If you are a homeowner having trouble making your mortgage payments, a short sale might be a good way to avoid foreclosure. However, a short sale can be difficult if you have more than one mortgage or loan on your home. Read on to learn more about how short sales with multiple mortgages work and how to navigate the process if there is more than one lien on your home.
In a short sale, you sell your home for less than the total debt remaining on the mortgage and the proceeds of the sale pay off a portion of the mortgage balance. The lender accepts the “short” amount to satisfy the debt and releases the mortgage lien. Short sales are one way for borrowers to avoid foreclosure. (Learn more about short sales to avoid foreclosure.)
To complete a short sale, the lender’s loss mitigation department must first approve the transaction. The homeowner must submit a loss mitigation application (which includes a financial statement, proof of income, tax returns, bank statements, and a hardship letter) to the lender, along with a copy of the purchase offer from a potential buyer.
If the lender approves the short sale application and there is only one mortgage on the property, the homeowner proceeds with the short sale. However, if there is more than one lien on the home, such as a second mortgage, tax lien, HOA lien, or home equity line of credit, this adds a layer of complication to the short sale process.
In order to obtain clear title following a short sale, the first mortgage lender must receive releases from all of the lienholders. This means that if there is a second mortgage, tax lien, and/or home equity line of credit on the property, all must sign off on the short sale deal—not just your first mortgage lender. But it's often not in the other mortgage holders best interest to accept the short sale.
Example. Let’s say you have a first mortgage on your property for $160,000, a second mortgage of $30,000, and a $10,000 home equity line of credit. However, you can only find a buyer willing to pay $150,000 for the property. Generally, all of the $150,000 would go to the first mortgage lender, while the second mortgage lender and home equity lender (the junior lienholders) would get nothing from the deal. For this reason, the second mortgage lender and home equity lender would rather not accept this short sale deal and release their lien. For them, it would be better for the foreclosure go through and later sue you for the amounts owed. Even though the junior lienholders may collect only a small percentage of what they’re owed by suing you, they would consider this a better option than totally releasing you from liability as part of a short sale. As a result, junior lienholders often refuse to approve short sales. And, if all lienholders don’t agree to the sale, the short sale can't close.
Example. Let's say you have a junior HOA lien on your home and you want to do a short sale. The HOA will have to release it in order for the short sale to go through, just like any other junior lienholder. To get the HOA to release its lien, your mortgage lender will have to give up a portion of the short sale proceeds to the HOA. Usually, the amount it offers is less than the total debt owed. A problem can then arise when the HOA wants the debt paid in full, but the lender doesn’t want to give it any more of the sale proceeds. If the HOA refuses to accept the amount offered by your lender, this could cause the short sale to fall through.
To convince the HOA to accept the amount offered by the lender and agree to a short sale, you can argue that this is an easy way for the HOA to get some money with little effort on its part. Because collecting the debt on its own can be time consuming and expensive, a short sale might be the easiest way for the HOA to get a portion of the money it is owed. You can also argue that if the HOA will accept a reduced amount and permit the short sale, it can avoid the problems associated with an empty, foreclosed property in the neighborhood. Vacant properties tend to fall into disrepair and can attract vandals. However, a person who buys a property in a short sale will likely maintain the property and will also start contributing dues to the HOA.
However, it is not impossible to convince junior lienholders to agree to a short sale. To incentivize junior lienholders to consent to a short sale, the first mortgage lender must determine an amount it is willing to give to each of the junior lienholders to release their liens.
Example. Building upon the scenario above, let’s say the first mortgage lender offers the second mortgage lender $10,000 and offers the home equity lender $2,000 from the short sale proceeds to approve the deal. Will the junior lienholders accept these amounts and allow the short sale to proceed? Probably yes. The second mortgage lender and home equity lender will likely feel that accepting these amounts is the easiest way to recoup some of the money they lent to you and will agree to release their liens in exchange for these funds.
However, what if the home equity lender insists on receiving $5,000 to approve the short sale, but the first mortgage lender has only offered to give them $2,000 from the short sale proceeds? Even if the first mortgage lender refuses to allocate more of the short sale funds to the home equity lender, this does not mean the deal is dead. The extra $3,000 can come from the buyer or seller if they have it.
The main issue in getting multiple lenders to agree to a short sale is that each party wants more money than they are getting and nobody really wants to share. This can make it very difficult to get an approval from each lienholder. Generally, while none of the lenders gets as much money as they would like from a short sale, in the end, short sales are often approved because it is the easiest way for all lienholders to collect something on the debts.
So, while it can be more challenging to complete a short sale when there are multiple lenders, convincing all lienholders to agree to a deal is not impossible. As long as each party receives sufficient proceeds from the short sale, junior lienholders often have little to gain by letting a foreclosure go through and consequently will approve a short sale deal.