With the influx of new foreclosures the past few years, you may have heard of homes in your community that are being sold through a ‘short sale’. While short sales are fairly common, few people understand what they are or how they should be handled by an association.  

 A short sale occurs when a lender agrees to accept less than is owed on a mortgage/Deed of Trust to permit an owner to sell their property. For example, an individual owning a home with a market value of $200,000 but with a $225,000 mortgage would not ordinarily be able to sell their home since a necessary condition of sale is to payoff the outstanding mortgage and any liens. In this example, the homeowner would need to come to closing with $25,000 in cash to allow the sale to close. Since most individuals are financially unable to sell their home under these circumstances, a solution is to convince a lender to accept a payment of $200,000 on their loan to permit the sale to go through. 

 Why would a lender agree to a short sale under these terms? In a distressed economy, a lot of owners cannot afford to continue making the regular mortgage payments on their homes. To make matters worse, the values of their homes have deteriorated to the point that they owe more than their home is worth. Inevitably, this leads to a default on the mortgage. Instead of proceeding with a foreclosure, it can be more cost effective for a lender to cut their losses and accept less then what they are owed by authorizing a short sale. It costs the bank a lot of money to complete the foreclosure process and even more money to maintain, repair and resell a home that it takes title to through their foreclosure. A short sale is a ‘win-win’ for both the homeowner and the bank- the homeowner does not have to go through the foreclosure process (and may have the remaining debt written off by the bank ) and the bank can quickly cut their losses for a fixed and ascertainable amount.

So what role does a community association have in this process? If the association is owed money from an owner, it has a lien against their property for the balance owed. Under normal circumstances, upon the sale of a home, the association’s lien is paid in full. This is rarely the case in a short sale.  Besides agreeing to ‘short’ the amount that they are owed on their own loan, a lender needs to settle the payoff of other liens for the sale to close. A lender will typically have an undisclosed ‘pot’ of money that it is willing to expend to release these liens and permit a short sale to occur. If a deal cannot be reached with all of the parties holding the liens, the short sale won’t be approved.

An association will typically be initially offered only a small percentage of its lien balance. The offer may also be presented in conjunction with a mild threat that the property will ‘end up in foreclosure’ if the association does not accept that initial offer. The implication is that the association will only receive its super priority lien if the property forecloses. It’s important at this juncture to immediately refer the matter to the association’s legal counsel to negotiate the best possible deal. Legal counsel will also take measures, if permissible, to ensure that the association retains the right to collect any remaining balance owed following the sale of the property.