Legislative Committee
Real Estate Finance Committee

December 23, 2008

(This material is for discussion purposes only and has not been reviewed by the Legislative, Real Estate Finance or Executive committees, or the Board of Directors)

Issue:
Should C.A.R. sponsor legislation to create a "Shortclosure" process to expedite resolution of short sale transactions?

Action:
Optional

Options:

1. Sponsor legislation
2. Amend legislation of others
3. Other
4. Do Nothing

Status/Summary:
REALTORs® working to put short sales together complain that lenders ignore them for unreasonably long periods of time. Lenders often do not respond in a timely manner as to what price or terms are acceptable to them. In many cases delays by lenders result in a failed short sale and the property going to foreclosure. The proposal is to develop a "shortclosure" process that provides sellers, seeking to complete a short sale, with leverage on the lender to generate a response in a timely fashion and, failing that, to expedite the return of the property to the lender free of junior liens while relieving seller of debt in excess of the value of the property.

Discussion

As mentioned above, the short sale process is complex and varies from lender to lender. Indeed, the process with at least some lenders is reportedly so difficult that REALTORS® are steering away from that segment of the market, or hiring transaction processors that are familiar enough with the idiosyncrasies of a given lender to successfully document short offer. Reportedly, Lenders delay responding to sellers seeking a short sale, hoping to get a better offer. They have an incentive to do so, knowing that if they must foreclose, junior liens will be wiped out and the lender will be able to take the property back free of those liens at the foreclosure sale.

It is no solution, at least under existing law, for the owner to threaten to give the property to the lender via a deed in lieu of foreclosure if the lender doesn't approve the sale. The lender is not required to accept it, and is motivated to refuse because the "deed in lieu" doesn't wipe out junior liens like a foreclosure does. Even worse, there may still be personal liability on the mortgage for the seller that simply abandons the property.

The Goal: Develop a process that provides sellers, seeking to complete a short sale, with leverage on the lender to generate a response in a timely fashion and, failing that, to expedite the return of the property to the lender free of junior liens while relieving seller of debt in excess of the value of the property.

The "Shortclosure" proposal: In an effort to give lenders effectively the same incentive they have when they foreclose, namely, the ability to take the property back free of junior liens, and the greater incentive of getting the property back quicker than the minimum 111 days necessary for the a completed foreclosure, legislation could add to the existing foreclosure process a hybrid process called a SHORTCLOSURE. Basically it would provide that:

1. When a seller receives a short sale offer, it can be presented to the lender who will then be obligated, within a set period of time, to accept or reject that offer.

2. If the lender rejects the short sale offer, the borrower could convey the property back to the lender by way of a statutorily-authorized deed in lieu. In other words, the lender has a first right of refusal on the short sale. If the short sale looks an appropriate value, the lender accepts it. If not, and the lender thinks it can do better; it rejects it and (at the seller's option) gets the property back. This gets these properties "moving," avoiding the foreclosure process, which is expensive time consuming, and works to the mutual detriment of the borrower and lender.

3. If the lender ignores the short sale offer in the time specified, the short sale price will be deemed the balance due on the debt, allowing that debt (under state contract law) to be "discharged". The borrower would convey the property to the lender by way of a deed-in-lieu. Note: this is the same result that occurs if the lender takes by foreclosure and is prevented from going after the borrower personally (one action rule and anti-deficiency) with the exception that here, this new law would prevent the lender from reporting the transaction as a borrower's "default".

4. Finally, if the lender takes the property via a deed in lieu "jingle letter" (one that contains the house keys), then the transfer will wipe out junior liens, just as they are wiped out now in a foreclosure sale. Junior lenders will suffer no practical loss over existing law, as they would have been wiped out in a foreclosure sale anyway and they will still retain their right (if any) to pursue the borrower for personal liability on the note.

It is not clear how lenders will react. On the one hand, it creates a procedure for getting the property back, free of junior liens, more expeditiously than the existing foreclosure process permits. On the other hand, it puts REOs on their books perhaps faster than they would like, affecting their reserve requirements.

It is also unclear how consumer groups will react. By giving the homeowner more leverage to force the lender to react to a bona fide short sale offer; and by keeping the discretion to go forward in the hands of the consumer, the proposal is consistent with previous policy pronouncements of the consumer groups. On the other hand, the new process may result in home owners leaving their homes more quickly, and the consumer groups may resist that possibility.

Should C.A.R. sponsor legislation to create a "Shortclosure" procedure?