We’ve described many of the benefits of a successful short sale. Now we’re going to make you aware of many of the legal issues associated with short sales.
Consequences of Short Sale for agents
1. Inability to handle the workload.
Some real estate agents, in order to obtain a listing, promise their clients that they’ll personally process the short sale. There are numerous situations where the agent becomes overwhelmed and fails to follow up on case files. In short sales, time is of the essence.
Sellers face a foreclosure date that may be difficult to delay. If the agent fails to process the short sale in a timely manner, the seller could lose the property to foreclosure. In some cases, sellers have initiated lawsuits against inexperienced or overwhelmed agents for bungling the short sale
negotiation.
2. Misrepresenting tax consequences.
Sometimes a person inexperienced with short sales may inform borrowers that they will not face any taxation on forgiven mortgage debt. Historically, the Internal Revenue Service (IRS) has treated canceled or forgiven debt as if it were income, which means that a person has to pay income tax on the forgiven amount.
3. Leading the seller to believe that all their debt is forgiven.
A seller may believe that they can walk away from the short sale with no further liability to pay off debt. In many cases that is true, but in other cases, the lender may pursue the seller for the remaining balance. Holders of second mortgages or deeds of trust sometimes do not forgive the debt.
In some short sales, the second mortgage holder accepts a partial payment to release the mortgage lien, but they later sell the balance to a collection agency. Also, it is imperative for the agent and seller to understand whether they have a recourse or non-recourse loan. With a recourse loan, unless otherwise stated in the short sale approval paperwork, the lender may later seek payment of the remaining debt.
An irate seller who finds out a year later that they still owe money might sue the agent who handled the short sale. It is best to have the seller review the short sale approval document with their attorney to determine if there would be any continued debt obligation after the short sale. The Significa short sale program provides an attorney to represent the seller if they do not have one. That attorney will review the short sale approval letter with the seller and advise them whether to accept the terms and conditions.
4. Failing to uphold one’s fiduciary duty.
A real estate licensee has a fiduciary duty to do what is best for the client. If a listing agent allows a “double-close and flip” scenario, the seller client may feel that the agent failed to bring the highest and best offer. The situation will be compounded if the seller client must pay income taxes on a larger portion of forgiven debt than they would have.
Some opportunists and investors may induce the seller and agent to unknowingly commit mortgage fraud.
When a short sale is listed, some sellers and agents are besieged by unorthodox requests from seemingly helpful real estate investors or other short sale opportunists. Of course, many buyers look for a good deal, and it is the bank’s prerogative to allow a property to be sold for less than fair market value. However, some of these investors or opportunists may entangle the agent and seller in what amounts to mortgage fraud.
One fraudulent situation is the double-close-and-flip transaction. That occurs when an investor places the property under contract at a low price and offers to negotiate that offer with the bank. Meanwhile, the investor tells the listing agent to continue marketing the property so they can procure a much higher offer. The investor tells the bank that the low offer is the only one while concealing the much higher offer from the bank.
The investor’s intention is to engineer the transaction so they can collect the difference between the low offer and the higher offer while keeping the bank unaware. The listing agent, who has a fiduciary duty to the seller, ends up procuring a higher offer for the investor’s benefit and not the seller’s benefit. Furthermore, the short sale fraud department within many banks may sue all the parties if they discover that a double-close-and-flip transaction occurred.
Another potentially fraudulent situation involves the investor placing an option on the property or inducing the seller to turn over the deed without paying off the mortgage. The investor creates a cloud on the title and then demands a payment from the ultimate buyer to release their option or transfer the deed.
The third type of fraudulent transaction involves a non-arm’s length transaction or collusion in which the buyer allows the seller to remain in the property. Some sellers convince a family member, often with a different last name, to buy the house at a discount. Then the family member either rents or sells the house back to the former borrower. The bank is defrauded out of thousands of dollars.
5. Some sellers may attempt to defraud their banks.
In some situations, it is the seller who attempts to defraud their lender by encouraging their agent to allow a family member or business associate to surreptitiously purchase the house. The intent of the seller is to have their family member or associate pretend to be someone they do not know, and then the bank may allow the house to be sold for a discount along with the debt being forgiven. That way the seller receives the benefit of staying in the house while being relieved of the debt obligation.
Some sellers may believe that if their family member or associate has a different last name, then the lender will believe it is an arm’s length transaction. If a lender discovers that the sale was not an arm’s length transaction, they have the right to file criminal charges and initiate a civil lawsuit against all the parties involved.
Significa protects sellers and agents from fraudulent transactions. Significa’s trained staff can quickly identify a proposal from a potential buyer that is designed to defraud the lender. Significa can guide the agent and seller through the transaction, explaining the various benefits and consequences associated with offers. Furthermore, the real estate attorney provided to the seller at no cost under the short sale program helps keep everyone out of trouble with the law. The system is designed to protect the consumer and the agent.
Should I Pay My Property Taxes While I Am Facing Foreclosure?
It is the owner’s responsibility to pay real estate taxes. However, if someone is in financial distress, it is likely they will not have the means to pay the taxes. Many borrowers who are behind on their mortgage payments are also behind on their property tax payments.
Some mortgage companies pay property taxes on behalf of the owner via an escrow account that the owner is supposed to pay into on a monthly basis. If a person is delinquent for only a few months and they have an escrow arrangement with their mortgage lender, there may be enough funds in the escrow account to pay off the current year’s taxes. The lender might even temporarily fund the escrow account if there is a slight shortfall. If the borrower believes they can sell the property in the near future or they reach an alternative arrangement with the lender, no other taxes may be due at that time.
If the borrower is more than a year behind on payments, then any escrow account will probably have no money left. If nothing is done, the taxes will go unpaid. Eventually a tax sale will be scheduled, with the borrower and the lender being notified of the sale. In many cases, the mortgage lender will pay the delinquent property taxes shortly before the tax sale just to protect their interest in the property.
If a borrower is facing foreclosure, it is a judgment call whether they should pay the property taxes. Assuming they have the funds to pay the property taxes, it is often wise to pay the delinquent taxes if they have equity in the property. That will eliminate the tax sale and buy the owner time to sell the property or find another solution to the foreclosure action. It protects the owner’s equity.
If a borrower is attempting to sell their property via a short sale, the property taxes are often paid out of the lender’s proceeds at the sale provided that the back taxes were included on the preliminary HUD-1 Settlement Statement submitted to the lender. It may not be as prudent for the owner to pay the property taxes in a short sale, as every dollar they spend on the property is a dollar that they will not recover.
If a mortgaged property is sold at tax sale, the mortgage obligation may still exist. Depending on the type of tax sale, the original borrower will still be on the hook to pay the mortgage loan while the new owner will have the mortgage clouding the property’s title. Until that mortgage is paid, the lender can pursue the seller for the balance while continuing with the foreclosure action.
WILL I GO TO JAIL OVER NOT PAYING MY MORTGAGE?
A borrower will not go to jail if they default on their mortgage loan, but they could face criminal charges in a couple of extreme situations described below.
In some states, foreclosure involves judicial proceedings. In other words, the lender must hire an attorney who initiates a foreclosure lawsuit against the borrower. The lawsuit does not involve any criminal charges against the borrower. It is merely a civil proceeding that involves the lender’s attempt to collect a debt or be given ownership of the property in exchange for the unpaid debt obligation.
If a borrower fails to maintain their property prior to being foreclosed, the local municipality could issue a citation and/or a fine. Common citations include failure to keep grass cut, leaving pets behind, having an unfenced or tepid swimming pool, or leaving a house unsecured. Some municipalities will even condemn a property. If the borrower fails to address the issues and pay the fines, some municipalities have the ability to take the borrower to court. In rare cases, failure to show up for court could result in an arrest warrant being issued.
If a borrower deliberately trashes a house, it is possible for the lender to sue them after the sale for the destruction of property and perhaps even press criminal charges. While rare, it is done in cases where the borrower creates major damage to the house. We have seen cases of angry borrowers clogging toilets and sinks with a concrete mix or stopping the drains with other things like tennis balls. They then turn the water on and leave it on. In other cases, borrowers have ripped out all the fixtures and appliances.
In some blighted cities, lenders have taken the unusual step of not foreclosing since they determine that the property’s value is so low that it is better to not take it back. This is known as a bank walkway, where the bank charges off the loan and stops the foreclosure action. Therefore, the borrower remains the owner. The city can then issue citations against the owner for failure to maintain their property.
In some cases we have seen, the owner walked away from the property only to find out years later that they still owned the property. The city may even have the right to demolish the property and bill the owner for the cost. In rare cases, failure to respond to the city’s citations or court hearings could result in an arrest warrant being issued.
