What Happens in a Short Sale When You Have Two Loans?
A short sale happens when you sell your home for less than the amount of the debt that is left on your mortgage. You might not have any problems finding someone to buy your home at a cheaper price, but you may encounter problems with lenders—especially if you have more than one loan on your home.
Short-selling is generally a technique used to avoid foreclosure, which is what happens when you can't afford to pay your mortgage, and you can't seem to sell your house. Knowing the difference between short-selling and foreclosing, and how the battle for money will be carried out, can help you determine your negotiating strategy with lenders if you're faced with this choice.
Positions Between Multiple Lienholders
It doesn't matter if you take out a second mortgage to help buy the home or if you have secured a home equity loan after the fact. Each lender takes a position in a priority of payment queue. The second lender will always be second in priority unless the first is willing to subordinate (relinquish its position as the first collector).
The lender in the first position has the first right to collect from foreclosure proceedings. This means when a Notice of Default is filed, if the second lender wants to be first in line to receive proceeds from the auction or sale or to take the property, the second lender must initiate its own foreclosure proceedings.
In most parts of the country, this means the second lender must:
- Make up the back payments to the first lender.
- Pay the first lender's cost to file the Notice of Default and associated expenses.
- File its own Notice of Default.
If the second lender does not complete these steps, they will not succeed in collecting any money in the foreclosure.
Second lien holders in this situation will generally negotiate for as much as they can get because it will generally be more than they would have received otherwise.
When the second lender receives a notice that states the first has foreclosed, after checking the value of the home, many do not initiate their own foreclosure proceedings. Much of the time, the cost of foreclosure is higher than the equity (value) the second lender has in the home.
Negotiating With the Second Lender
After you've determined that your situation fits short sale qualifications, found a buyer, and complied with all lender requests, you'll have to work with each of the lenders to determine the amounts they are going to receive.
Assume a home with two mortgages was worth $100,000, with the two loans being split 80/20, or $80,000 to the first lender and $20,000 to the second. There is still $90,000 left on the mortgage. Due to a market downturn, the sale price is short of the amount owed and is thus a short-sale, at $85,000.
Closing costs are 5%, or $4,250. After deducting the closing costs from the sales price of $85,000, you will have $80,750 of value left. This is the value the two lenders will fight for as they both work to get the highest amount they can.
Generally, the first step in negotiation is to offer the second lender a small amount to release the lien, such as $1,000. This may not seem like much compared to the second loan balance of $20,000 because you're asking the lender to lose $19,000; however, if the second lender refuses, they might receive nothing.
There are times, it seems, that junior lenders appear to cut off their noses to spite their faces. But this is where the first lender can give up a little more to make the deal work. Most lenders in the first position are thrilled to receive 90% of the value of a home. On an $85,000 loan, the primary lender might agree to take $72,675 (90% of $80,750).
The second lender is generally referred to as the junior lender.
This would leave $8,075 that the first lender could offer to the second lender. The second lender must then agree to release the loan. If they do not, the short sale will likely be denied, with the first lender seizing the property in foreclosure, which eliminates the second loan.
Try to keep negotiating until a resolution is reached. Remember, both the first and second lenders have a stake in making the short sale work.
One reason a junior lienholder in some states may refuse to cooperate is if the loan was a hard-money loan (using a property as collateral), secured to a residence of 1 to 4 units. In that instance, if the second lender is wiped out during a foreclosure under a trustee's sale, that second lender may have the right to pursue a deficiency judgment (a legal order to pay off the remaining balance).
Multiple Lien Closing Costs
Even though the seller may have signed a listing agreement with a real estate agent, it is very likely that the lender will renegotiate the commission. Lenders pay less than traditional fees and try to minimize all costs of the transaction.
To further reduce closing costs, there are also fees that lenders commonly will refuse to pay. They are:
- Home Warranty Plans
- Pest Inspections and Pest-Related Work
- Roof Certifications
- Sewer Inspections
- Repairs Requested by Buyers such as a Request for Repair
- Credits for Buyer's Closing Costs
This means that a short seller will typically be stuck with debts relevant to these unpaid fees unless the buyer can be persuaded to pay for them. Taking all of these factors into consideration when developing your short sale strategy can help reduce the stress of short selling your home.