Here is more proof that the loss mitigators used by some banks just don't quite "get it".

In an article this morning in the Palm Beach Post, by staff writer Eve Samples, Wells Fargo is targeted for its botched handling of a short sale opportunity, resulting in a loss to the bank of at least $40,000 more than it would have experienced in the short sale opportunity.  The article goes on to say,

Behind on their mortgage and forced to move to Miami-Dade County for work, Reggie and Noelvis Capiro this summer petitioned their lender, Wells Fargo Home Mortgage, and its servicing company to allow a short sale on their three-bedroom, three-bath house. They found a buyer who was willing to pay $400,000, about $40,000 less than they owed on the mortgage.

The bank countered at $520,000, and the deal fell apart, according to the Capiros' agent, Dave Derrenbacker, owner of Water Pointe Realty Group in Stuart.

The Capiros lost the home to foreclosure in June, and the bank this month sold the house to a new buyer. The sale price this time: $360,000, according to Multiple Listing Service data.

The writer does not realize that the loss to the bank is even greater, since the costs of taking the property into the REO department of the bank needs to be added to the simple math loss in the selling price.  My guess is the loss is more like over $50,000.

This example goes to the heart of the issues that the Federal Government is facing if they want to get into the loss mitigation business, and confirms that this situation is not isolated and that the real number in aggregate losses is enormous. See Banks Create Billions More In Losses.

To understand how and why lenders should do short sales in a declining housing market, a review of the short sale philosophy is in order.  I wrote about this about six months ago in BACK TO BASICS - A REVIEW OF SHORT SALES and an excerpt seems appropriate:

Who Qualifies - And Why A Lender Would Want The Loan Paid Off -

You can read discussions on who qualifies for a short sale in a previous article (see this link  Some Sellers Think They are Entitled to a Short Sale and Economics 101).  Technically, everyone can qualify for a short sale.  To understand this we need to become more, well, "technical".

Logically, a lender is not going to want to keep a secured loan on its books where it has evidence that the security has decreased in value dramatically and the loan to value ratio under which the loan was originally made is now "upside down", meaning the value is less than the amount of the loan.  The portion of the loan that is not in compliance with the original loan to value ratio is, for bank auditing purposes (or investment valuation purposes if the loan is not a portion of a mortgage backed collateralized security) and therefore is not considered secured.  That is bad since it makes the lender set aside reserves of cash for the lack of value in the loan.  The lender needs to do something to change that situation.

Depending on the language in your mortgage or your promissory note, the valuations being upside down could be reason to put your loan into breach and call the promissory note.  I have not seen this done as of yet by any residential lender.  But technically, if a property is in this upside down situation, the loan could already be technically in default.

Often, the desire to unload the upside down property is made based on economic calculations made by the owner of the property.  Those calculations usually show that it is better to take a loss now of a known amount of money rather than continue to pay interest, insurance and taxes in excess of the income from the property for an unknown period of time until rental or property values increase so the economic cash drain is reversed.

In any event, the lender would prefer to have the loan right side up or off its books.  In some cases the property owner has excess cash laying around and can just sell the property (if that is their plan) and pay the amount to the bank that they are "short" at the closing so the loan is paid off in full.

In other cases, usually where the borrower has become financially distressed but also where the borrower is asset rich but presently is lacking liquidity (I call it financial indigestion), other arrangements satisfactory to the lender can be accomplished.

These other arrangements usually come in two flavors: (1) providing alternative secured collateral to the lender, such as a first or second mortgage on another borrower owned property that has equity value, or (2) having the borrower sign a new or modified promissory note that is unsecured and payable over a fixed period of time, usually 3 to 10 years from the date of the short sale.

Where the borrower is experiencing extreme financial hardship, a third alternative can occur, which is actual forgiveness of the unpaid amount to the lender.

This leads us to the issue of the unpaid portion of the short sale.  Many lenders will not provide a release of the balance due.  This causes some good and some bad issues for the borrower.  The good part is that without a final disposition of the unpaid portion, the borrower has not received any phantom income (i.e.: that 1099 stuff).  This good news does not last forever.  Once the statute of limitations on enforcement of the promissory note expires, then the borrower has that income to report to the IRS.  The bad news is that the lender very well may sell the unpaid promissory note to some investor for 5 or 10 cents on the dollar and then that investor will definitely come after the borrower for as much as they can get above that 5 or 10 cents on the dollar.  The small element of good news here is that as long as they are trying to collect on the unpaid portion, that unpaid portion is not income that the borrower has to report to the IRS.

Why mistakes are made by lenders in the short sale process.

 I am going to be conservative and say that Wells Fargo in this case had incorrect information on the market when undertaking their valuation and "potential" for the property.  At my firm we have come across this situation several times - often when there are two lenders and one approves the short sale price while the other says they need it "much higher".  The reason for the mis-valuations can be several, but some common ones are size of the property (one lender used the property appraiser size calculations, which were overstated by 30%), condition of the property (most lenders do not do an inside inspection and none do an inspection of the mechanicals of the home), liens or other property associated obligations being assumed by the buyer (thereby lowering the stated price, but raising the value price), rapidly declining values for the neighborhood (and determining where in the cycle this sale might occur - ie how much further to bottom for this neighborhood), and certainly others.

Short Sale consultants and attorneys should make it their business to be aware of the valuations for similar homes in that neighborhood so they can counter erroneous arguements for a higher price - when none is justified.

How will the additional loss affect a foreclosure deficiency judgment? 

When a foreclosure occurs, the lender may be entitled to the dreaded foreclosure deficiency judgment.  How does the court determine the amount the lender is entitled to if the lender screwed up an opportunity for mitigation of that loss to the ultimate detriment for the borrower?  I know of no reported case law on the subject, but surely if one makes it to the appellate courts, equity will have the judge decrease the deficiency judgment by the amount of the additional loss created by the mistake or stubbornness of the lender.  I say here that equity will cause that to occur because as a matter of law, the lender had no obligation to entertain a short sale at all.  For a more detailed discussion on the deficiency process see my article Foreclosure Deficiency Judgment Compared to Deed In Lieu and Short Sale Scenarios.

In the past I have often stated that the short sale process is like living in the Wild West - this is still true, but slowly we are spiraling into some focal point (like a tornado drawing into its core all it touches or gets near) where some common means of accomplishing loss mitigation will be standardized.  That time probably will be accelerated if the Federal Government steps in to be the loss mitigator.

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  New Website www.Florida-Counsel.com