What if the seller desperately needs to sell the property quickly – must the lender be notified of all subsequent offers after the first one? What if the seller wants to reject an offer rather than submit it to the lender? What if a better second offer comes in after the seller has submitted the first offer – does the lender need to be informed? To put a finer point on this: “How much information, if any, does the seller and/or their representative need to disclose to the lender?” It must be remembered that since the seller is getting nothing from the transaction, all available net proceeds after closing costs and commissions go to the lender(s) and other secured creditors whose consent is necessary to convey marketable title.

Two of the reasons that short sales can be troublesome for real estate listing agents (and their clients) are due to the potential legal issues involved for sellers: (a) There may be tax ramifications on the debt forgiveness if the property is not a primary residence, and (b) There may be personal liability on the promissory note, regardless of whether the property is a primary residence. Under current Oregon law, the non-recourse language of the statute only applies if there is a “foreclosure” on a purchase money mortgage or trust deed. Thus, a voluntary lifting of the liens on the residence does not automatically trigger the non-recourse (i.e. anti-deficiency) provisions of the trust deed foreclosure statutes.

The underlying reason that the short sale concept is foreign to most Realtors® is that they are not used to dealing with a seller contingency. In the traditional transaction, virtually all of the contingencies, such as financing, inspection, title, well testing, etc., are intended to primarily benefit the buyer and are generally within the buyer’s control to manage and complete. However, in the short sale transaction, lender consent is actually a seller contingency. Legally, this means that the seller is not required to sell to a particular buyer until the contingency, i.e. lender consent, is either satisfied, removed or waived.

Further confounding this process are the following factors: (a) Since lenders are not parties to the Sale Agreement, they have no contractual obligation to honor any of the transactional terms already negotiated between the seller or buyer; and (b) The lender’s decision to consent to the short sale is based upon what is good for the lender, not necessarily what helps the seller or buyer. All of this means that the lender can, in its own time and at its own discretion, dictate the terms of the transaction. For example, if they want the sales price to be higher, they can condition their consent upon that change; if they do not agree that the buyer should receive a seller credit for repairs, they can strike the provision from the Sale Agreement. If they want the property to remain on the market for greater exposure, despite the fact that one or more offers are already pending, they can demand it. If the seller refuses to agree to the lender’s conditions of consent to the short sale, their only option is to terminate the transaction and continue marketing the property; if the buyer rejects, he/she may terminate the transaction and secure a refund of their earnest money since the contingency (i.e. lender consent on terms satisfactory to seller and buyer) has not been met.5

The Treasury Department has recently added two more alternatives in cases where the borrower cannot qualify for the MHA loan modification program. This is known as the “Foreclosure Alternative Program.” Borrowers will be eligible for this program “…if they meet the minimum eligibility criteria for a Home Affordable Modification but did not qualify for a modification or were unable to sustain payments under a trial period plan or a modification. Prior to proceeding to foreclosure, participating servicers must evaluate each eligible borrower to determine if a short sale is appropriate. Considerations in this determination include: (a) Property condition and value; (b) Average marketing time in the community where the property is located; (c) Condition of the title including the presence of junior liens; and (d) A determination that the net sales proceeds are expected to exceed the investor’s recovery through foreclosure Incentive Payments.” (Emphasis added.)

Servicers may receive incentive compensation of up to $1,000 for successful completion of a short sale or deed-in-lieu. Borrowers may receive incentive compensation of up to $1,500 to assist with relocation expenses and the Department of Treasury will split the cost of paying junior lienholders (e.g. HELOCs, etc.) to release their claims, matching $1 for every $2 paid by the investors, up to a total contribution of $1,000 by Treasury.6 7

Here are some tips when dealing with short sales transactions:

  • First and foremost, one should make sure that their seller is a legitimate candidate for a short sale. Otherwise, much time will be wasted, the seller will be unhappy and the agent will not make a dime. To that end, it is essential to thoroughly understand your seller’s financial situation, especially as it relates to recorded liens against the home. It’s one thing to try to negotiate a short sale with the first mortgage holder, but quite another when there are one or two subordinate liens. Since a subordinate lien (that is, one recorded after an earlier recorded lien, is inferior, it will only be paid through a foreclosure after the first lienholder is fully paid. When the owner has “negative equity,” that is, the total liens exceed the distressed sales price, it means that subordinate lienholders only get paid if there is extra money after the first mortgage is satisfied. If the first mortgage is more than the home’s value, then the subordinate lienholders stand to get nothing from the foreclosure or short sale. As a result, securing the consent of a junior lienholder can be very difficult, since they gain nothing by cooperating. In order for them to get anything out of closing means that someone who would otherwise be paid at closing has to forego a portion of their share. This may be the first lienholder, the real estate broker, or perhaps the seller, if he/she can bring money to closing. Buyers themselves have been known to pay money into closing in order to secure the cooperation of stubborn creditors. It is frequently this process of negotiating among the creditors that can drag out, or kill, a short sale. If the seller is so far underwater that no amount of concessions can work, the broker is wasting his/her time in trying to make it happen. In these cases, a frank discussion with the owner is in order so that he or she can explore other avenues that will be less time consuming and more likely to work.
  • Secondly, one must make sure that the property has sufficient value to make the short sale process feasible. If the current value (in light of similar sales, albeit distressed) is far less than the indebtedness encumbering it, a short sale may be a waste of time. Similarly, if the seller insists on a price that is unrealistic in light of comparable sales, a short sale may also be a waste of time.
  • Related to the first point is the “frank discussion” the person must have with the client. Unfortunately, if a short sale would be impossible, there really is no other standard alternative that can result in a closing and payment of a real estate commission, should a broker be involved. Thus, the information the broker gives the seller is merely a courtesy for which there is no compensation. It should always be in general terms and coupled with a recommendation that the seller secure professional assistance from a CPA, tax attorney, consumer credit expert, workout lawyer, or other expert of their choice.
  • Before arriving at the decision to actually try to effect a short sale, there must be a basic evaluation as to whether: (a) This is the alternative that the seller wants; (b) The short sale is, after review of all other alternatives and seller’s consultation with experts of his/her choice, the best alternative; and (c) It is likely to work.
  • If the short sale is a viable alternative, the listing agent should make sure that the seller is in agreement on the proposed marketing program which, of necessity, must include a realistic evaluation of the market place, and agreement upon a price reduction schedule should the home either not sell, or not receive the requisite showings to suggest it has been accurately priced. (Remember, all it takes is another sale down the street for experienced buyers (and their brokers) to know whether a nearby home is now overpriced).
  • If the short sale is to be pursued, sellers must be fully prepared for the delays and frustrations that frequently accompany these transactions.8
  • If a Realtor® intends to handle the discussions with the lender on behalf of the seller, they must be very careful to avoid (a) the practice of law and (b) falling into the realm of a “foreclosure consultant.” The former issue is best addressed by encouraging the client to get their own legal counsel and avoid “advising” the client about what to do, tax implications, credit or legal impact. The latter issue is less risky since real estate licensees are exempted from this law (HB 3630), but make sure that you confine yourself to the short sale transaction alone, and avoid getting into other issues such as contacting credit agencies, contacting foreclosure companies to negotiate an extension of time, etc. In other words, let the seller make the decision based upon competent advice from their own “expert.”
  • If the seller is working with a private foreclosure consultant and you are working with the buyer, make sure you know where your compensation is coming from. Technically, Realtors® have no protection for a commission unless (a) it is contained in an offer of compensation, or (b) it is paid through escrow pursuant to written instructions, and/or (c) there is some written agreement for payment of a certain amount (or percentage if a Realtor®) from closing. If there is a listing agent (as well as a foreclosure consultant), then there should be an offer of compensation in the MLS listing. Be pro-active in finding out early whether the commission will be paid through escrow. If everyone thinks the lender will pay the commission, it should be addressed with the lender early in the transaction.
  • Be careful when representing the seller but delegating work to a separate mortgage consultant. If they are not exempt, they must have a written agreement that conforms to HB 3630. If they are exempt, e.g. they are an Oregon licensed broker or attorney, then they do not need a written contract following HB 3630 (the Foreclosure Consultant Law passed in 2008) but they still must comply with law. It is still a good idea to have a written agreement with the seller. Some mortgage consulting agreements require that they be indemnified from liability – which could be unwise in most cases.
  • Make sure you know, understand and follow your company’s office policy regarding how short sales are to be conducted. If your company has no policy, consider encouraging one.
  • Make sure you use a good short sale form that covers all the essentials in the short sale transaction such as: (a) (If representing the buyer) A time frame within which he/she can get out of the deal if the lender does not accept or reject; (b) A clear contingency that both seller and buyer can terminate the transaction if the do not agree with any of the lenders conditions should they vary the terms of the offer; (c) Making sure all parties are clear as to which buyer due diligence contingencies begin immediately, and which ones are triggered only by acceptance of the lender’s consent/conditions. The OREF Short Sale Addendum covers all of these issues and has informational forms for sellers and buyers.
  • Realtors® must be careful about holding themselves out as an “expert” in their advertising or discussions with potential clients. Notably, in Oregon there are certification programs that issue designations that include the word “expert.” That term has legal significance and is not one that should be used, given the fact that almost no one is an “expert” in this relatively new area of practice.
  • There can be serious adverse tax consequences and promissory note liability in any situation in which the seller is relieved of liability by the lender. If the seller is an owner and occupies the home as a primary residence, it is likely there is no tax liability for relief of indebtedness on the first mortgage, as discussed in the Tax Section below. However, release of liability under the promissory note must be negotiated before the seller can make an informed decision to complete a short sale. The lender may consent to the short sale but insist the seller sign a promissory note for some or all of the sums remaining due under the promissory note. Make sure your client obtains competent tax advice on this issue before proceeding. If your seller client does not occupy the property, there may be tax liability for the debt relief, as well as personal liability. Do not take a “Don’t ask, don’t tell” mentality on these issues.
  • If there is a foreclosure consultant involved, do not abdicate or delegate any of your fiduciary duties to him or her. They may be gone tomorrow, but you’re in the picture for the long run.
  • Read the last deed of record. If the seller acquired the property within the last six months, the title company will likely take a different and more cautious view of the transaction, and may impose additional conditions, including writing an exception into the deed and/or owner’s title policy. The lender may impose new conditions of loan approval such as an additional appraisal. Delays may occur. Your seller may be a “flipper.”
  • Beware of loan fraud issues on all short sales. Things to watch for: (a) The sale is not arms-length; (b) The seller and buyer are both investors; (c) There are escrow instructions requiring that third parties will receive payment from closing, etc.
  • Check with the lender(s) to find out how they want you to deal with multiple offers – i.e. submit them one at a time, allowing the lender to accept or reject before submitting another, or submit multiple competing offers together allowing the lender to pick which one they wish to pursue and (at least temporarily) rejecting the others.
  • There will likely be adverse consequence to the seller’s credit score and they should be encouraged to consult with a counselor or other expert if they have any concern about these consequences.

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Footnotes

  1. The actual foreclosure process is a minimum of 120 days, but there are several additional steps a lender must take before commencing, e.g. .
  2. ORS 86.770(4)
  3. Early on, when prices were falling but lenders had not yet begun restricting their lending practices, some homeowners merely secured a smaller loan on a comparable- but less expensive – home down the street that had plummeted in price, then after closing, abandoned their pre-existing home because that mortgage far exceeded the now declining neighborhood values.
  4. The failure to timely record the Option, or a memorandum thereof, would be highly risky for the buyer.
  5. This assumes the parties used the OREF Short Sale Addendum or one containing a similar clause.
  6. See, http://www.ustreas.gov/press/releases/docs/05142009FactSheet-MakingHomesAffordable.pdf
  7. Federal Incentives Coming for Short Sale, Dees-in-Lieu, September 10, 2009.http://www.housingwire.com.
  8. According to a recent Inman News survey, only 1% of respondents said that the typical short sale buyer received any response from the lender in less than a week, and 34% said the response usually came within one month. Sixty percent reported having to wait two months or more. Interestingly, the response time for banks responding to offers for their REO properties was significantly faster. “A Changed Market: Short Sales and REOs,” Inman News Case Study, September 10, 2009, page 11. This study was conducted online between May 13, 2009 and May 29, 2009. It resulted in 541 responses from real estate agents, brokers, office managers and owners. Twenty-eight of the respondents were from California, Florida, New Jersey, New York and South Carolina, representing the top five states with the most respondents.
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