What Happens to the 2nd Trust Deed in a Short Sale?
Westcoe Realtors, Riverside California…Since the current “hubbub” in the media these days is the whether the big banks have handled their foreclosures properly (and will they need to take another “time-out” from foreclosures while they check their procedures…again), short sales have once again taken center stage. Everyone knows by now that when a lender agrees to accept a short sale, they are accepting a payment less than what is owed on the property in order to get it sold and off their books…but one of our regular readers (thank you, by the way) wants to know what happens to the 2nd trust deed (if there is one) in a short sale ?
Good question…and here’s your answer.
In a nutshell, they are generally going to get some money, but not very much.
Understand that if there is a 2nd lender on your home, you will need their permission to sell for less than owed just like you do on the 1st loan. However, there is a catch, and here it is…The amount of money the 2nd lender will receive is up to the 1st lender too, not just the 2nd lender. In other words, the 1st lender must approve the amount of money they will allow the 2nd lender to receive…and if both lenders cannot get on the same page, then the transaction will never close, and all bets are off.
Here’s and example of what we mean.
Let us assume that there is a 1st loan on a home of $300,000, and a 2nd loan of $75,000, and that the home is now actually worth $250,000.
OK…if the home went to foreclosure, the 1st would lose $50,000 (plus sales costs, fix-up costs to sell, vandalism repair, utility costs, etc.), and the 2nd lender would be wiped out completely, losing all $75,000. The 2nd lender may have legal recourse against the seller (see an attorney), but the simple reality is that they would lose their entire loan amount of $75,000 at the foreclosure sale.
In a short sale. since the seller must have the approval of both lenders to sell for less than what is owed, the 1st lender would still probably agree to accept the $250,000 sales price (still losing $50,000 on the sale, but avoiding many of the other costs that can come with a vacant home), and the 1st lender will stipulate that in agreeing to accept the $50,000 loss, they will only allow the 2nd lender to get very little, since the 2nd would get wiped out completely if the home went to foreclosure. Usually the 1st lender will limit the 2nd lender to around $5,000…sometimes more, but mostly less.
Now…understand that the 2nd lender knows all this…and also knows that no matter what they want for their $75,000 loan, they will only get what the 1st lender allows them to get paid…but that does not stop the 2nd lender from playing hardball and insisting on more money, threatening to stop the entire sale if they don’t get what they want.
The 2nd lender understands that the only leverage they will ever have in this transaction is
right now…when a buyer, both agents, the seller, and the seller’s lender want to close the sale…and they generally play their cards to the hilt. At this point in the transaction, it becomes a giant game of “chicken”, with the player who blinks first losing. So what happens?
Sometimes, the 1st lender gives in and allows more money to go to the 2nd lender…sometimes the 2nd lender “caves” and agrees to accept what the 1st lender is offering…sometimes the buyer agrees to pay the 2nd lender more money if they really want the home (but the 1st lender must agree to this because they may want the additional money the buyer is now agreeing to pay), sometimes the seller “finds” some more cash to get to the 2nd lender (again, this needs the 1st lenders approval as well), and sometimes, after months and months of everybody working to make this happen, both lenders dig in their heels and the entire transaction falls through…in which case the 1st lender will simply foreclose on the house and sell it later…without any hassles from the 2nd lender, who got wiped out in the foreclosure.
Sound complicated? It is. No wonder buyers and real estate agents are not exactly thrilled to get involved with a short sale.
As a note, if the 1st lender and the 2nd lender are the same bank, then this process can go a little smoother since it is all in the same family…but not always. Just like in your family, certain members don’t get along too well, the same can be said for different departments in the same bank. Usually, someone can cut through the bickering in this situation, but not always…but generally it can be done.
However, if the 2nd lender is different from the 1st, don’t expect them to play “nice” just because it makes sense for them to do so…which means that your short sale ordeal may be lengthy and frustrating.
In the end, just remember that there is a pecking order to what short sale has the best chance of closing without you wanting to kill someone. In order, a single 1st bank is best, then comes a 1st and 2nd loan with the same bank, and the rear is brought up by a different 1st and 2nd lender…and God help you all if there is a 3rd lender. In that case, just turn and walk away with your sanity!
Hope this helps answer our readers question, and remember….If you are a seller and are involved with a short sale, your really, really need to consult with both an accountant and a lawyer whether you short sale your home, or lose it in foreclosure. Depending on what type of loans you have on your property, there could be lingering issues with your bank losses well after the sale…so be sure to check.
Take care, and let us know if there is any real estate issue you would like to see addressed in the future. Thanks for reading.
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