With the continued high unemployment rate and stagnation in residential resale prices, many homeowners find themselves unable to make their monthly mortgage payments or to sell their homes at prices sufficient to pay off their lenders. As a result, many of those owners are considering engaging in “short sales.” Put simply, a short sale is a sale of property for less than the outstanding loans against it. A short sale may sound appealing for many homeowners who find themselves “under water,” but there are a few significant issues to consider.
First, you cannot complete a short sale without the consent of your lender (or all lenders, if more than one have liens against your home). Closing a short sale requires that you convey title to your home free of any mortgages, and your lenders are not required to release their liens unless they are paid in full. Thus, you would need the agreement of your lenders to accept less than the full amount they are owed in return for releasing their liens. Unfortunately, the process of obtaining that consent can take many weeks, or even months. In part, this is because lenders are overwhelmed by similar requests from other homeowners. Lenders are also taking a lot of time to process such requests so they can be sure they are getting as much money as possible out of each proposed sale.
Second, buyers are increasingly wary about doing short sales. They have heard the stories about how long the process can take, and often are unwilling to agree to that long a delay. This is especially true now that builders of new homes have cut their prices to be competitive with short-sale properties and foreclosures, and can deliver a brand new home in less time than it might take to complete a short sale.
Third, some sellers are concerned about the effects on their credit ratings or tax liabilities following completion of such a sale. Those subjects are beyond the scope of this client alert, but homeowners investigating the possibility of a short sale should consult with their tax advisors and should discuss the credit rating issue with their lenders.
There is a fourth issue that may be even more important than the first three, but that many such sellers and their brokers don’t know about, or don’t fully understand: The potential liability of such seller, after completion of the short sale, for the amount remaining on their home loans after application of the proceeds of the sale. Homeowners may know that Arizona has an “anti-deficiency statute” that they believe would protect them from any such post-sale liability. However, the applicability of that law in the case of a short sale is the subject of much debate among Arizona real estate lawyers.
There are actually two “anti-deficiency statutes” in Arizona, one relating to loans secured by deeds of trust (A.R.S. § 33-814(G)), the other pertaining to loans secured by realty mortgages (A.R.S. § 33-730). There are some differences between the two statutes, but for the limited purpose of this client alert, we will not dwell on those differences. Instead, the key issue for this client alert is the fact that many knowledgeable real estate lawyers believe that the anti-deficiency protections of those statutes only apply once a trustee’s sale or judicial foreclosure action has been completed. Thus, those practitioners argue, a lender who agrees to a short sale and to accept less than it is owed to release its lien would be free to pursue the remaining balance owed in a personal action against the seller. Many lenders require a seller to sign an acknowledgement to that effect, or even that the seller sign a new promissory note at the closing for that remaining balance. Far from relieving a seller of debt in excess of the current value of the home, a seller would end up worse off than if he or she simply let the lender foreclose.
Other experienced real estate lawyers argue that completed trustee’s sales or judicial foreclosures are not required for the Arizona statutes to shield short sellers from liability for deficiencies after completion of their sales. Some of those lawyers even argue that any acknowledgement or new promissory note signed by a short seller in order to secure the lender’s consent to a short sale would be unenforceable. Unfortunately, neither group of lawyers can point to clear, unequivocal support in currently reported Arizona cases for their positions.
So what is a prospective short seller to do? Given the current unsettled state of the law, there are only two ways to proceed that would ensure that the short seller has no “deficiency” obligation with respect to its home loan: (1) get the lender to agree in writing as part of the short sale documents that the seller has no further liability to the lender with respect to the loan (which a few lenders are beginning to do); or (2) forget about doing a short sale and let the property go to foreclosure or trustee’s sale (because in that circumstance the law is very clear as to the seller’s protections).