One of the greatest areas of uncertainty among REALTORS® is in the determination of the proper listing status in the context of short sale transactions. This pervasive uncertainty is no doubt attributable in large part to an industry wide lack of experience in short sale transactions given a decade of artificially inflated sales due to subprime lending and the ease of credit. This brief article is intended as a primer for those entering the short sale market as well as a refresher for those already experienced in short sale transactions. To fully understand the reason for short sale transactions, we should briefly discuss the concept of foreclosure of real estate property.
Types of Foreclosure In California there are two types of foreclosure with which a home owner might be faced. These are the “judicial foreclosure” and the “trustee sale” (sometimes called the “power of sale” foreclosure). In a judicial foreclosure, where the amount recovered in the sale is less than the amount owed on a loan, the difference is called a “deficiency.” A “deficiency judgment” is a judgment against the borrower for the difference between the unpaid balance on the loan and the amount generated by the foreclosure sale or the fair market value, whichever is greater. Where the foreclosure is accomplished by judicial action, the lender may be able to obtain a deficiency judgment against the borrower. However, the recovery of the deficiency amount is only available in a judicial foreclosure and is not permitted after a “trustee’s sale.” In other words, if the lender utilizes the non-judicial method of a trustee sale, a deficiency cannot be collected. Additionally, the recovery of a deficiency is not possible on a “purchase money” loan, including seller-carried financing, on any real property or loans on property consisting of 1 4 family units of owner-occupied residential property. (The term “purchase money” loan refers to a loan where 100% of the proceeds of the loan went for the purchase of the home. A refinance of a loan, for example, ordinarily destroys the “purchase money” characterization since the loan proceeds from a refinance are not used to purchase the home. There are exceptions which are beyond the scope of this brief article.) Recovery of the deficiency amount is possible, however, on a refinanced property loan (non purchase money) or on a 1-4 family non-owner occupied residential property loan.
Short Sales
“Short sales” may occur once a home is in foreclosure but before the property goes to sale. In a short sale, the lender accepts an offer from a third party buyer for less than the outstanding loan on the property and forgives the deficiency owed by the borrower. This arrangement may be appealing to lenders because it saves time and money by stopping the legal foreclosure process and by taking the property off the lender’s books. However, it has come to light that some lenders agreeing to short sales are including language in the release which allows them to sue on the note even though they are releasing the security in the property. It is questionable whether the courts will allow these lenders to sue on the note after a short sale though at this time there is no appellate court has addressed the issue in the context of residential foreclosures.
Until December 21, 2007, if the lender accepted less than the balance owed and cancelled the debt, that amount would be considered debt forgiveness, and tax would be due on the amount forgiven. This forgiven amount was called “phantom income” and was treated as part of the gross income by the IRS. Lenders reported the forgiven amount to the IRS on form 1099. According to the IRS it is the same as if the borrower received that amount of income. On December 21, 2007, President Bush signed H.R.3648: Mortgage Forgiveness Debt Relief Act of 2007, which provides relief to certain homeowners facing foreclosure from the phantom income realized from debt forgiveness or foreclosure. The Mortgage Forgiveness Debt Relief Act generally applies to “purchase money” loans on property consisting of 1 4 family units of owner occupied residential property. The Act also applies to funds from a refinance loan used to construct or improve a primary residence up to the amount of the mortgage principal remaining, just prior to refinancing.
Which Option is Best for Your Client When Facing Foreclosure There are a number of reasons a home owner may prefer a short sale to a foreclosure. For example, where the loan is recourse, meaning that the lender may be entitled to a deficiency judgment against the homeowner, a short sale may be a way of eliminating that risk. Although judicial foreclosures constitute less than five percent of all residential foreclosures in California, many borrowers prefer the security and peace of mind of working out a resolution rather than allowing the property to be taken by foreclosure.
A second reason that a borrower would prefer a short sale to a foreclosure is that it may be easier to obtain credit after a short sale than after a foreclosure. While there is some dispute in the lending industry, it appears that obtaining credit is more difficult after a foreclosure than a short sale. According to the Fannie Mae latest credit guidelines, the earliest a borrower can obtain credit to purchase another home is five years to seven years after the foreclosure sale. Where the borrower can show extenuating circumstances, the length of time may be reduced to three years. In contrast, the earliest a borrower may obtain credit after a short sale is two years after the sale date. Thus, the ability to obtain credit to purchase another home, according to Fannie Mae guidelines, is restored much earlier where the property is sold in a short sale compared to when the property goes to foreclosure.
The determination of which option is best for a client facing foreclosure is the subject for someone fully informed of the intricacies of California foreclosure law. The incorrect advice can cost a client tremendously both financially and emotionally; and if an agent has provided his client incorrect or incomplete information which leads to the wrong decision, the cost can be shifted to the agent or his insurance provider by prosecuting a claim against that agent. For that reason, most of the attorneys on the CAR Strategic Defense Panel advise agents and brokers to refer every client facing imminent foreclosure to an attorney for a full explanation of the foreclosure process and the options available to the client. We also recommend that REALTORS® document this referral by sending a confirming letter and keeping it in the file as proof that this advice was given. Maintaining a detailed transaction log delineating all conversations and events is a “best practice” to be followed. This would be tremendously helpful should a client ever claim that a REALTOR® provided incorrect advice. Even if the client ignores advice to seek legal counsel, most courts will determine that the REALTOR® has discharged his or her duty if he or she can show that the client was referred to an attorney for legal counseling. In so doing, a REALTOR® is removing potential liability and placing it on the shoulders of the attorney to whom the client is referred.
Proper Use of the MLS in Short Sale Transactions
Rule 7.1 of the CARETS Rules and Regulations requires that every listing placed in the service by a participant comply with the Rules of the MLS. Rule 7.19 sets forth the rules pertaining to expiration, extension and renewal of listings. Rule 8.3 imposes an obligation on the listing participant to utilize good faith in assuring that the listing is accurate to the best of his or her knowledge and belief. Rule 10 of the Rules and Regulations sets forth the applicable statuses of listings in the MLS. (It is important to note that not all MLS Rules and Regulations provide for these same statuses. The statuses below are applicable to the CARETS’ MLS Rules and Regulations. If you are not a member of CARETS, you should consult the Rules and Regulations of your MLS to determine which statuses are available.) Those statuses include the following:
On Market Status:
On Market status refers to listings where a listing contract is in force and the property is available for offers.
Active Status:
(A) Where no offer has been received the listing is in Active (A) status. Back-up Status (B): Where an offer has been received and accepted and the seller is accepting backup offers or where an offer has been accepted that is subject to third party approval, the property is in Back-up (B) status.
Off Market Status:
Rule 10 of the MLS Rules and Regulations provides for seven different Off Market statuses.
These are as follows:
Hold Status (H):
The Hold (H) status applies where there is a listing contract in place but the seller has for some reason requested that the property not be shown.
Withdrawn (W):
The Withdrawn (W) status applies where there is a listing agreement still in place but the property is no longer being marketed.
Pending (P):
This status applies when an offer has been accepted and the Seller is no longer soliciting offers through the MLS.
Canceled (C):
The Canceled (C) status applies when a listing has been canceled.
Expired (X):
This status is applicable when the time of the listing has expired and has not been renewed.
Sold (S):
Sold (S) status applies when the listed property has been sold and escrow has closed.
Leased (L):
The Leased (L) status is used when the property has been leased.
What is the Appropriate Status for a Short Sale Listing?
Depending upon the circumstances, a short sale listing could fall into one of several different listings statuses. In the ordinary course of a short sale listing, the following would be the statuses:
Active (A): At the time of listing the property, it would be in Active (A) status unless for some reason the Seller entered into a listing contract with the agent then advised that it should not be listed. In that situation the listing would immediately go into Hold (H) or Withdrawn (W) status depending upon the wishes of the Seller, until the Seller decides how to proceed with the transaction either On Market or Off Market.
Back Up (B): In the ordinary course of short sale transactions, the property will proceed into Back Up (B) status if an offer is made on the property. This is because in a short sale transaction, the lender has to approve the offer before it is deemed accepted. Thus, the offer is accepted contingent upon the acceptance by a third party, the lender.
It is important to remember that Rule 10.2 requires that accepted offers be reported to the MLS or input into the data base as “pending” or “back-up” within 48 hours. Where the property is sold in a short sale transaction, upon final closing of escrow the broker must report or input the status change within 48 hours. At that time the status would be Sold (S).
Remarks in MLS A common question among REALTORS® is whether there should be a comment in the Remarks section of the MLS stating that the property is a short sale listing. Is this a critical piece of information that must be disclosed to the Buyer? Arguably it is a matter required to be disclosed pursuant to Article 2 of the NAR Code of Ethics as well as the disclosure requirements of Civil Code §2079(a). On the one hand, knowledge that the property is being offered as a short sale could affect the price the Buyer is willing to pay, thereby bringing offers lower than one might expect. On other hand, knowledge that the property is being offered as a short sale could result in more offers as Buyers try to take advantage of a bargain. This condition demonstrates the elasticity of demand relative to price. Please keep in mind that the CAR Short Sale Listing Agreement (SSL) includes at paragraph 5 a provision that the Seller authorizes the agent to advertise in the MLS and other advertising medium and that the property transfer, payment of commissions and sales price are subject to lender approval. Thus, an agent using the CAR SSL, which is highly recommended, has authorization to disclose in the MLS that the sale is subject to lender approval.
Not only is the Buyer affected by remarks in the MLS concerning the fact that the property is a short sale, but this is also a matter of concern to the cooperating agent who is being offered a commission relative to the selling price. Not infrequently, the lender in a short sale transaction requests the listing agent to take a commission reduction in order to “make the deal work.” While NAR has provided guidance for addressing the prohibition on contingent offers of commission, it is still a matter of interest to cooperating agents because the short sale transaction is more precarious and time consuming than a normal sale transaction. This may affect the cooperating agent’s decision whether to spend a substantial amount of time pursuing the short sale transaction. Therefore, the fact that it is a short sale should always be disclosed in the confidential broker/agent remarks or the listing agent may be required to absorb any lien holder reductions in commission.
Conclusion The real estate industry is evolving rapidly with changes occurring on a daily basis. To keep pace with this rapidly changing environment, it is imperative that the agent have a working knowledge of the MLS rules and regulations and an understanding of how they impact offers to sell real estate and offers of commission. Not only is a thorough knowledge of the MLS necessary for an efficient exchange of information between REALTORS®, but lack of knowledge is one of the primary reasons for claims against agents. For this reason, REALTORS® are encouraged to familiarize themselves thoroughly with the MLS Rules and Regulations.
Information provided by the law offices of Giardinelli & Duke, APC
www.gdlawoffices.com
