Payments and Promissory Notes for Second Lienholders in a Short Sale
This questions was asked by someone in a different listserve that I belong to but would like to share with this group and get your take on it. I have included the original question in addition to my expansion of the question.
ORIGINAL QUESTION:
In a short sale, it’s a pretty common practice, I think, for the second lien holder to require something beyond the standard $1K-$3K consideration for release of their lien. For example, Payoff amount for second lien = $15,000, Consideration from first = $1,000. Second lien insists on, say, $3000, and accepts a promissory note at the table from the seller for $2,000. Performance on the $2,000 promissory note will be considered “full satisfaction” of the obligation and is not listed on the HUD. Property closes, First takes loss of $25,000, Second takes loss of $14,000, with expectation of $2000 recovery.
Does this violate RESPA or any other law? (I think not, as the second has the right to collect on their remaining balance, but others say it is a violation.)
MY EXPANSION OF THE QUESTION:
I am finding recently that not only are the 2nd lien holders asking for $3,000 at closing which would appear on the HUD-1 but, also for the Seller to sign a Promissory Note for 10% of the principal balance left on the 2nd lien. I am not a lawyer, but from those I have talked to this doesn’t seem to be any kind of violation. It is a way for the 2nd lien to recover part of the deficiency. The problem area seems to be if the Seller agrees to sign a Promissory Note, the transaction goes through and the Seller then files for Bankruptcy. Would this be considered fraud if the Seller signs the note with the intention of filing for bankruptcy later?
The other scenario I see happening more often, which MSNBC recently did a report on, is the 2nd lien holder doesn’t want a promissory note. However they still demand 10% of the principal above the $3,000 the 1st lien is offering, and suggest that the buyer, seller, or the agents pay it directly in advance so it is not part of the HUD-1. In the MSNBC report they mentioned Bank of America and JP Morgan Chase. I have had both of these banks and others suggest exactly this type of thing. This clearly seems to me to be defrauding the 1st lien holder and would be a violation.
On a side not but somewhat related topic. It is my understanding that Oregon Real Estate Board is looking into whether Realtors are over stepping their bounds by negotiating short sales and could possible prohibit it or create some very stringent guidelines on the process.
In addition the Oregon Attorney General is questioning some business models of Short Sale Companies that charge a Fee. Many lien holders refuse to pay an attorney fee or short sale fee that appears on the HUD-1. So companies are asking the buyer to pay for the fee which would then not appear on the Seller’s side of HUD-1, but the Buyer could then ask for the amount of the fee back in closing costs which most lien holders will agree to up 3%. If the Buyer can’t pay the fee because FHA lenders won’t allow such a fee on the Buyer’s side of the HUD-1 they are asking for the agents to split the fee. Is this a RESPA violation? The DOJ’s concern seems to be one of disclosure. Is the lien holder aware the Buyer is willing to pay extra money for the transaction to go through and that those funds are going to a third party (Short Sale Company). Also is who is the Short Sale Company really working for if they contact with the Seller to negotiate the Short Sale on their behalf, but then require the Buyer to pay the Short Sale Company, who in return often asks for the money back from the lien holder in closing costs. Seems like a lot of gray area, and I would be interested in hearing others take on it.
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