Despite New Consumer Protection Law, Home Sellers May Still Owe the Difference in Short Sale

When you are facing foreclosure and your bank steps in offering you a short sale, it sounds like a deal. Who doesn’t want to get rid of a debt they can no longer afford. But what many don’t realize is that banks will often only agree to a short sale if they can reserve their right to obtain the difference for the loss at a later date.  In other words, just because you short sell your home, you are not entirely off the hook.

The California legislature recently beefed up a law around short sales in an attempt to give consumers protection, with SB 931, which went into effect January 1st. But the reality is that borrowers still may not have the protection they are intended to.    

Under the law, if you now short sell your home, the lender holding your first mortgage cannot come after you for a deficiency judgment, (i.e. the difference between the amount of the loan on the home and the price the home was sold for through a short-sale). 

This includes all first deeds of trust/first mortgages.  It doesn’t matter if you have the original loan used to purchase the property or you refinanced later on.  However, if you refinanced and you borrowed more money than your original loan amount, this new law most likely won’t cover you.  Second mortgages are also not covered.

Still sound like a good deal for distressed homeowners?  Unfortunately, lenders have already found a work-around. In recent years, it has been common practice for a lender to ask a home owner to sign a promissory note in order for the lender to agree to participate in the short sale. 

This promissory note, in so many words, says that a borrower agrees to pay the bank’s loss from a short sale, at a later date.  Banks are continuing this practice, albeit with complex legal language they feel addresses the new law.  

The concern is that homeowners may sign the promissory notes, thinking that they are not enforceable due to the new law.  But banks believe that their promissory notes supersede the new law, allowing them to enforce the note. 

The California Association of Realtors and others looking to improve borrower protection in short sales, feel that the promissory notes hold little weight because the intent of S.B. 931 is being circumvented.  I am not an attorney, but after hearing both sides, the bank can certainly make a strong argument in their favor. 

So who’s right?  No one knows yet.  Because this law is so new, there isn’t any case-law to support either side.

The bottom-line is despite a law meant to protect sellers, nothing has really changed. Until we have the needed case-law in place, it is now not clear whether a homeowner has any additional protection when short-selling their home. Regardless of the outcome, if you are considering a short sale or foreclosure, it is imperative you consult an attorney and CPA and not just a real estate agent or broker.

Sean Payne is a realtor with CPS Realty in Petaluma. Contact him at Sean@707realty.com