Salute short-sale heroes

As a result of the steep decline in values since 2005, many homeowners have found themselves with mortgage debt greater than the current market value of their property. Household budgets have been strained by other downturns in the economy, and job losses have made it impossible for some to continue making monthly loan payments.

Even for those who can hang on through tough times, it may be many years before some properties are no longer upside-down in debt. Meanwhile, an owner with the right situation and right arithmetic may find relief in a negotiated modification of a loan. It can require a great deal of patience and persistence, but some banks are beginning to show a willingness to change the interest rate and payment terms on some existing loans.

What about owners whose straits are more dire and for whom loan modification will not solve the problem? Of those I meet who are in the greatest difficulty, most are people who have maintained excellent credit all their adult lives, would never have considered being late with an installment payment, and who now are unable to make payments. Unemployment or business failure is the usual problem, but illness and family crises sometimes compound the woes.

Unfortunately, the available options are not pretty. One amounts to a complete surrender, taking no action until eventually there is a foreclosure of the debt. From start to finish, foreclosure of a loan secured by a deed of trust takes almost four months to complete, and most banks do not rush to start the process, sometimes waiting until after many months of delinquency before filing a notice of default. I have worked with one homeowner who has been out of work for more than a year, unable to make a payment on either of two loans in 12 months, and still has not received a notice of default.

You might conclude that waiting out a foreclosure is the simplest, easiest path. But the idea of a foreclosure on one’s credit history can be hard to swallow, and some will go to extraordinary lengths to avoid that consequence. Which leads us to the other most common option: the short sale.

Of the 57 closed residential sales in Petaluma last month, 13 were short sales. That means the price paid for each of those 13 homes was insufficient to pay the balance of the loan(s) secured by the property. A short sale can be completed only if each secured lender agrees to accept a reduced payoff. The property owner offers the home for sale and negotiates a sale contract with a buyer in the usual way, except that the sale is conditioned upon the owner obtaining approval from the secured lender(s) for the short payoff(s). A bank may approve such a proposal, provided that its borrower (the homeowner) proves a genuine hardship, demonstrates that reasonable efforts were made to obtain the best possible price and will not receive a dime in proceeds at the close of the transaction.

So, once a proposal is submitted, how long does it take to get an answer? It could range from as little as a week to (hang onto your hat) more than a year. And sometimes, after the most infuriatingly long waits, the answer is “no.” The process is complicated by the inability of many banks to adequately organize departments and train specialists to handle the proposals. Some are better than others, but when there is more than one secured lender, the problems multiply. Buyers often lose patience and terminate their purchase after months in suspense; there may be three or four cancelled short sales on a property, each at successively lower prices, before one is finally approved and closed.

Keep in mind that a short-seller must do everything other sellers do — make the property available and presentable for showing to prospective buyers, receive and respond to offers, allow property inspections, complete disclosure forms — plus provide a mound of documentation to satisfy the bank. And in every short sale, the amount distributed to the seller must be zero.

Is it worth the trouble? We Realtors will always suggest that our clients consult an attorney and a tax advisor before committing to the short sale process, and we equip them with good questions to ask. A successful short sale will still be a blemish on a credit history, but may not be as damaging as a foreclosure (much depends on how the transaction is reported by the bank).

In cases of refinance debt in excess of acquisition and improvement costs, the mortgage debt forgiveness, whether resulting from short sale or foreclosure, may have significant tax consequences. Refinance loans and most junior loans, such as equity lines of credit, may be characterized as “recourse” debt, meaning that if a lender does not use a trustee’s sale (non-judicial) foreclosure, the borrower may be sued for the deficiency. Many junior lienholders, whose notes are virtually unsecured because of loss of property value, are threatening to pursue the borrower for the deficiency even after a negotiated short sale. In other words, a bank whose loan is secured by a second deed of trust may accept a relatively small portion of the outstanding balance to release the lien on the property, but that may not be the end of their quest to collect the rest of the debt. Unfortunately, the aggressive stance of many “juniors” has led to a substantial increase in personal bankruptcy filings, even after short sales that were supposed to preserve a bit of creditworthiness.

I hate to say it, but it seems to me the benefits of a short sale have become elusive if not illusory. Of course, if a client is determined to make it work, I’ll do everything I can to help, but I always feel compelled to ask why he or she is willing to go to so much effort in pursuit of a result that may be only marginally better than a foreclosure? I have received the same answer from several clients this year: “I just feel like it’s the right thing to do. I don’t want anyone losing money because of me, not if I can help it.” These are people acting responsibly, doing all they can to prevent creditors from suffering more losses than necessary. No one thanks them, certainly not the creditors. I call them short-sale heroes, and I salute them.

(Clark Rosen is a broker associate with Coldwell Banker of Petaluma. He can be reached at 762-6611.)