Short Sale Bill Has Unintended Consequences

California homeowners who are considering a short sale on their underwater property thought they could rest easier after Senate Bill 458 became law last summer, but loopholes in the law are creating unintended consequences for some distressed borrowers, according to real estate experts.

According to short sale specialist David Dufresne, junior lien holders like Ally’s GMAC are misinterpreting SB 458 by only allowing the 1st or 2nd lien holder to contribute funds at the time of settlement, scuttling short sale deals and forcing distressed borrowers into foreclosure.

Other lenders — like PNC, E-Trade, National City and Green Tree — are not accepting the maximum contributions allowed by the 1st lien investors or the giant government-sponsored enterprises Fannie Mae or Freddie Mac, writing off the loss of the “non-recourse purchase money” loan to punish the homeowner further. Or if the loans are non-purchase money “recourse” junior liens, the lenders are taking their chances and going after the borrower after the property is foreclosed.

Unintended Consequences
“The problem is general laws like SB 458 are not equipped to help every single distressed borrower,” said Dufresne, a broker at in San Ramon, Calif. “Short sales should be addressed on a case-by-case basis, giving borrowers the ability to make choices on whether they voluntarily wish to work something out with the 2nd lien holders. The law was passed with good intentions. But unfortunately it has had unintended consequences. Many first mortgages agree to a short sale, but the second or third mortgage holders are asking for large considerations that must come from the buyer or the agent. This is making it impossible to complete a short sale transaction.”

New California Anti-Deficiency Law Passed
SB 458 builds and extends on the protections offered by a previous law, SB 931, which required the first lien holder in a short sale to accept an agreed-upon payment as the full payment for the outstanding loan balance. SB 931, however, prohibited a lender from pursing a deficiency judgment against a borrower on a first mortgage or deed of trust; it did not address junior lien holders (2nd and 3rd mortgages). SB 458, which became law in July 2011, now prohibits secondary lien holders from pursuing deficiencies after a short sale closes.

Dufresne added that often bank short sale negotiators are inexperienced and not familiar with California real estate law.

Approximately 26 percent of all residential home sales in California were pre-foreclosure sales — typically short sales — in the first quarter of 2012, according to RealtyTrac’s latest Foreclosure Sales Report. In Q1 2012, there were 34,029 pre-foreclosure sales in California, up 35 percent from last year. Yet, fewer than three of five short sales close, according to the California Association of Realtors (CAR), illustrating the complexity and difficulty of navigating lenders’ and servicers’ short sale procedures.

“Despite assurances by lenders in recent months that they would improve their short-sale processes, clearly, not enough is being done,” said Don Faught, treasurer of the California Association of Realtors in a CAR news release. “Lenders are out of touch with the realities of the market and the consequences to struggling homeowners, and the result is unnecessary foreclosures that only make California’s economic problems worse, hindering a desperately needed recovery.”

What do you think readers? Do we need more nanny state laws like SB 458? Or should we let the free market solve the foreclosure mess?

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You may also be interested in the following articles:
Short Sales Hit Three-Year High in First Quarter
Short Sale Bill Approved in California
Short Sale Tax Tip: Mortgage Forgiveness Taxable in 2013

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