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The Danger of the Short Sale

key of mortgaged home

Frequently the best way to get out of an upside-down mortgage without bankruptcy is to short sale a house. The basics of a short sale are that the lender allows the borrower to sell his real estate for less than is owed. In exchange for saving the lender the cost of foreclosure, the borrower typically expects to be forgiven of the remaining balance. The borrower must always look at the terms of the short sale contract.

Be sure that your short sale contract contains a term to allow you off the hook. Unless the short sale contract specifically states that you will not be liable for the deficiency, the contract will do little or nothing to protect you. In some cases the short sale contract may expose you to greater liability after a short sale than you had before it.

Below you may read selections from an opinion letter I wrote to Bank of America for a client who Bank of America was trying to force to sign a letter assuming the liability after the short sale. For this particular client, I was quite certain that the California anti-deficiency statute would protect. The last thing I wanted was for them to sign away their strongest protection in a short sale while trying to gain protection from the deficiency.

I write to share with you my opinion that the terms of the proposed short-sale may require the Borrowers to forfeit protection against collection actions afforded them by state law. I believe that the Borrowers are currently protected by the California anti-deficiency statute. However, I believe that the borrowers may lose their protection and become liable for the loan deficiency if they short-sell their home. Therefore I have recommended that the borrowers desist with the short sale in order to keep their protections under the anti-deficiency statute.

If your intention was not to change Borrowers' loan into a non-recourse loan, I would encourage you to rewrite your agreement in such a way that does no jeopardize Borrowers' rights under the California anti-deficiency statute.

The California Anti-Deficiency Statute protects Borrowers from Deficiency Judgment Upon Sale of Home.

California Code of Civil Procedure Section 580(b) states: "No deficiency judgment shall lie in any event after a sale of real property … for failure of the purchaser to complete his or her contract of sale, or under a deed of trust or mortgage given to the vendor to secure payment of the balance of the purchase price of that real property... or under a deed of trust or mortgage on a dwelling ... given to a lender to secure repayment of a loan which was in fact used to pay all or part of the purchase price of that dwelling occupied, entirely or in part, by the purchaser."

Borrowers qualify for protection from deficiency judgment under the anti-deficiency statute. They occupied entirely the dwelling in question at (street address omitted), Concord, CA from the time of the purchase of the property until well into the present foreclosure proceedings. The deed of trust on the residence was given in exchange for funds originating from Bank of America for the purpose of purchasing the property. Borrowers assure me that they have, to date, taken no action to change the classification of this loan from a non-recourse loan.

I believe that the Borrowers are currently protected from a deficiency judgment on their current loan. As such Bank of America may not pursue Borrowers for a deficiency judgment after sale of the real property. Any such action would be a violation of the above and other consumer and homeowner protection laws.

The Loss Mitigation Short Sale Agreement may Strip Borrowers of Non-Recourse Loan Status

Loans that originate as non-recourse may be changed to recourse loans by any of several actions taken by a borrower. These actions include certain refinances and certain contractual modifications for new consideration. Contractual modification is valid and binding when consideration is offered by both parties to modify the original agreement.

The short sale letter agreement (hereinafter “Letter Agreement”) may change the non-recourse nature of Borrowers’ loan to a recourse loan. The Letter Agreement takes the language of a contract, offering consideration (acceptance of partial payment to release the lien), for an additional right against Borrowers (the ability to seek a deficiency judgment). The Letter Agreement specifically requests Borrowers to acknowledge that any remaining balance on the debt after the short sale as a “collectible balance.” Such acknowledgment may change the debt into a recourse debt and subject Borrowers to significant liability following the short sale.

I cannot recommend that Borrowers become more liable for their debt due to the short-sale than they would have been in foreclosure. Therefore, I have recommended that they not sign or submit the Letter Agreement with their short-sale paperwork and that any short sale that Borrowers pursue not jeopardize the non-recourse nature of their home.

This communication represents the extent of my representation of Borrowers. Any further communication should be directed directly to them and to their agents.

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