Everyday we’re meeting with property owners who can’t get a loan modification and are deciding whether to attempt a short sale or just let the property go to foreclosure.  For more than 90%, a short sale is the best solution because it causes less credit damage, provides negotiation of recourse liability (especially important with multiple lenders), and avoids the potential future career damage of having a “foreclosure” on your record. Indeed, having at least attempted a short sale demonstrates a cooperation that may speed up the willingness of future creditors to provide a new loan.  But short sale is not always for everyone.

For the past three years, most people struggling with upside-down loans were those who bought their homes in the early to mid-2000’s with teaser loans such as negative adjustable, or pay-option ARMS which allowed them to qualify for the loans based upon “stated income” and a starting interest rate that virtually guaranteed a loan.  But then, as the teaser rates ended and interest adjusted, borrowers could no longer afford the payments.  For most of these borrowers, short sales work well because they don’t have any substantial assets and, unless they refinanced, they may have no deficiency liability (at least in CA). 

But now the profile of the upside-down owner is changing.  Today’s troubled owner is more likely to have a decent loan but they’ve lost their job or otherwise been impacted by the recession.  These owners may have lots of other assets but they can’t afford to keep paying for the negative cash-flow on the over-encumbered second home or rental property.  In California, these loans generally have deficiency recourse and, if a lender pursued a deficiency judgment, they could reasonably collect some or all of the deficiency from the borrower.  If the borrower attempted a short sale, they would have to disclose their assets as a part of the hardship package and, in doing so, they would be letting the lender know: 1) they have assets to contribute to payoff a short sale deficiency; and 2) if the short sale fails, they would be a good candidate for a “judicial foreclosure” which would allow a lender to get a deficiency judgment.  Even though that process could take over 2 years, the collectability could make it worthwhile for the lender to pursue.

Faced with this reality, it can be better for an otherwise solvent borrower to let the property go to foreclosure and, by not disclosing assets, have a better chance of avoiding the liability. In California, most lenders will foreclose through “non-judicial foreclosure” (also called Trustee Sale) because it is both cheap and fast but they give up any right to deficiency judgment.  Without knowledge that a borrower has other assets, the lender is most likely to take this path instead of the long, expensive, and generally non-productive judicial foreclosure route.  So, strategically, for the solvent but upside-down borrower, it may be better to walk away than short sale.

Of course, everyone’s situation is unique and there is no single best solution. The information presented in this Article is not to be taken as legal advice. Determining what to do involves consideration of judgment risk, tax factors, and credit and career impacts as well as the type of property and number of loans involved.  If you are considering default on your loans, get competent legal advise in your State immediately so that you can determine your best options. 

If you have specific questions about your liability in California or about short sales, foreclosure, or any legal issues, feel free to contact us at sjbeede@bpelaw.com.  We offer a $200 flat fee consultation to evaluate your liabilities and strategize a resolution. This can be done in person or by phone. If interested, please call us at 916-966-2260.