When a lender agrees to do a short sale, it generally comes to this decision because it's more profitable for the bank to do the short sale than to foreclose. It may or may not require that the seller have a financial hardship but most certainly the home is underwater.
In a short sale, the bank agrees to release the loan in exchange for receiving less than the amount owed. But it doesn't necessarily release the seller. Releasing the loan from the property and releasing the seller are 2 different things. If you owe the bank $200,000 but your home is worth $75,000, the bank might accept $75,000 and release the loan. However, without a release of liability, you could discover a few years later that the bank is now coming after you and demanding that you pay the $125,000 difference.
Release of Liability and the Short Sale Approval Letter
The short sale approval letter holds the key. This approval letter details exactly what the bank expects. It lays out the following terms, among other considerations:
- The acceptable sales price
- Maximum allowable commissions
- Maximum closing costs
- Minimum net proceeds
- Closing date
Don't ever sign a short sale approval letter without asking a lawyer to read it and give you legal advice. Don't ask your agent because unless your agent is an attorney, that agent is not licensed to give you legal advice. It is against the law for a real estate agent to dispense legal advice.
I tell my clients that if I see their short sale approval letter contains a release of liability, I cannot advise them of such. I tell them to call a lawyer. If the letter is unclear or does not specifically spell it out, I will suggest that the seller contact a lawyer to try to obtain a release of liability. Under no circumstances do I give legal advice.
I will not be astonished to hear of sellers filing lawsuits against their real estate agents because those agents assured them the lender would not go after a deficiency judgment. Even in California, where we are lucky to have certain non-recourse loans, that non-recourse typically applies to foreclosures, not to short sales. In other words, a seller who did a short sale on a purchase-money loan has no guarantee that a short sale lender will release them unless the lender specifically releases the seller.
We do have Section 580e of the California Civil Code, added January 1, 2011, but that has not yet been tested in court, and it does not apply to secondary financing nor to previous years.
Types of Verbiage in Short Sale Approval Letters Addressing Release of Liability
While I cannot possibly give you every conceivable type of release of liability or non release of liability in short sale approval letters, here are a few examples. Some of these statements release the seller, some do not offer any kind of release of liability.
- Upon the bank's receipt of $XXXXXX, the bank will release the lien and charge off the remaining debt as a collectable balance.
- The bank has approved a discounted payoff. Nothing in this letter shall be construed to prejudice, waive, modify or alter any of the bank's rights or remedies in law or in equity in collecting the entire amounts due.
- The bank issues its approval to sell the subject property which will result in a short payoff of the mortgage . . . and will waive any deficiency rights, if applicable.
- Upon receipt of this payment, we will report the debt as "paid in full for less than the full balance" to all credit agencies.
- The borrower must sign the attached acknowledgement to all terms specified in this approval and must acknowledge that the bank retains all deficiency rights as provided by the note, deed of trust and/or security agreement and local and federal laws.
- The bank agrees to accept in certified funds $XXXXXX as payment in full of the loan, additionally, the bank will report the amount of the debt forgiven to the Internal Revenue Service.
- The bank may pursue a deficiency judgment for the different in the payment received and the total balance due, unless agreed otherwise or prohibited by law if the short sales closes on the loan referenced above.
- Upon receipt of the funds the bank will release the lien, and the deficiency balance will be reported as a charge off collectable balance.
- Upon receipt of the agreed amount, the bank will waive the remaining balance due on the above referenced loan and release the borrower from further obligation therein, and waive all rights to pursue further judgment or deficiency.