Second Mortgage Short Sale - Holding Up the Railroad Loot

The Second Mortgage Dilemma can ruin your short sale -

Like the old West, the stagecoach holding the railroad's payroll was always getting held up by the bad guys - at least in the movies.  Has much changed in the Wild West environment of short sales and the fight between primary and secondary mortgage holders?

Remember the old adage, "the tail that wags the dog"?  Second mortgage lenders are experiencing percentage losses probably beyond the losses of first lenders.  In mortgage foreclosure proceedings the second mortgage typically ends up with little if any dollars from an overbid on the first mortgage judgment, and if there is no bidding because the property is worth less than the foreclosing mortgage, the first lender typically receives the property for a nominal bid and the second mortgagee loses its collateral entirely.

Second mortgages and their short sale resolution have a whole different set of rules vs. short sale with only one mortgage. [SEE UPDATE BELOW]

Issue #1 - the "under the table" payment.

In the short sale transaction where there is a second mortgage encumbrance that must be cleared, we are increasingly seeing the second lenders "hold-up" the transaction in an attempt to flush out more money.  If the seller has no more money to give up and the first lender has no more money to let loose, then sometimes the brokers or the buyer will contribute to pay the second mortgage lender.  The problem is the payments to the second mortgage lender are not authorized by the first lender and thus are literally "under the table".  By this I mean that the payment is outside of the settlement statement.  That being the case the second lender is creating a fraud upon the first lender.  I have not researched whether this practice is a violation of banking or other laws.  As Realtors and attorneys we know that the settlement statement is to properly and accurately reflect the actual residential transaction.  Dual and different settlement statements or non-disclosed transactions part of the closing are prohibited.  Yet, without this practice a significant number of transactions would fail to close.  Although it is not easy to swallow, the best practice is to get the 1^st lender to approve the payment.  It takes longer but with a smart loss mitigator for the lender it will get approved.  Making the loss mitigator "smart" may take patience and information, and of course more time.  But honesty can pay big dividends not only for the pending deal but for future deals as well (provided you get the same lender loss mitigator).

Issue #2 - the failed contract.

Sometimes opportunity knocks.  You go through the whole deal and the first mortgage lender is in approval for the short sale and the second mortgage lender is also in agreement.  The buyer walks from the deal.  Or maybe the first lender has some problem with the deal.  You still have an approval from the 2^nd lender.  We have become successful in simply advising the 2^nd lender of the problem and asking them if they will take the money as if the sale went through.  So far our experience is that they usually will take the money and issue a release of the mortgage and typically a release of liability of the borrower...  This can put the owner is a seriously better position than before and possibly even allow the owner to keep the property.

Issue #3 - the conflicting appraisals

For the most part, serious 2^nd lenders have a problem with the short sale when there is an appraisal or BPO in possession of the 2^nd lender that is materially higher than the appraisal of the 1^st lender.  Recently we had a 2^nd lender that said that the sale price was unrealistically low (at $165 per sq. foot) when other sales in the neighborhood were no lower than $240 per sq. foot.  After careful examination and discussion with the first lender and the selling broker we determined the tax assessor as well as the 2^nd lender's BPO (which used the tax assessor's information) showed the home to be 45% larger than it actually was!  This was precisely the difference in the valuations.  The 1^st lender got it right because they used an appraiser that actually measured the home.  7 weeks later the deal is closing this week.

Dealing with 2^nd mortgages in short sales takes time and timing.  Don't leave the 2^nd mortgagee for the end of the process with the assumption that they will fall in line and go away.  They don't and they are growing smarter.  Keep every lender in the loop and the deal will go smoother.

UPDATE: Second Mortgage lenders (remember, this includes the equity line of credit and any other "junior" lienholders) are more and more entertaining short pay settlements.  For example, if the junior mortgage has no equity in the real property because of a decrease in value of the property, and especially if the first mortgage is in foreclosure, then the junior lienholder is likely to entertain a cash settlement of the unpaid balance to fully satisfy that mortgage.  The amounts of the settlement will vary with lender and borrower finances and other parameters, but we have seen settlement amounts between 10 and 50% of the unpaid balance.

Be sure to contact your own attorney for your state laws, and always consult your own attorney on any legal decision you need to make.  This article is for information purposes and is not specific advice to any one reader.

Richard Zaretsky, Esq., RICHARD P. ZARETSKY P.A. ATTORNEYS AT LAW, 1655 PALM BEACH LAKES BLVD, SUITE 900, WEST PALM BEACH, FLORIDA 33401, PHONE 561 689 6660  RPZ99@FLORIDA-COUNSEL.COM - FLORIDA BAR BOARD CERTIFIED IN REAL ESTATE LAW - We assist Brokers and Sellers with Short Sales and Modifications and Consult with Brokers and Sellers Nationwide!  Shortsales@Florida-Counsel.com