In California, it's against the law for a short sale seller to make a seller contribution to a short sale, but not so in other states. Before this law passed, Shari found out the hard way just how low her bank would stoop. Both she and her husband had lost their jobs. They were forced to move 100 miles away so her husband could take a new job at reduced pay while residing in a cramped, one-bedroom apartment. Cradling a newborn in her arms, Shari was in tears when she heard her bank's initial demand prior to issuing short sale approval.
The bank said Shari enjoyed an excellent credit rating, with FICOs in the high 800s, and saw that Shari had an untouched cash credit line. Her VISA had an available cash advance limit of $10,000. The bank asked Shari to tap her credit card and give that $10,000 to the bank. If Shari could not afford to repay the VISA, the bank did not care. It didn't issue her the VISA.
In other words, the bank's message was two-fold: Shari should trash her credit rating and deceive a lending institution. True story. I represented that seller.
Why Banks Demand a Seller Contribution
Banks are already eating it in the shorts on a short sale. A bank may have made a loan for, say, $500,000. In some parts of Sacramento in 2008, for example, values fell by more than 50%. If the bank took that home through foreclosure, it would lose at a minimum $250,000 of its initial investment. Ditto on a short sale.
The seller has an incentive to do a short sale because there are benefits to doing a short sale vs. a foreclosure. Therefore, the seller is the entity the bank may try to squeeze. Because it can.
Here are other reasons banks might ask for a seller contribution:
- The seller has disposable income. Most banks examine the seller's financial statement to determine how much money is coming into the household and how much money is going out. Banks allow certain allocations for expenses. If the seller has money left over at the end of the month, the bank might ask for it.
- The seller refinanced and pulled cash out of the home. It's one thing if the seller refinanced to pay off a high-interest rate or completed a home improvement project. It's entirely another thing if the seller bought a big-honkin' boat. If the seller's setback is temporary, the bank might ask the seller to contribute. The bank will order a Broker Price Opinion or BPO. They won't steeply discount the property. They want to minimize loss as much as possible. If the sales price is not high enough to give the bank its required net, the bank may ask the seller to foot the difference.
- The Pooling and Servicing Agreement (PSA) guidelines require a seller contribution. Investors want a return on their investment, and PSA guidelines are generally set to provide a profit. Those guidelines may state that all mortgagors in that pool must make a seller contribution to facilitate the short sale.
- The seller has no financial hardship. Many banks will agree to do a short sale if the seller suffers from various types of hardship that are not necessarily of a financial nature. However, if the seller enjoys a strong cash flow, the bank might want part of it.
- State laws may allow a deficiency judgment. When a bank has the right to personally pursue the seller for the difference between the amount of the mortgage and the short-fall payoff, a bank may prefer to negotiate with the seller prior to short sale approval. That negotiation may involve a seller's contribution.
The Type of Seller Contribution a Short Sale Bank Might Accept
In the best of all worlds, the bank would like the seller to repay the entire debt, but banks know that most reasonable sellers will not agree to do a short sale under those circumstances. Because a seller may have other options such as a loan modification, foreclosure, or bankruptcy. So, banks typically ask for one of two things or both:
- Cash. Although the bank has the right to ask for the entire difference, most banks realize that sellers don't have that kind of money or they would not be doing a short sale. It is not uncommon to see requests that vary from 2 to 10 percent of the shortfall.
- Unsecured Promissory Note. Cash talks but promissory notes are also a solution. Generally, prom note requests are higher than cash requests. But banks will often agree to non-interest-bearing terms and a three- to 15-year payback of principal.
At the time of writing, Elizabeth Weintraub, CalBRE #00697006, is a Broker-Associate at Lyon Real Estate in Sacramento, California.