Short Sales and Deficiencies

It is not much of a stretch to understand why a Michigan asset protection lawyer would be contacted by a prospective client about a possible short sale. The concern of the homeowner, of course, is whether the lender will agree to accept the proceeds from the short sale in full satisfaction of the debt. The opportunity to have a debt discharged for less than its balance is a goal typical of the asset protection planner and thus a short sale can be an excellent strategy to reduce debt for which an individual has personal liability. However there are significant issues that need to be considered.

Many homeowners who are substantially under water on their home mortgages do not even bother to attempt a short sale. They cease making mortgage payments, fail to pay property taxes and continue to dwell in the home through the foreclosure proceeding…vacating only after the redemption period has occurred. These homeowners hope that their lenders will not pursue them for a deficiency although there is no doubt they are personally liable on the mortgage note. Anecdotally, the large banks are not generally pursuing borrowers for the deficiency on first mortgage residential loans. While some states actually have laws preventing lenders from suing for a deficiency on such loans, most states permit it. Why, then, are lenders not pursuing their rights?

These are unprecedented times and the volume of mortgage defaults and foreclosures are at historic highs. In this financial environment, there are probably a number of factors influencing the industry’s reluctance to pursue defaulting borrowers. First, there is the moral issue. With borrowers losing their jobs or incurring uninsured medical expenses, lenders are hesitant to beat them up further. Second, many of the borrowers are truly broke and if the banks elect to pursue the deficiency it will simply force the borrowers to file for bankruptcy which will wipe out the deficiency. Third, the cost and time to pursue a deficiency claim against parties who are of dubious collectability may not be merited. Fourth, the sheer volume makes it difficult for the banks to determine which borrowers may be collectible and those who are not.

I recently heard that a well known title company executive in Michigan has been claiming in his lectures that these lenders have not definitively decided to walk away from their deficiency claims; instead, they are keeping them on the books to avoid a write off on their books. The message he delivered is that the defaulting borrowers may yet be pursued for the unpaid debt – either by the lenders or by investors purchasing these claims on a discounted basis.

Message to short sellers: make sure as part of the lender’s agreement to discharge the mortgage in exchange for the short sale proceeds and that the lender also agrees to cancel any remaining debt. Just because the lender discharges a mortgage does not mean that the mortgage note is considered paid in full!!!