Bulletin: RI2008003

Dear Associates:

With the downturn in the housing market, many distressed homeowners who are in default of their mortgage have sought to sell their property at a "short sale"; that is, for less money than they owe on their mortgage(s). As a result, secured lenders or other secured creditors receive less money than what is actually owed. Hence, the seller is "short" on cash needed to close as the current sales prices have dropped considerably from those that were high and inflated over the past few years when the homeowner purchased or refinanced, leaving no equity in the present market value of the distressed property. For a short sale to occur, the informed consent of ALL secured creditors is required.

If you are representing a distressed homeowner as seller in a short sale, heighten your awareness of the client's financial situation. He may not have revealed the full scope of his financial obligations and may not even be aware of how bad the outlook is. Be particular in your engagement letter as to the scope and cost of the services to be provided to effectuate the sale. Consider bankruptcy options, possible defenses to foreclosure and the inevitable blemish to his credit standing. Under the Mortgage Forgiveness Debt Relief Act of 2007, some of the debt forgiven may later resurface as income to the client.

When negotiating a short sale with the lender, full disclosure of all secured debt is required. Lenders generally make their decisions to accept a short sale based on the current fair market value of the property determined by an independent appraiser and not on the amount of the debt owed. Today, they are overwhelmed by the number of proposed short sale transactions, which can take an average of 3 months or more to close. In many cases, the deals fall apart when prospective buyers cannot wait that long or lose their financing during that time.

Lenders are also specific in the disclosure requirements to be reviewed in considering a short sale request. Financial statements, paycheck stubs, bank statements, income tax returns, marketing efforts, hardship letters, estimates of closing costs and other documents to support the seller's need for assistance are among the items sought. Be certain to obtain an agreement from the lender to waive collection of the deficiency balance during negotiation efforts. Include this occurrence as a contingency in the purchase and sales agreement with the prospective buyer. Also, be wary of the buyer.

To distinguish a legitimate short sale from a rescue scam that results in an insurable title, the following conditions must be met:

1) The payoff lender's written conditions of the short sale requirements must be strictly met;
2) The new lender must have full disclosure of the short sale transaction;
3) The HUD-1 must be accurate and precisely reflect the short sale transaction;
4) The Owner MUST be represented by independent counsel;
5) The Owner cannot remain in possession after closing;
6) Both Owner and the payoff lender must be informed that a flip of the property will occur.

Keep control of the deal and don't let others misguide you by mischaracterizing items on the HUD-1 or failing to include everything that should be on it. In the event that you sense a rescue scam, a "flip", or find yourself in a not-so-ordinary closing that involves complicated steps and additional parties, call your underwriter to assist you in evaluating the transaction. For additional information on Mortgage Foreclosure Consultant Regulation (RIGL 5-79-1, et seq.), see the following Stewart Bulletin RI2008001.
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