Recent estimates are that 25 percent of Americans live in houses where the balance on the mortgage exceeds the value of the home. These houses are frequently referred to as being “underwater,” “upside down,” or having “negative equity.” For homeowners who are employed and are current with their mortgage payments (and who want to continue living in their homes), being upside down is certainly disconcerting but has no immediate adverse effect on their lives. However, consider the upside-down homeowner who also is being presented with a job change that requires him or her to relocate.
Whether the employer offers a direct reimbursement program or engages a third-party company to administer an appraised value or an amended value buyout program, the homeowner’s situation is the same: he must relocate, and he must address the fact that his house sale will not yield enough proceeds to pay off the mortgage(s).
Clearly, a homeowner can elect to become a landlord and rent the house to tenants. The hope is that the rental stream will cover the mortgage payments and property taxes, and over time, the value will return to a level at which the sale proceeds will be sufficient to pay off the mortgage(s). This overlooks the months when the house will be vacant, as well as the stress and economic loss caused by any damage done by the tenants. Either a local rental management agent is needed, or the homeowner must have the strong skills necessary to personally manage this arrangement from afar.
As another option, using the figures from the example in the sidebar on page 32, the employee may have the personal resources to fund the $100,000 shortfall out of his own funds. Depending on the value of the home and the homeowner’s personal assets, this may or may not be an option.
Increasingly, an option of choice is a short sale—a transaction in which the homeowner convinces the lender(s) to accept the proceeds of the sale as full payment on the mortgage. The homeowner in the sidebar example would have to convince the two lenders to agree to accept a division of the $340,000 sales proceeds between them. Banks are inundated with such requests and frequently take months to approve them, only to ultimately issue approval letters that contain very harsh provisions or provisions that will not work in a relocation context.
First Versus Second Lenders
The sidebar example concerns a borrower with two mortgages. Prior to the recession, such borrowing practices were common, with the homeowner often using the proceeds of the second loan for home improvement or personal use, such as for vacations or car purchases.
When there are two mortgages on the property, both lenders ideally want to be repaid in full. However, failing that, they each want as much of the proceeds as they can get. The law favors the rights of the first mortgage holder. Typically, in a short sale, that first lienholder will agree to allow a modest sum to be paid to the second lienholder in the interest of getting the short sale closed. In the sidebar example, the first lienholder might agree to let the second lienholder receive $10,000 of the sales proceeds, lowering its recovery from $340,000 to $330,000. When this allocation is acceptable to all parties, the escrow officer disburses $330,000 to the first lender; $10,000 to the second lender; and nothing to the homeowner (It is common for the first lender to allow a deduction from their proceeds to pay the real estate brokers, where required. Where the employee is taking a corporate buyout, there are no brokers, and no deduction is made.).
In a January 2010 report, “Big Banks Accused of Short Sale Fraud,” (http://m.cnbc.com/id/34877347/Big) CNBC described lenders (most frequently in the second mortgage position) who were trying to use unscrupulous and sometimes unlawful means to augment their net proceeds. In some cases, they demanded “side payments” from the homeowner that were not to be disclosed to the first lender and were to be made outside the closing (and not reported on the HUD-1 report from the closing). Such demands for side payments continue to be made, creating legal exposure for all involved parties, since the first lender will universally request an assurance from the buyer and the seller that there are no side payments of any kind being made.
An Upside-down Mortgage
Example: The homeowner purchased the home in 2003 for $400,000 and secured a $380,000 mortgage. In 2005, the home’s value was appraised at $490,000, and the homeowner took out a second mortgage for $100,000. In 2011, the house is appraised (and is later under contract for sale) at $340,000, with a first mortgage balance of $350,000 and a second mortgage balance of $90,000.
Loss-On-Sale Benefit Monies
Many relocation policies include a “loss-on-sale” benefit that makes the employee whole if they incur a loss when selling the home (subject to caps or other limits). In our example, such a benefit might pay the homeowner $60,000 ($400,000 sales price less the $340,000 resale price yields a loss of $60,000). Lenders uniformly include provisions in their short-sale approval letters that specify that the borrower is to receive no other funds from the buyer. It is clearly the lender’s intention that the $60,000 must be factored into the pool of money to be paid to the lenders. Yet, many transferring employees want to keep that money for themselves and insist that these funds are somehow uniquely different, are in the nature of “benefits” and absolutely are not proceeds of the homesale.
This position creates risk for the employee, for the buyer, and for the relocation provider. The buyer (or third-party relocation provider) is expected to sign not only the short sale letter, but also, frequently, other documents and affidavits. These documents (frequently signed under oath) state that there are (i) no other monies being paid; or (ii) no agreements in place between the buyer and seller beyond the stated purchase price (i.e., the $340,000). So agreeing with a homeowner to conceal the $60,000 from one or both lenders is an extremely risky step that creates legal exposures for all parties.
Employers formulating relocation policies should seriously consider eliminating this benefit for any employee in a short sale situation. In a short sale, the employer’s money is going straight to the lender. It is not making the employer whole on its lost investment in the home. Essentially, the employer is getting no “bang for the buck.”
No-Flips and Clawbacks
These are not gymnastics maneuvers; they describe provisions frequently found in short sale letters.
Clearly, any lender that agreed to a “haircut” and permitted a sale of the property at $340,000 would be outraged to see the house re-sold weeks later for $450,000. Consequently, many short sale approvals require the buyer to represent that they will continue to own the house for a specified period (e.g., six months to a year). A relocation company, which is the interim owner for a short period, will not be able to sign such representation.
Some lenders will accommodate a request for a modification to this provision; others are so inundated with short sales in process that they refuse to make any changes to their stock letter. Such intransigence makes it impossible to conclude a short sale in a relocation context with this “no-flip” provision in the letter. An employer is best advised to provide direct reimbursement to such an employee so that the “no-flip” provision can be truthfully signed by the outside buyer. It also will be an employer decision on whether such a reimbursement is, or is not, grossed-up for taxes.
Similarly, a lender that agreed to a “haircut” and a distressed sale price would be upset to learn that its borrower had untapped wealth, and that the bank had mistakenly failed to inquire about this prior to the closing. For that reason, short sale letters often contain provisions that allow the lender to “clawback” the release of lien on discovery of new facts. However, a relocation company (as well as all buyers and new mortgage lenders) always insists on clear title and cannot agree to a short sale where the bank retains these rights. Further, when an outside buyer is secured, the new title company will not insure title where this risk is lurking in the background. Consequently, such verbiage in the letter will render the property virtually unsaleable and therefore, not one that can be handled in a relocation program. As mentioned, some lenders will make the requested change, and others will not. While direct reimbursement is an option when the “no flip” language is encountered, it is not a viable solution when the claw-back language is encountered.
Short Sales: What Does The Future Hold?
As scam artists find ways to unlawfully exploit short sales, lenders will undoubtedly respond with countermeasures that will have an impact on those who are trying to put together legitimate short sale transactions. These countermeasures will have an unintended impact on legitimate transactions that are perceived to be a little out of the norm—such as relocation transactions.
Even for borrowers who already have short sales in progress, or who successfully completed a short sale during the past few years, oddly, the future remains unpredictable—even though the house was sold and closed.
A mortgage consists of two separate documents: (i) a promissory note, in which the borrower agrees to pay the bank a set amount of money; and (ii) a mortgage instrument (called a “deed of trust” or “trust indenture” in some states), recorded on the land records, granting the bank a security interest in the home, to secure the promissory note obligation. Most short sale approvals release the lien (item [ii] above), freeing up the property to be sold. However, not all short sale approvals contain language releasing the borrower from their promissory note obligations (item [i] above). In some states, the law protects the borrower from this continuing exposure; however, in most states, this remains a valid debt of the borrower that survives the release of the lien and the sale of the house. The original lender can pursue collection on this note or sell it to another investor, who can elect to pursue collection. There will undoubtedly be those lenders who just let it drop entirely. However, a borrower really doesn’t know where his lender stands unless the home was in a protected state, or unless the short sale letter clearly released the borrower from all remaining debt.
A borrower trying to get a short sale approval right now may or may not be successful at getting the lender to release the remaining debt, and probably has little leverage to insist on a full release. He or she may have to make do with a release of the lien and then hope for the best. For this reason, employees should be encouraged to engage with their own counsel to negotiate with the lender, so they understand their risks. Oddly, in some situations, a borrower will gain more certainty by letting the home go into foreclosure.
Based on the continuing foreclosure statistics, short sales will remain a fact of life for the foreseeable future. With that reality, it makes sense for employers to re-examine their relocation policies to see whether revisions are appropriate to deal with the unique challenges that are presented by short sales.
Bruce Perlman, Sr., SCRP, is senior vice president and general counsel of Cartus Corporation, Danbury, CT. He can be reached at e-mail bruce.perlman@cartus.com.