Short Pay-Offs and Redemptions
by Jonathan A. Goodman, Esq.
Short pay-offs and redemptions are alternative techniques to allow an owner to close on
the sale of property worth less than the debts secured by it. Depending on the
circumstances surrounding a particular property and seller, either alternative may be
possible with each option having its own pros and cons.
A "short pay-off" or "short sale" is a transaction in which a lender agrees to accept less
than it is owed to permit a sale of the property which secures its note. (Throughout these
materials, the term "lender" or "lenders" refers to the collection of institutions aligned on
the "lender's" side, which might include the holder of the note, a loan servicer, and a
private mortgage insurance company.) HUD seems to call these sales "Pre-Foreclosure
Sales."
In a typical short pay-off, the lender agrees to accept the net proceeds from the closing
(the sales price, minus the cost of closing the transaction, including your commission),
perhaps with some additional consideration from the seller (such as a promissory note) in
exchange for releasing its lien. Lenders do not agree to short pay-offs to be generous. In
negotiating the short pay-off, the lender needs to be convinced that it will come out better
than it would by foreclosing on the property and pursuing the seller/borrower for its losses.
Though short pay-off procedures vary somewhat from lender to lender, most lenders need
to be convinced of the following:
The sales price under the proposed contract is equal to or higher than the amount for
which the lender would be able to sell the property after a foreclosure. The lender will
require a market analysis from the REALTOR®; listing the property. The lender will also
confirm the market analysis by contacting its own sources, such as an appraiser or the
real estate agents which handle its REO sales.
The lender will want to know as precisely as possible the amount of proceeds it can expect
to receive from the sale. The more precise the estimate, the better.
The lender will want an explanation of the circumstances which created the need for the
short pay-off transaction. Common explanations include divorce, medical problems, death,
birth of a child taking one wage earner out of the work force, birth of children making the
existing home too small, loss of a job, or a job transfer creating the need for a move.
That the seller doesn't have the money to make up the shortfall on their own. To verify the
financial condition of the seller/borrower, the lender will require: financial statements
showing the seller's assets, liabilities, income, and expenses; the seller's tax returns for
the previous two years; and the seller's paycheck stubs for the most recent pay periods.
The most common disputes which arise in short payoff sales concern the seller's financial
condition. On the one hand, the lender will be reluctant to approve a compromise without
having the ability to analyze the financial strength of your seller. On the other hand, if this
information is provided, there are potentially grave consequences for your seller if a short
pay-off is not approved. The lender will have a significantly easier time pursuing your
seller for a post-foreclosure deficiency.
A borrower with minimal assets, little income, and a willingness to file bankruptcy has little
to lose by providing financial information. However, most candidates for short pay-offs
have some assets, a good job with garnishable wages, or a desire to avoid bankruptcy.
Candidates for short pay-offs need legal advice regarding the advisability of
submitting financial information to the lender. Though a refusal to submit financial
information to a lender greatly decreases the chances of closing, a refusal to submit
financial information does not necessarily preclude closing on a compromise sale.
Short Pay-Off Traps
When working on short pay-offs, certain issues and problems frequently arise. It is
important to keep them in mind as you proceed.
Your seller is already facing a potential deficiency lawsuit from its lender; he does not want
to be sued by a buyer also. A seller's ability to close on a compromise sale is not
within his control. It is important that in any contract which your seller accepts,
his obligation to close is contingent upon successful negotiations with the
lender.
Most sellers would like to protect their credit rating as much as possible. A substantial
motivation for a short pay-off as an alternative to simply allowing the property to go into
foreclosure is avoiding the detrimental credit consequences of a foreclosure. The seller
should be advised to seek legal counsel regarding steps which can be taken to
ameliorate the credit consequences of the work-out.
It is unlikely that your seller will receive any proceeds from the closing on a compromise
sale. (Note, however, that in the HUD short pay-off program, borrowers may receive
money out of the sale as an incentive to close.) Yet the closing is likely to force the seller
to move. If the seller hasn't already moved, or doesn't have some other reason to
move, closing on a short-pay might actually hurt the seller. The dawning
realization of being homeless might make a short pay seller back out of a closing.
Because the foreclosure process generally takes five or so months to run, it
might be in the best interest for some owners to live in their home until the end
of their redemption period in the foreclosure. Don't embark on a short-pay
transaction unless the seller has already moved out of the property or unless
the seller has made an informed decision to move out earlier than he would
otherwise need to do so.
These transactions often require a patient buyer. Working through the
bureaucracy of the loan servicer, the investor, and the private or public
mortgage insurance company takes time. Closing dates may need to be
extended. It is important to work with buyers who have flexible closing needs
and flexible dispositions.
As many as three entities may be involved on the lender's side of a short pay-off
transaction. It is not unusual for the mortgage insurance company, the investor, and the
loan servicer to have several different departments working on the transaction. Errors may
arise simply due to bureaucratic miscommunication. It is important to get the terms of the
short pay-off transaction (release of liability, no adverse credit consequences ... etc.) in
writing.
You may occasionally run into a seller who initially does not care about the financial or the
credit consequences of a short pay-off transaction because he has filed, or is about to file,
bankruptcy. While this may seem to be a blessing, it should raise concern. Bankruptcy
affects the seller's ability to convey title and may disrupt a transaction which you
have worked long and hard to put together. A seller filing bankruptcy will usually already
have legal counsel. In these circumstances, the REALTOR®; needs legal advice.
A seller who has little concern for the financial and credit consequences of a short pay-off
has little incentive to avoid these consequences. Often these sellers seem to be very
agreeable until they realize that they will need to move out of the property
sooner than if the property went into foreclosure These sellers may decide to let the
foreclosure run its course, rather than close on a compromise sale.
While residential short pays rarely create capital gains problems for their sellers, a
commercial short-pay is likely to cause a recapture problem for a seller. Sellers should
consult their tax advisors.
Keeping the above factors in mind should increase your chances of successfully closing
on short pay sale.
Redemption Background
In Colorado, a lender can sue the borrower for the difference between the pay-off on the
note and the highest bid at the foreclosure sale. This difference is called a "deficiency." In
the vast majority of foreclosure sales, the lender is the successful bidder at its own sale.
As a consequence, a lender has much control over a borrower's post-foreclosure liability.
The foreclosure statutes are written to encourage lenders to bid a property's fair market
value at a foreclosure sale. One of the ways in which the statutes encourage fair bids is by
giving the foreclosed upon owner redemption rights. The successful bidder at a
foreclosure sale does not obtain title to the property. Instead, it obtains a receipt (the
"certificate of purchase") which entitles it to receive a public trustee's deed after the
expiration of all applicable redemption periods.
If the owner, during his redemption period, can tender an amount equal to the
highest bid at the foreclosure sale (plus accrued interest and certain other
allowable costs) to the public trustee, the holder of the certificate of purchase is
divested of its interest in the property, and the borrower acquires the title, free
of the lien being foreclosed upon. (Liens junior to the lien foreclosed upon remain on
the property after an owner's redemption.) The redemption does not eliminate the
deficiency, but allows the owner to keep title to the property.
Though most people who are foreclosed upon have insufficient sums to redeem, they can
sell their rights in the property and use the proceeds from the sale to redeem. There can
be one closing in which the funds from a third party purchaser are transferred to the
seller, and the seller, through its closing agent, uses those funds to redeem. The seller
issues a deed to the purchaser, the public trustee issues a redemption certificate to the
owner, and the third party purchaser acquires title to the property.
If a lender does not bid a deficiency at a foreclosure sale, it is unlikely that there will be an
opportunity for a redemption. If the property was worth more than the loan balance owed
against it, a rational owner would sell the property rather than losing it in a foreclosure.
Redemption Nuts and Bolts
First, obtain a copy of the "bid letter" (the written evidence of the amount bid) from the
foreclosure sale. Do not rely on bid information given to you over the phone by the
Public Trustee. Public Trustees can become quite busy and, like anyone else, give
incorrect information over the phone.
If the successful bid at the foreclosure sale is in an amount which is greater than the
amount for which you can sell the property, then there is no redemption opportunity. If the
successful bid is less than an amount for which you can sell the property, it
creates a redemption opportunity and an opportunity for a seller to realize
proceeds from a sale.
The sale must close during the redemption period which is typically 75 days, or
occasionally six months, depending on the type of the property. Contact the Public
Trustee to find out the exact date of the expiration of the owner's redemption period. In
order to have the right to redeem, the owner must file a written notice of intent to redeem
no later than 15 days prior to the end of the owner's redemption period. Lenders have the
option of accepting a late notice from an owner, but owners should not count on a waive of
the 15 day deadline.
It is important to deal with a closer who is experienced with redemptions. The closer will
get pay-off numbers from the Public Trustee rather than from the lender. The pay-
off on the seller's original loan with the lender is irrelevant for the closing. The amounts
necessary to close are only those sums necessary to redeem. Though the title insurance
commitment will vary somewhat from a "normal" commitment, the closing will feel very much
like an "ordinary" closing.
Comparing Redemptions and Short Pay-Offs
Redemption Advantages:
In many respects, a redemption is a simpler transaction than a compromise sale. There is
no negotiation with a mortgage insurance company, an investor, a loan servicer, or
anyone else on the lender's side. Redemption numbers are simply obtained from a Public
Trustee. If the lender fails to provide redemption figures to the Public Trustee, the Trustee
calculates these figures.
The seller may receive funds (sometimes substantial funds–when the lender has
bid too low) from the sale and there is no disclosure of financial information to a
lender.
A failed attempt at a short pay-off can actually put a seller in a worse position
than he would have been had a short pay-off not been pursued at all. The efforts
to document the property's fair market value (the market analysis and the proposed offer)
help the lender justify bidding its deficiency at the foreclosure sale. In most circumstances,
the seller will have provided financial information to the lender. This financial information
will increase the likelihood of pursuit, and successful pursuit, of the borrower by his lender.
Short Payoff Advantages:
A redemption does not eliminate the Seller's liability on a deficiency. A
redemption does not avoid the detrimental credit consequences of a
foreclosure. Also, seventy-five days may be a relatively short period of time in
which to sell property. A redemption opportunity may fail because of lack of time.
Perhaps most significantly, the seller doesn't know whether a redemption
opportunity exists until the property has gone to foreclosure sale. If the
successful bid at the sale is too high to permit a higher sale to a market buyer,
there won't be redemption. Once the property goes to foreclosure sale, the
opportunity for a short-pay is lost.
Depending on the interplay of a variety of circumstances, it is sometimes best not to
aggressively pursue the short pay-off, and to instead allow the property to go into
foreclosure as quickly as possible. Of course, this strategy has its dangers. Once the
property goes to foreclosure sale, the seller has lost the short pay-off alternative. It has
put all of its "eggs" in the "redemption basket." Decisions regarding how aggressively to
pursue a short pay-off, when to give up pursuing a short pay-off, and the likelihood of a
redemption are decisions which should be made after careful consideration between the
REALTOR®, the seller, and the seller's lawyer.
Jonathan A. Goodman is a shareholder in Frascona, Joiner, Goodman and Greenstein, P.
C., a Colorado law firm. His practice areas include Real Estate, Brokerage Law,
Contracts, Land Use, Leasing, Real Estate Title, Association Law, Business Law, and
Finance. He can be reached at jon@frascona.com.
A version of this article appeared in the Colorado REALTOR® News, the monthly
publication of the Colorado Association of REALTORS®.
Disclaimer -- Content is general information only. Information is not provided as advice
for a specific matter, nor does its publication create an attorney-client relationship. For
legal advice on a specific matter, consult an attorney.