Short Sale Bill Has Unintended Consequences: Part II

This is a second post about Senate Bill 458, which 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.
SB 458 Loophole
But SB 458 has a huge loophole. Since the senior lien holder has first call on the sale proceeds, why would a junior lien holder want to give up its rights to pursue or sell the remaining debt?

Although 2nd lien holders may agree to the short sale, many don’t want to release the debt obligation of the remaining loan balance — or accept the small amounts offered by 1st lien investors. When loans are recourse, the 2nd lien holder knows it can pursue the  collection of the debt itself, or it can sell the debt — at a steep discount —  to a debt collection agency often getting more than the amounts allocated or even force the borrower into bankruptcy.

When loans are non-recourse it appears lenders want justification for their loss and punishing the borrower appears to be a delight, Dufresne said.

Moreover, the law needs to address the common practice of 2nd lien holders seeking additional funds to approve a short sale. It should be made clear that if borrowers, agents or buyers wish to voluntary agree to contribute cash to a short sale, it should be allowed. If not, we will see an increase in these cash  contributions by buyers and agents to allow junior lien holders to approve  short sales.

Banks like Wells Fargo, Bank of America and Chase have worked well with SB 458, according to Dufresne. But he said the smaller banks and servicers have made the closing of short sales nearly impossible, using SB 458 as the culprit and sending more borrowers into foreclosure. Click here to read the full text of SB 458.

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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