Short Sales & Second Mortgages

A short sale is a negotiation with a lender/lienholder for a homeowner to sell a home short of the total amount that he/she owes.

Short sales are common for homeowners with little or no equity in a property or for those who owe more than what a property is worth due to declining home market values.

Short sales for a primary loan are straightforward.  However, it’s more complicated when a second home loan (mortgage) is involved.

In California, the primary lender is the mortgage holder that’s first in line with filing/recording of its deed of trust.  The primary mortgage holder doesn’t have an obligation to pay off the second in a foreclosure settlement and is typically interested only in recovering its investment.

When entering into a short sale arrangement with the primary lender, the second mortgage holder has the right to pursue foreclosure proceedings against a homeowner on its own.

When negotiating a short sale transaction on a property, an agreement must be reached with the primary lender and also with the second holder.

Both first and second lienholders must agree to settle the debts for less than what the homeowner owes.

The 2nd mortgage holder will know that if agreeing to the short sale, it can get something and avoid all loss.

In California, the 2nd mortgage holder sometimes has the right of recourse written into its note and deed of trust.  This right of recourse against the obligor on the note allows 2nd lienholder to not participate in the short sale and later file a lawsuit against the obligor for deficiency after foreclosure.

However, it there is debt forgiven by holder of first or 2nd in a short sale, that can be considered as phantom income of the obligor and and taxed accordingly.

Short sales or foreclosures don’t extinguish the obligation to pay back the debt. 

The only action that will completely wipe out a second mortgage on a short sale or a foreclosure is for the obligor to file bankruptcy.  In either a Chapter 7 or Chapter 13 bankruptcy, a second mortgage is usually considered unsecured and discharged by the court.  This will leave the second mortgage holder without any recourse and without the ability to file a charge-off on a credit report. 

Short sales are good options for homeowners who do not have the long-term financial capability to stay in their home.  Short sales cqan help homeowners avoid the emotional trauma and financial devastation of foreclosure.  Reaching agreement with holder of first and 2nd liens in a short sale would be the best option.

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