Short Sale Transactions

By K. Michelle Lind

Unfortunately, some homeowners today owe more on

their home than what the property is worth. Some programs

that were intended to make it easier to obtain financing

and increase homeownership resulted in loans

that required small or no down payment, interest-only

loans that do not build equity, and other loan programs

that require such small payments that the loan amount

actually increases rather than decreases. As a result,

some homeowners have negative equity in their homes.

Stagnant or decreasing property values add to the

problem. Homeowners who financed their homes with

loan programs with low initial rates of 1% to 2% will

experience dramatic increases in their monthly payment

when the loan resets to the market rate. These and other

factors have contributed to a striking increase in home

loan defaults and foreclosures.

Short Sales

In a loan default situation, the lender may be willing to

work with the homeowner to avoid foreclosure. For

example, a homeowner in default who owes $300,000 on

a property that is worth $250,000 may be able to

convince the lender to allow the home to be sold for less

than the loan amount, or even accept less than the

amount owed as payment in full. This is known as a short

sale. A lender may agree to a short sale to save the costs

associated with a trustee’s sale, such as attorney’s and

trustee’s fees, eviction, property repair and resale costs.

Additionally, a lender may agree to a short sale because,

if the property is foreclosed upon, the loan becomes a

"non-performing" loan on the accounting books, which

may affect the funds the lender can obtain from the

Federal Reserve for other loans.

Seller Considerations

When considering a short sale, the seller must first

determine how much is owed on the property. For

example, in addition to the delinquent loan, there may be

a home equity loan, past due homeowner’s association

fees or unpaid property taxes. Then, the seller must add

the costs of a sale, such as closing costs, escrow fees

and brokerage commissions. All of the seller’s debt and

costs must be factored in before determining whether a

short sale is feasible.

The seller should also be aware of some of the downsides

to a short sale. A short sale could affect the

seller’s credit score. Further, even if a lender agrees to a

short sale, the lender, the VA, or the FHA may not agree

to forgive the debt entirely, and may require the seller to

pay the difference as a personal obligation. The outstanding

debt could result in a subsequent collection

action. Therefore, the seller should be certain of the

terms of any short sale before making a decision and

obtain any debt forgiveness agreement in writing.

Also, a short sale in which the debt is forgiven is a relief

of debt and may be treated as income for tax purposes.

A lender who forgives a debt must submit a 1099 form to

the IRS indicating the amount of the debt that has been

forgiven. (Note: The NATIONAL ASSOCIATION OF

REALTORS® supports proposed legislation that would

change this tax law.)

The seller must convince the lender that it will fare better

by agreeing to a sale for less than the outstanding loan

amount. Thus, a short sale may involve more

documentation than the original loan application since

the seller must “reverse qualify” and prove that the seller

is financially incapable of paying the loan. Also, different

lenders have different short sale department names, so

contacting the person who has the authority to authorize

a short sale on behalf of the lender may require some

tenacity. The appropriate department may be called the

loss mitigation, work-out, foreclosure, loan modification

or loan reinstatement department.

Purchase Contract Considerations

The purchase contract in a short sale must be

contingent upon a short sale agreement acceptable to

both the lender and the seller. AAR is currently working

on a short sale contingency clause to add to the Additional

Clause Addendum. In the meantime, the following

short sale contingency clause may be used as a guide:

CONTINGENT UPON ACCEPTABLE

SHORT SALE AGREEMENT: Buyer

acknowledges that Seller owes more for the

Premises than the purchase price and the

Premises are encumbered by a loan(s) in

excess of the purchase price. Therefore,

this Contract is contingent upon an

agreement between the Seller and Seller’s

lender(s), acceptable to both, to sell the

Premises for less than the loan amount(s).

In the event that Seller and Seller’s lender

(s) are unable to reach an acceptable

agreement, this Contract shall be deemed

cancelled and all Earnest Money shall be

returned to Buyer. Seller is advised to

obtain legal advice regarding the terms of

any such short sale agreement with lender

(s) and professional tax advice regarding

the tax implications of any such sale.

Other contract considerations include whether the buyer will

be entitled to cancel the contract at any time before the

seller enters into an acceptable agreement, whether the time

periods in the contract should be extended and whether the

seller’s warranties should be omitted. Thus, the listing agent

and the buyer’s agent should consult with their brokers or

managers before drafting a contract in a short sale

transaction or using the foregoing clause.

Brokerage Commission Considerations

Because the lender is accepting less than the full obligation,

the lender may demand that the real estate brokers in the

transaction reduce their commission as a condition to any

short sale agreement. However, the brokers cannot be

forced to reduce the agreed upon commission, even if the

lender refuses to agree to the short sale unless the brokers

do so. A.A.C. R4-28-1101(D) states:

A licensee shall not allow a controversy with an

other licensee to jeopardize, delay, or interfere

with the initiation, processing, or finalizing of a

transaction on behalf of a client. This prohibition

does not obligate a licensee to agree to alter the

terms of any employment or compensation

agreement or to relinquish the right to maintain an action

to resolve a controversy.

Therefore, even if the transaction will not close unless the

brokers agree to reduce their commission, the brokers

have no duty to do so.

Further, if the listing broker agrees to reduce the listing

commission, the buyer’s broker’s commission is not

affected by the listing broker’s agreement. Unless the

buyer’s broker also agrees to reduce his or her commission,

the listing broker is obligated to pay the buyer’s

broker the amount of commission offered in the MLS,

regardless of any agreements between the listing broker

and the seller or lender.

Finally, the purchase contract should not be used to

address commission issues even in a short sale. Any

commission agreements should be handled by separate

signed writings to avoid misunderstandings, disputes or

potential violations of either the Commissioner’s Rules or

Article 16 of the REALTOR® Code of Ethics.

Consult With Your Broker or Manager

Short sales can be very complex and risky transactions

for everyone involved. Unless you are confident in your

ability to handle such a transaction alone, consult with

your broker or manager for advice and guidance.

Thanks to Martha Appel, Jerome King, James Tsighis,

and Mark Ross for their input on this subject.

Editor’s Note:

Michelle Lind, the General Counsel to the Arizona

Association of REALTORS® (“AAR”), is a State Bar

of Arizona board certified real estate specialist and

the author of Arizona Real Estate: A Professional’s

Guide to Law and Practice. This article is of a general

nature and may not be updated or revised for

accuracy as statutory or case law changes following

the date of first publication. Further, this article

reflects only the opinion of the author, is not

intended as definitive legal advice and you should

not act upon it without seeking independent legal

counsel.