Colorado Short Sales...Short Pays and Foreclosure

Most "Short Sales" take place during the formal Public Trustee foreclosure process called the cure period...the period of time between the recording of the Notice of Election and Demand and the Public Trustee auction sale.  Under current Statute, the cure period runs 45 to 60 days from the recording of the Notice of Election and Demand. On January 1, 2008, the cure period will last between 110 and 125 days for non-agriculturally assessed property after the recording of the Notice of Election and Demand. Under the current law the auction sale can also be “continued” week to week by the foreclosing lender for up to six months. On January 1, 2008, the auction sale may be continued for up to twelve months after the orginal sale date by the foreclosing lender. After January 1, 2008, the foreclosing lender who holds the Certificate of Purchase as the successful bidder at the auction sale can also request the Public Trustee to rescind the auction sale within eight business days after the auction. Between the week to week continuation of the auction possibility and the ability to rescind the sale, the foreclosing lender is providing a broker an opportunity to extend the foreclosure process in order to bring in an acceptable contract with a qualified buyer and thus cause the foreclosure process to terminate.

In addition, a short sale is rarely negotiated prior to the recordation of the Notice of Election and Demand. A “short sale” is defined as the lender accepting less than what is owed in order to avoid or terminate a specific foreclosure process; thereby, allowing a distressed owner to sell a property to a qualified buyer at a negotiated contract price. In order to close the transaction with such negotiated sales price, the current lender may need to accept less than what is totally owed to permit the transaction to close.

The lender when accepting a less than full payoff will have two options. The first option would be going after the distressed seller in court in hopes of obtaining a “deficiency judgment”. The other option the lender has is simply forgiving what was not received…there is one caveat to which a distressed owner needs to be alerted. “Forgiven debt” is considered income by the Internal Revenue Service in the tax year the lender forgave a portion or what was owed. New law has been passed called: "The mortgage forgiveness debt relief act of 2007" H.R. 3648. Please call me for details at 970-623-1389 or 970-424-0332. This act supersedes some of the content in this report.

Various factors are considered by the lender when the lender decides to accept less than what is owed including:

1.    The borrower’s overall “as is” value.

2.    The property’s “as is” value.

3.    The cost to put the property into resale condition

4.    The property’s “as repaired” value.

5.    The cost of securing and maintaining the property while it is being marketed for resale.

6.    The cost of marketing and selling the property.

When looking at the overall financial condition of the distressed seller, the lender looks at whether the borrowers are insolvent and that one or more of the following may have occurred:

1.    The property was purchased or refinanced at the top of a seller’s market at an over-inflated price, and a substantial drop in value has occurred.

2.    The property was financed as an interest only ARM loan and there is no capability for the borrower to refinance at a lower interest rate.

3.    The property was refinanced at 100%, 110% and 125% of its value.

4.    The property is located in an area where property values have dropped and value of the home is below the loan balance due.

5.    The property’s “as is” condition prevents the lender from putting the property back in a marketable resale condition.

6.    Proposed purchase price is more than the lender would be able to sell the property for after foreclosure.

7.    Any sales commission proposed is less than what the lender would typically have to allocate to market and sell the property.

Lenders consider the following types of properties to be prime candidates for a short sale.

1.    Houses that need a lot of work and repairs.

2.    Properties that are over-leveraged-a common problem in Colorado today

3.    Properties with large second mortgages.

4.    Properties located in subdivisions with a large number of foreclosures.

Short sale tips for FHA loans:

1.    FHA requires the home owner to be a participant in their “pre-foreclosure” program and to have attended counseling and signed their Counseling and Participation Application

2.    Home must remain owner-occupied during the process--no walk-a-ways are considered.

3.    Loan must be in default 3 or more installments.

4.    Net sale proceeds must be at least 82% of the property’s “as is” appraised value.

5.    FHA may pay up to $1000.00 for sale proceeds to discharge any junior liens, or if no junior liens, to the homeowner which is also referred to as an “FHA seller incentive.

6.    Borrowers who participate as good-faith participants shall not be pursued for any deficiencies in the event that foreclosure ends up occurring after participation.

Short sale tips for conventional loans:

1.    If the Broker Price Option appraisal is less than 63% of what is owed, the short sale will not be approved.

2.    Normally, the seller cannot be receiving any proceeds from the sale.

3.    Deficiency amount, when debt is forgiven, can be shown as gross income to seller and lender will report to the IRS under a 1099-C (lender has 3 years to issue)
     a. Seller should get a CPA or legal advice on income implications
     b. Lender may offer a tax break to the seller and not report, but will  have a seller sign an unsecured promissory note or pursue judgment against the assets owned by the seller including:  
            a.  garnishment of wages
            b.  Sheriff seizure of personal property
Seller could try to get a “non-recourse agreement” with the lender.    

4.    Deficiency judgments are dischargeable in bankruptcy provided the judgment remains an unsecured debt. However, bankruptcy will not eliminate any taxes due to the IRS if the lender reports deficiency as gross income, as income taxes are a non-dischargeable debt in bankruptcy.                                                     

Portions re-published with permission of United Title written by Ron Childs

Disclaimer: Legal, accounting or other expert advice should always be obtained from a competent professional