Short Sales Present Daunting Contract Issues

A "short sale" is a sale at a price that is insufficient to allow the mortgage encumbering the property to be paid in full from the closing proceeds.  Consenting to such a sale may make good economic sense for a lender.  Making an offer to buy a property in a short sale, however, is full of traps and frustrations for a buyer.  It is vital that a buyer obtain experienced legal counsel before signing a contract.

Let's use, as a typical example, a house that sold in 2005 for $300,000 that has a mortgage for $270,000.  In today's stressed market, depending on the location, that property may be worth only $180,000.  If the lender actually forecloses it will experience costs of $4,000 to win a foreclosure action, and will then be lucky to get an offer on a foreclosed  property at $160,000 (Lenders are really lousy at getting full value for their foreclosed properties.)  After paying management and closing costs, the lender will be lucky to recognize $145,000 from the sale of the property.  If a purchaser offered $170,000 to the current owner, the lender could clear over $154,000, and would be better off.

You can't, however, count on bureaucratic lenders acting rationally.  Sometimes you will not draw an executive that can make close to a rational decision.  One thing you can count on is that the approval process will frequently take 3 or 4 months.

Then, there is the issue of the "deficiency."  The lender is entitled to a judgment for the full $270,000.00.  The borrower is entitled to a credit forbureau the full fair market value of the property as of the date of the sale (I smell a full-blown trial with expert witnesses...).  Sometimes the lender says, "OK.  We will approve the sale if the borrower, your seller, signs a promissory note for $100,000.00. 

You, the buyer, are caught.  You are bound by your contract with the seller.  The seller is playing "chicken" with the lender.  You have paid for application fees, inspection fees, legal fees, and a survey.  This deal may never close.

To make matters worse, if you, the buyer needs 45 days to secure financing, any consent by the lender to a short sale will be so full of loopholes that the lender can force the seller to abandon you to anybody who offers a few dollars more.  The result is that the buyer is bound, but the lender can call the shots.  Only if the closing is in the next two weeks or so can you get a real commitment from the lender.  What makes this frustrating is that you may have to wait several months before you get into a rush closing.

What this means is that, if you have the cash in the bank and can close within two weeks, you can make an offer for a short sale, eventually get lender approval and close.  Anything that requires longer will be subject to no better offers coming in and that the lender's executive not change his or her mind.  Many buyers do not realize this until a month or two after signing the contract.

Real estate brokers tend, in honest enthusiasm for a deal, to understate these challenges.  They get paid by the closing.  Your lawyer gets paid by you for the unvarnished truth.

What can a lawyer do?

1.  He or she can explain the rules of the game to you so that you know what you are getting into.

2.  Your lawyer should give you the right to bail out of the contract quickly at any time before the lender gives an unconditional and irrevocable consent to the closing agent for the short sale that will extend through your anticipated closing date.

This is far from providing guaranties.   It is far better, however than the typical buyer is treated under a "standard short-sale contract."

If you are thinking of making a short sale offer, do not sign any offer until you have had it reviewed by an experienced real estate attorney.  Times are slow and many good attorneys will agree to meet with you within 24 hours.  We know that time is critical and will respond quickly.

The good news is that, although short sales are contingent on lender approval, they otherwise are somewhat typical.  The closing process can be trying and expensive because of the lender issues, but the chances of being haunted by old title problems are much lower than in purchases of properties that have completed the foreclosure procedure.  If your contract is well-drafted, treachery is much less frequent as you approach closing.  If the contract is "standard," you may spend months on a wild goose chase.

Be careful out there!

Bob Sammons,  February 15, 2010