A LONG HOT SUMMER OF SHORT SALES

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1 A LONG HOT SUMMER OF SHORT SALES There are an amazing number of houses that are continuing to be sold as short sales. The chaos that dominated short sales just a few years ago has been replaced with something of a functioning short sale market. Lenders have hired more staff to handle the high volume of short sales and have developed better and more standardized criteria for deciding: 1) which short sales to approve and disapprove; and 2) what information they need from sellers to make a decision on the short sale. REALTORS continue to look for advice on short sales in three main areas. First, they still have questions as to what they are permitted to do as real estate licensees to assist in the short sale process. Second, they remain hungry for sound practical advice on how to get short sale transactions approved by the lenders with whom they are working. Third, property owners continue to ask REALTORS advice on the tax consequences of short sales. This article will address all three of these topics. While some general advice is provided in this article on the tax consequences of short sales (so that REALTORS have some general background on this subject), REALTORS should recommend to their clients that they seek the advice of a tax professional due to the complicated nature of our federal tax laws. I. THE ROLE OF REAL ESTATE LICENSEES IN THE SHORT SALE PROCESS State law limits what real estate licensees can do to assist a seller in obtaining short sale approval from the lender. The Georgia Residential Mortgage Act ( GRMA ) requires anyone who directly or indirectly solicits, processes, places or negotiates mortgage loans for others to be licensed as a mortgage broker. 1 The Georgia Department of Banking and Finance has broadly interpreted this definition to mean that real estate licensees are not permitted to negotiate with a mortgage lender over reducing the amount of a mortgage loan to accommodate a short sale transaction. Specifically, the Georgia Department of Banking and Finance has stated in an informational brochure that Negotiating terms of any loan and / or modifying the current loan terms for a client with a lender would require a Mortgage Loan Originator License. 2 One of the exemptions from GRMA is for a real estate broker or real estate salesperson not actively engaged in the business of negotiating mortgage loans; however, a real estate broker or real estate salesperson who directly or indirectly negotiates, places or funds a mortgage for others shall not be exempt from the provisions of this article. 3 Based upon this exemption, the Georgia Department of Banking and Finance has indicated that a real estate licensee can provide facts and information regarding the subject property to a lender 4 such as conducting a market analysis, recommending a list price or presenting offers to the lender. The position of the Georgia Department of Banking and Finance appears to be that real estate licensees can provide factual information relative to the property but cannot be involved in filling out a short sale application or providing financial information about the borrower to the mortgage lender. However, the Georgia Department of Banking and Finance is currently reviewing its position on this issue since so many lenders are requesting that real estate licensees help them get the information they need to make a decision on a short sale request. The Georgia Association of REALTORS has been meeting with the Georgia Department of Banking and Finance to try to bring more clarity as to the permitted role of real estate licensees in the short sale process. 1 O.C.G.A (19). 2 See Georgia Department of Banking and Finance Q&A GRMA and Safe Act Applicability to Real Estate Brokers. 3 O.C.G.A (a)(6). 4 See Georgia Department of Banking and Finance Q&A GRMA and Safe Act Applicability to Real Estate Brokers. 1

2 II. PRACTICAL TIPS ON SHORT SALES While not all lenders are alike when it comes to short sales, there are certain issues of which real estate licensees should be aware when it comes to short sales. These include the following. 1. Most short sale lenders want to see a conformed or clean copy of the purchase and sale agreement signed by the buyer and seller. Some lenders will not accept a purchase and sale agreement signed by just the buyer and a counteroffer form signed by the buyer and seller. While having a GAR Counteroffer Form signed by the buyer along with a GAR Purchase and Sale Agreement signed by the buyer or seller clearly creates an enforceable contract in Georgia, it falls outside the box of some lenders standard procedures for acceptable documentation of a real estate contract. 2. Many lenders in short sale transactions will not accept electronic signatures of the type offered by some companies. Many short sale lenders want what are referred to as wet signatures (i.e., written by hand with a pen) on a purchase and sale agreement. However, once a contract has been signed, most lenders will accept a faxed or ed copy of such a contract. 3. In setting a closing date for a short sale transaction, it is best to allow for at least 60 days for short sale approval. Including a provision in the contract to allow the contract to be unilaterally extended for an additional 30 days is also a good idea. A sample of such a stipulation is set forth below: Buyer shall have the unilateral right (but not the obligation) to extend the date of closing once for up to 30 days upon notice to Seller if the mortgage lender(s) who are responsible for approving the short sale to which this Agreement is subject have not either approved or disapproved the short sale at least seven (7) days prior to the date of closing. 4. The devil is in the details with most short sale transactions. Lenders want the borrower to provide accurate and complete financial information showing that the borrower cannot afford to pay the mortgage on the property. This information typically has to be updated every 30 days. The challenge for listing agents with the short sale process is how to keep the seller sufficiently motivated to continue to provide the lender with needed information. 5. Lenders in short sale transactions will generally not accept a purchase and sale agreement that only comes into existence if the short sale is approved by the lender. Instead, most lenders want to see that there is an existing Purchase and Sale Agreement with a Binding Agreement Date. Of course, the purchase and sale agreement can be subject to a short sale contingency where the lender must approve the short sale. 6. Real estate licensees should go ahead and get documents needed to prove that a party is signing in a representative capacity. For example, if the seller is a limited liability company, the lender will normally want to 2

3 review the Articles of Organization and the Operating Agreement for the company. If a husband and wife owned a property together which one of them is now selling on a short sale subsequent to a divorce, go ahead and get the former spouse to quitclaim his or her interest in the property to the owner who is now selling the property. 7. Do not expect a short sale lender to pay for repairs to the property, Official Georgia Infestation Reports, home warranties, etc. The buyer should plan to purchase the property in as-is condition. While in some cases, the seller may be willing to pay for some repairs, in most transactions the seller does not have the financial wherewithal to do this. Some lenders will insist that the transaction be as-is-where-is. 8. Recognize that most lenders will only deal with one offer at a time. If there is a backup offer at a higher price, most lenders will only consider it after they have first decided whether or not they can accept the offer that has been presented to them. If the first contract falls apart and a new buyer steps in to purchase the property on the same or similar terms, do not expect the approval process to take less time. For many lenders the introduction of a new buyer will cause the approval process to be started over. 9. The amount of commission paid by a short sale lender will vary from lender to lender. While many larger lenders are now willing to pay a commission equal to 6% of the purchase price, some lenders will pay only a 5% commission. Determining the lender s position on the payment of commissions is the best way for a real estate licensee to avoid being disappointed. 10. Some REALTORS mistakenly think that second mortgage holders will be pushovers in the short sale process. This is generally not the case. If anything, they are usually just as meticulous as the first mortgagee in verifying the financial hardship of the seller. It is also increasingly common for second mortgage holders to ask the seller to sign a promissory note for the amount that the second mortgagee is owed. Most second mortgage holders know that they will be wiped out in the event the property is foreclosed upon by the holder of the first mortgage. However, many second mortgage holders have come to realize that playing hardball is often a way to get some money out of a short sale seller who is looking to avoid foreclosure. Under the federal HAFA program, if the first mortgagee approves the short sale, then an amount up to $6,000 is available to the second mortgage lender if the lender agrees to forgive the remainder of the second mortgage. Some second mortgage lenders will agree to accept this payment and others will not. 11. Many lenders now require the listing and selling agents involved in a short sale transaction to sign a certification confirming that all offers have been presented to the seller, the licensees have tried to get the maximum price for the property, the licensees are not receiving anything of value other than what is listed on the HUD and the licensees are not engaged in either flipping or appraisal fraud. Key provisions in a typical certification include the following: 3

4 a. Licensee representing Seller acknowledges and agrees that, in his or her professional opinion, Property has been listed on the appropriate local Multiple Listing Service at a listing price intended to generate open market competitive offers to purchase Property and not at an artificially low or high listing price. Licensee representing Seller further acknowledges and agrees that his or her marketing efforts were in fact and in spirit aimed toward maximizing the selling price of Property from a ready, willing and able buyer. Licensee has not engaged in any conduct that restricts or limits offers from buyers, including but not limited to requiring cash offers, using disparaging language regarding the property or tenants, or unreasonably restricting access. b. Licensee representing Seller acknowledges that he or she has made Seller aware of all offers to purchase Property that Licensee received during the listing period and that he or she has not coerced, harassed or improperly influenced Seller in selecting a buyer for Property or in agreeing to the terms and conditions of the purchase contract. c. Licensee acknowledges and agrees that Licensee is not engaging in appraisal fraud, flipping (a predatory lending practice whereby a recently acquired property is resold for a considerable profit with an artificially inflated value within a short period of time), as defined by the Federal bureau of Investigation, identity theft and / or straw buying. Licensee has disclosed all agreements or understandings relating to the current sale or subsequent sale of Property of which Licensee is aware or should be aware. Licensee is not aware of any other agreements or understandings that call for the subsequent sale of the Property within 30 days of the current sale, the assignment of the property to the Seller or the option for the Seller to purchase the property. d. Licensee acknowledges and agrees that he or she is not receiving any compensation, remuneration or benefit from the completion of this Residential Purchase Agreement other than what has been disclosed in the preliminary and certified HUD-1 closing settlement statements. Licensee is not aware of any arrangement for compensation or other remuneration to Seller, Buyer, Licensees or other lien holders, either directly or indirectly related to the purchase agreement, that has been or will be paid outside the official terms of closing as presented in the purchase contract and the preliminary and certified HUD-1 closing settlement statements. e. Licensee acknowledges and agrees that he or she has disclosed to Lender any known relationship to Buyer or ownership interest in Buyer s company, and Licensee representing Seller further acknowledges that he or she has no existing business relationship with Buyer and / or Seller other than the purchase of Property according to the terms and conditions of the purchase contract. Licensees should carefully review these certifications before signing them to ensure that they are not creating potential liability for themselves if their 4

5 III. certifications are inaccurate. Most of these certifications highlight the importance of an accurate certification by reminding licensees that any misrepresentation or omission of a material fact may subject the responsible party to civil and / or criminal liability. In other cases, the lender may also require the listing and selling agent to sign an indemnity agreement in which the licensees involved in the transaction indemnify the lender (including the repayment of the amount written down on the loan) resulting from any negligent or intentional misrepresentations in the short sale transaction. To limit the liability of real estate licensees in these indemnity agreements, it is important to confirm that the indemnity obligation is limited only to intentional misrepresentations either made by the licensee or of which the licensee has actual knowledge. A sample of such a stipulation is set forth below. Notwithstanding any provision to the contrary contained herein, the indemnity obligation of the undersigned real estate licensee in this short sale transaction shall apply only to intentional misrepresentations made by the licensee or intentional misrepresentations made by others which the undersigned licensee had actual knowledge. 12. Have realistic expectations. The short sale approval process is significantly more organized and rational than it was even a year ago. However, properties still get foreclosed upon while the seller is trying to get short sale approval. Information sent to the lender still occasionally gets lost causing much duplication of effort. Lenders do not always appear to be acting rationally when it comes to deciding which offers to accept and which offers to reject. Real estate licensees do not do their seller clients any great favors in creating unrealistic expectations that all short sales will be approved. The truth is that some short sales are approved and others are not. Most importantly, if the seller can afford the mortgage payment, but does not want to continue to make payments because he or she is underwater on the loan, do not expect much sympathy from mortgage lenders. This is usually not the type of short sale that will be approved by most lenders. TAX CONSEQUENCES OF A SHORT SALE In considering whether to seek a short sale, many sellers want to better understand the tax consequences of a short sale. Based on the example below, here are basic rules applicable to short sales. Let s say that an owner paid $250,000 for his or her principal residence 5 years ago and obtained a mortgage for $225,000. The property today is worth $150,000. If the lender agrees to write down the mortgage, what are the federal tax consequences of the short sale? The general rule is that any forgiveness of mortgage debt on a person s residence is taxable income to the borrower unless the borrower qualifies for an exception. The most common exceptions are set forth in the Mortgage Forgiveness Debt Relief Act of Under this federal law, up to $2 million in forgiven debt does not have to be counted as income on the seller s federal tax return. However, this only applies to a person s primary residence. Forgiveness of debt on investment property and second homes does not qualify for the exemption. Home equity loans used to pay off credit card debt or make other purchases also does not qualify for this exemption. 5

6 The debt cancelled by the lender must have been used to buy, build or substantially improve your principal residence. Therefore, if the seller s need for a short sale is the result of the seller having obtained a home equity loan that was used for things other than the above, the seller will not be entitled to the relief the seller was thinking he or she would obtain. The federal law also contains a sunset provision where the tax benefits to owners selling in a short sale expires at the end of It is unclear whether the law will be extended. Short sales are a product of difficult economic times. There is solid evidence that the housing market may have finally turned the corner. Let s hope that as this long hot summer fades from memory, so will the many short sales that have dominated the market. Seth Weissman is general counsel to the Georgia Association of REALTORS. He is the senior partner in the law firm of Weissman, Nowack, Curry & Wilco, P.C. He is also a Professor of the Practice of City Planning in the College of Architecture at Georgia Tech. 6