The large number of foreclosed properties in New York State has caused a situation where banks may be more willing to compromise when a borrower cannot make their mortgage payments. If a lender proceeds with a foreclosure to its final conclusion, the lending institution will end up taking title to the property. Many lending institutions would rather not be “in the business” of owning, selling, and managing real estate. As a result, there are several alternatives to foreclosure which may be available. The first is a loan modification. As discussed in a prior blog post, courts in New York State are required to attempt to settle foreclosure actions in a separate foreclosure part.
Another alternative is a short sale. A short sale happens when the mortgage balance exceeds the current value of the property. This is an increasingly more common situation in our times, as lenders in the past were overly generous in issuing loans on properties, including second mortgages. Overly optimistic appraisals and credit reports were the foundation of said loans. Combined with a recent decline in real estate values, the result is that many homeowners find themselves unable to pay their mortgage, and also find that the total debt on their property may exceed the current fair market value of the property.
When this occurs, the borrower may ask the lender to allow a “short sale” on the property. A short sale is when a lender allows the property to be sold for less than the amount due on the mortgage, and then forgives the rest of the debt on the property after the sale. The main reason that this may be an acceptable alternative for a homeowner is that they remain personally liable on the Note and Mortgage, even after foreclosure and sale of the property. A lender may seek a deficiency judgment against the borrower if the property is auctioned for less than the amount owed by the borrower. This can result in a large judgment entered against the borrower, and could result in the borrower having their personal credit damaged, or being forced to file for personal bankruptcy.
A short sale will avoid this situation. In a short sale, the lender agrees to forego entering a deficiency judgment against the borrower in exchange for the immediate proceeds of a sale of the property to a third party. Usually, the borrower markets the property and locates a potential buyer. At this point, we recommend that legal counsel communicate with the lender to discuss the possibility of a short sale. The lender will almost always require that the borrower provide proof of their income and assets to show that they are unable to pay their mortgage, which should be done through counsel. If the bank approves a short sale, there must be a written agreement executed at the same time as the Contract of Sale stating that the lender agrees to accept the sale amount in exchange for foregoing further foreclosure proceedings and a deficiency judgment against the borrower.
Once an agreement is reached, the sale of the property proceeds as in an ordinary real estate transaction. The only difference is that the proceeds, instead of being received by the seller, are instead turned over to the lender in exchange for a release of all liability for the borrower. Such arrangements are becoming more common in today’s financial climate. If you feel that you are in need of legal counsel to negotiate such an arrangement with a lender, please feel free to contact our firm and we will be glad to assist you.