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Pirategirl, Home Seller in Huntington Beach, CA

How are you not liable for the balance of the short-sale? What is the "loophole" to that?

Asked by Pirategirl, Huntington Beach, CA Sun Feb 22, 2009

When you shortsale, I've been told the bank cannot come "after you" for the balance between what you shortsaled your home for and how much you still owed the bank for the loan. How is that? What law states that?

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"The Mortgage Forgiveness Debt Relief Act and Debt Cancellation

If you owe a debt to someone else and they cancel or forgive that debt, the canceled amount may be taxable.

The Mortgage Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for the relief.

This provision applies to debt forgiven in calendar years 2007 through 2012. Up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately). The exclusion does not apply if the discharge is due to services performed for the lender or any other reason not directly related to a decline in the home’s value or the taxpayer’s financial condition."

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1 vote Thank Flag Link Tue Feb 24, 2009
The Mortgage Forgiveness Debt Relief Act and debt Cancellation.

But it must be your primary residence, and this is only guaranteed on the first loan if your loan is secured by other mortgages unless agreed upon in writing a 2nd, or 3rd may still come after what you owe. So it depends on a case by case basis, Whether a Short Sale is truly beneficial, and completely forgiven.
0 votes Thank Flag Link Fri Feb 24, 2012
There is no loop hole for people who are lucky enough to sell a home short. When a home owners performs a short sale transfer of home to a buyer there is a note left on the bowers credit that the lender settled for less than the amount of the loan. This has essentially the same effect on the borrowers credit as a foreclosure.
0 votes Thank Flag Link Thu Feb 16, 2012
We are realtors not attorneys. We have been doing short sales since 2007. Then was very common getting approval letters with deficiency on it. Lately we have been seeing Approval Letters forgiving deficiencies. It all depends on many factors like current income, employment status, other debts etc. That is why the Lien holder"s request Income tax returns, paystubs, bank statments so they can review and their investors will decide if they will request something back like a note or a cash contribution. When the short sale has a mortgage insurance is a problem since that will almost sure request something back. if is a hafa short sale you will probably will have no deficiency.
0 votes Thank Flag Link Wed Feb 15, 2012
If you do HAFA the 1st lien can not. Otherwise it is wise to have it in writing on the short sale approval letter from the lender that they will not pursue.
0 votes Thank Flag Link Wed Feb 15, 2012
First - let's look at when this question was first asked - February 2009 - THREE YEARS AGO !

Second, laws are different in every state and especially in CA since July 2011. Google SB458 and SB931. Since July 2011, if a lender (1st or 2nd) approves a short sale, there is NO deficiency. Now, a lender has two choices; 1) approve it and they cannot collect or 2) deny it and take it in foreclosure.
0 votes Thank Flag Link Wed Feb 15, 2012
NO, everything is negotiable. A good short sale negotiation will end with an approval letter written by the Lien Holder stating "in writting" that after a completition of a short sale and funds received by Lien Holder, they will waive and forgive the deficiency balance from the debtor and report to all credit bureaus that the debt was settled in full. There are some banks that will reserve their rights to pursue a deficiency. Everything is in the approval letter. There is no LAW, is within the agreement between you and your bank.
0 votes Thank Flag Link Wed Feb 15, 2012
The easy answer is that you negotiate with your lender and get them to agree to it. The best way to get it done is to hire a lawyer to do that for you. I only refer my clients who need this to lawyers who specialize in that area though if for no reason the cost is much lower. If I get a lawyer that works that area of law they will do it for between $1500-3000 but other lawyers may start their charges closer to $5000. I used to work at BankofAmerica where part of my job was to deal with people who needed a short sale. So I am aware that some people do not need a lawyer as much as others; but for most people I recomend they get a lawyer. Feel free to contact me if I can be of assistance. 714-421-1037
0 votes Thank Flag Link Tue Jun 23, 2009
Hi there Pirategirl....great name!

It's pretty scary out there right now! You hear different things from different sources. All the answers you got here are good ones. The bottom line is when you get the approval from the bank. We need to find the exact language that releases you from further responsibility. If we don't see that in writing...we go back and keep negotiating. I physically take the approval to my sellers and show them in the agreement where they are being released. If you have a first and a second, then we find this in both approvals.

Every once in a while, the second won't be happy with the payoff and they will want a note from the seller. We work it as long as we can....but worse case, you can walk away from the short sale and let them foreclose. In California, a foreclosure is considered full payment for the liens and there is no recourse at that point.

I know you have lots of questions...and short sales have become a big part of my business in the last couple of shoot me an email if you want to get some more information. I also have a short sale page on my website. Agents are all here to help, just make sure you use one you feel comfortable with and ask them as many questions as you need to!

0 votes Thank Flag Link Tue Feb 24, 2009
As an addendum to my first answer, bear this in mind. Not all states are a recourse/non-recourse loan state. California definitely is. You really should consult an attorney on this issue.

By the way, a couple of answers to your question are answering a slightly different question, as the situation applies with 1099s being filed, by the lenders, and their eventual tax implications. The IRS HAS changed their position on this situation, to your benefit.

Again, consult a competent tax or legal authority for a more specific to your own situation explanation.
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0 votes Thank Flag Link Sun Feb 22, 2009
There are two parts to answer this question:
1. It is not by law but by lender and certain lenders will require that you sign an agreement that you may still be liable for the difference between the outstanding loan amount due (Total Debt and the net proceeds after all cost). The question will be if these funds are collectable and that is a question for an attorney , but if signed it will create a issue or problem that will have to be litigated or paid to the bank or investor. The other issue is if this transaction was being foreclosed with the right to difficentcy or not. In california they typically do not reserve the right for a deficency in the past. Again a attorney is the best one to discuss this with.

2. PRior to 2007 the IRS had the right taxes for the portion of debt that was forgiven. So if the loan balance was 100,000 and the value at sale received was $80,000 the tax liability would be the tax rate times $20,000. It is best to talk to a tax accountant to better explain the implications and what is needed now and what will be done when the the IRS policy goes back into effect.
0 votes Thank Flag Link Sun Feb 22, 2009
I have had a client who attorney worked with bank on their behalf placed in contract signed by bank and former owner PRIOR to short sale closing they COULD NOT BE SUED for any balance owed.


Dallas Real Estate Agent, Mortgage Loan Officer, Credit repair consultant
– Lynn A. Crosby
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0 votes Thank Flag Link Sun Feb 22, 2009

That's not exactly correct. The Unpaid Principal Balance (UPB) is the amount you owe to the lender(s) plus any legal fees, taxes, insurance, etc. they have paid on your behalf, if you have not been paying these items. In a short sale, the lender(s) agree to accept less than the full UPB (including the fees mentioned above) as payment of "less than the full amount". If your property has a loan the is the original loan used to purchase the property (NOT A REFINANCE) then there is legislation that allows for the forgiveness of the Income Tax liability that would be due the IRS on the amount of debt forgiven - there are some parameters about this having to do with when the loan was first made (year 2003 - 2007 etc.).

Having said that, there are some lenders that are requiring borrowers to sign promissory notes for the amount of debt being forgiven or something less, and there are some lenders that don't look back and just write it off. Sometimes it has to do with the amount of the loan and sometimes it has to do with the type of loan and who actually owns it. For example you might be paying your payments to XYZ Bank - but the loan is actually owned by an investment firm in Singapore...

99.9% of my business over the past 20+ months has been short sales and thus far no one has received a 1099 for the forgiven debt - nor have they had to sign a promissory note !

Consult a Tax Advisor and an Attorney.

Best of luck,

Thom Colby
Broker & Realtor
Orange County, CA
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0 votes Thank Flag Link Sun Feb 22, 2009
There ARE circumstances wherein the lender CAN come after you later, for a deficiency. Not on purchase mortgages ( The loan or loans you used in order to buy your residence.) BUT, they may be able to come after you for deficiencies in loans you obtained later, like HELOCS, ( Home equity, lines of credit.) or quite possibly, a later refinance for a higher amount. Those are usually or frequently written differently, giving the lender "recourse" - the ability to pursue you later, in court.

The bottom line might be, if someone has talked you into - or IS trying to talk you into - a short sale, you'd best be careful that you don't have a recourse loan. Bear in mind also, that I am not an attorney and I am not trying to give legal advice - just sharing some things I have heard.
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0 votes Thank Flag Link Sun Feb 22, 2009
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