In October, 2008 I wrote a blog post called “Are ‘Short Sales’ they worth the hassle?” My answer was a resounding and unequivocal “No!”  (In fact my view was so lopsided that I think it could be said that it was really “Hell No!)  Have things changed?  Well, I have received some boots-on-the-ground intel that suggests that there may be some circumstances where the effort may pay off. I’m not ready to do a 180, but there may be circumstances where it’s worth a look. (The italics and bold of all those “mays” and “suggests” is intentional.)

First, let’s go back to the basis premise, which is that most people who bother with short sales do so out of a desire to “do the right thing.”  An admirable motive in nearly any business endeavor. But it may not always be in one’s best interests. My objections to short sales is that they (1)  Trigger too much effort and frustration, (2) Are prone to falling apart at the last minute, (3) Don’t do much to really salvage one’s credit rating and (4) Require the homeowner to do all the work for the bank.  But the part that concerns me most is that in order to get a short sale approved, the homeowner has to open his financial books and records to the bank which may then turn around and use that very same information against the homeowner in a later lawsuit to recover a deficiency.  Importantly, in California, a litigant cannot get financial information about the other party during the litigation. This protects litigants from allowing their financial condition to be the tail that wags the dog of the lawsuit: If someone can find out that the defendant is wealthy, they may press a frivolous lawsuit harder in the hopes that the wealthy target will cough up some money to make the problem go away.  By giving a bank this information in the process of trying to get a short sales approved, you have now given them a possible road map to an easier recovery. For example, letting a property go in foreclosure forces the lender to consider a bankruptcy risk in their negotiating strategy; if you’ve told them that you have $100k in the bank or a stock portfolio, you have now minimized at least some part of that risk to the bank, and they’ll feel emboldened by knowing that you actually have something to lose.   (For a related post on deficiencies after short sales, see my recent blog post about the new California statute CCP §580e which precludes a lender on a first deed of trust from pursuing a deficiency after approving and getting paid off in a short sale.  This is a helpful development, but it doesn’t cover all situations.)  Of course, the borrower’s ultimate financial exposure is never any greater than what the bank could get in a Chapter 7 or Chapter 13 payout, but making that determination is part of the analysis.

So what has changed? Well, I have been told that, anecdotally, letting a home go by short sale may enable a borrower to re-qualify to buy a new home sooner than would likely be the case in the event of a bankruptcy or foreclosure. In other words, a short seller takes a smaller hit on their credit profile than one who lets the property go by straight foreclosure. Again, this is only anecdotal and I have no proof or verification from any lenders or credit agency that this is true. But I have been told this by enough reputable real estate and loan brokers to believe that there might be something to it.

But don’t make this decision on your own: You need to know your risk of being sued before you make the decision. Get legal help. You should do a complete financial analysis so you know just how tempting a target you make to a bank.  A $500 legal check-up may save you tens thousands of dollars–tens of thousands in some places–in later exposure.

Of course, you should never let a short sale go to close of escrow unless the bank gives you a complete waiver of a deficiency, but in the fog of war and after months of exhausting haggling with a bank, these things sometimes go unnoticed.

Call a lawyer before you close a short sale. Seriously.  Do it.

5 Responses to Rethinking Short Sales? Maybe. But only sometimes and not without legal advice first…

  1. torisf says:

    Hi David,

    Quick (hopefully) question re: liquidated damages on short sales. If the buy walks after the deadline for contingency removals, what happens to the earnest money deposit? Does the bank or the seller get the deposit?

  2. I’m sorry Tori, but I can’t answer that without reviewing the actual contract.

  3. […] Sales Worth the Hassle”  and softening my position a bit in my post last December called “Rethinking Short Sales…”   Then effective in January of this year, the California State Legislature passed some new […]

  4. slesinski says:

    You might consider writing something that addresses the legal obligation of the buyer in a short sale. What happens if there were liens that were not public record and therefore not covered by a title insurance policy?

  5. Buyers don’t have “obligations” in a short sale. They have opportunities. I don’t know what you’re referring to when you say liens that were not of public record, unless you’re referring to tax or mechanics liens. These are complicated issues and really can’t be addressed with generalities. I’d have to know the specific facts. Also, if you’re looking for title insurance coverage to protect you from off-record encumbrances, you need to get a broader form of title insurance than buyers usually get. Ask the title company about an ALTA buyer’s policy, as opposed to a CLTA policy. Explain what you are concerned about and then ask for a quote to cover the risk. Warning: It’s pricey.

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