Short sales can seem like salvation for homeowners in financial distress, but it can depend on receiving a release of liability for the mortgage obligation as part of the process. The bank might retain a right to collect the outstanding mortgage balance without such a release—from the homeowner who was desperate enough to ask for short sale approval in the first place.
A lender generally agrees to do a short sale because it's more profitable than it is to foreclose. It might or might not require that the seller have a financial hardship, but the home is most certainly underwater. And this can cause serious problems without a release.
Short Sale Definition
Banks agree to release the loan in exchange for receiving less than the amount owed in a short sale, but this doesn't necessarily release the seller from any obligation to pay it. Releasing the loan from the property and releasing the seller are two quite different things.
The bank might accept $75,000 if your home is worth $75,000 and release the $200,000 loan, allowing the transaction to close. But you could discover later that the bank is coming after you and demanding that you pay the $125,000 difference if you don't get a release of liability.
Release of Liability vs. Release of the Mortgage
The term "release" is tricky here. The lender is releasing the mortgage from the property in question, but it doesn't necessarily or automatically follow that it's also releasing you from any legal obligation to pay the difference.
Both are releases, but they're releases of two different things. A lender can and often will release the mortgage without releasing you from responsibility for the entire debt.
Not every short sale approval letter contains a release of liability, and lawyers have said that the lender might retain whatever rights are available to pursue a deficiency judgment under federal and state law if the matter isn't specifically addressed.
Some states, including California, have passed laws prohibiting deficiency judgments after a short sale. It's important to know what the rules are where you live.
The Short Sale Approval Letter
The short sale approval letter details exactly what the bank expects from the transaction:
- The acceptable sales price
- Maximum allowable commissions
- Maximum closing costs
- Minimum net proceeds
- Closing date
Don't ever sign a short sale approval letter without asking a lawyer to read it first and give you legal advice. Your agent isn't licensed to give you legal advice. It's against the law for a real estate agent to advise you on legal matters.
Types of Verbiage
Some of these statements release the seller, while others don't offer any kind of release of liability at all. But some verbiage is relatively common.
Releases of liability might be worded this way:
- "Upon the bank's receipt of $X, the bank will release the lien and charge off the remaining debt as an uncollectible balance."
- "The bank issues its approval to sell the subject property, which will result in a short payoff of the mortgage and will waive any deficiency rights, if applicable."
- "Upon receipt of the funds, the bank will release the lien, and the deficiency balance will be reported as a charge-off collectible balance."
- "Upon receipt of the agreed amount, the bank will waive the remaining balance due on the above-referenced loan and release the borrower from further obligation therein, and waive all rights to pursue further judgment or deficiency."
A lack of release might appear something like this:
- "The bank has approved a discounted payoff. Nothing in this letter shall be construed to prejudice, waive, modify, or alter any of the bank's rights or remedies in law or in equity in collecting the entire amounts due."
- "The borrower must sign the attached acknowledgment to all terms specified in this approval and must acknowledge that the bank retains all deficiency rights as provided by the note, deed of trust and/or security agreement, and local and federal laws."
- "The bank may pursue a deficiency judgment for the difference in the payment received and the total balance due unless agreed otherwise or prohibited by law if the short sales close on the loan referenced above."
And some statements don't really say anything about a release at all, although it might seem like they do:
- "Upon receipt of this payment, we will report the debt as 'paid in full for less than the full balance' to all credit agencies."
- "The bank agrees to accept in certified funds $X and will report the amount of debt forgiven to the Internal Revenue Service."
You might have to offer a seller contribution to induce the bank to provide a release of liability.
You might be assigned a negotiator who doesn't understand bank policy. You might have to escalate the file to a supervisor to get the release if you feel that the bank has no right to pursue a deficiency judgment against you, but the bank refuses to release you.
Your best bet is to ask a lawyer to get the release of liability for you, or at least to explain your legal rights if a release of liability can't be obtained.
Finally, bankruptcy might be an option if you realize too late that you weren't released from liability, or if you simply can't get a release and the lender does pursue you for the deficiency.
A deficiency is dischargeable in bankruptcy, and this might be the only solution, particularly if the deficiency is significant and if you entered into the short sale due to financial distress.
At the time of writing, Elizabeth Weintraub, CalBRE #00697006, is a Broker-Associate at Lyon Real Estate in Sacramento, California.