The current troubles in the credit markets, especially for sub-prime loans, means that many in the money trade will need a refresher on the comparative benefits and drawbacks of short sales and deeds in lieu. Bankers and credit managers are about to be overloaded with calls like this: The borrower can’t make the payments and needs to unload the property, but it won’t move at a price significantly over the secured debt.
Deeds in Lieu. The obvious solution would seem to be a deed in lieu of foreclosure, back to the lender, and then a sale of the property out of REO. The process is quick, it’s cheap, and it solves the problem of a non-performing loan.
It also has some problems. Lenders usually balk at taking a deed in lieu of foreclosure for a number of good reasons. Even with all of a foreclosure’s attendant delay and expense, there are potential risks for the lender in taking a deed in lieu, as opposed to pushing through to foreclosure and getting a squeaky clean title, sanitized through the foreclosure process. Junior liens that would be foreclosed by a trustee’s sale are unaffected by a simple deed in lieu. A title insurance commitment showing an absence of intervening encumbrances may soften a lender to the idea of a deed in lieu, but there remains the issue that a deed in lieu given during the ninety-day period preceding a bankruptcy filing by the borrower may be attacked as a preference voidable by the trustee or a debtor-in-possession, if the value of the property exceeded the lender’s secured debt forgiven when the deed is accepted. A properly-conducted trustee’s sale sets the value of the property for preference purposes, and thus builds a “safe-harbor” for the lender, a protection not afforded by a deed in lieu.
The lender should be worried about its own holding costs, liability for taxes and insurance, and the risk of further deterioration of the market value while the property slowly percolates through the REO department. That concern can be moderated where the borrower agrees to pick up all or a portion of such ongoing expenses and makes warranties that he or she is not insolvent. Also, a well-represented borrower offering a deed in lieu will always insist on an estoppels agreement with the lender, under which the parties confirm they are voluntarily giving up their statutory and contractual rights and protections in foreclosure and that the lender is accepting the property in full satisfaction of the debt.
Short Sales. A better alternative for the lender may be the “short-sale”, that is a sale of the property at a market price – one that nonetheless yields less than the full amount of the secured debt – that may be more attractive to the lenders’ natural resistance to deeds in lieu. A foreclosure is rendered unnecessary, the lender avoids having a non-performing asset, yet the value of the property is maximized and the lender has cash rather than a property that needs to be administered and liquidated. The realtor earns a commission by completing sale of a property neither the lender nor the borrower want. An experienced real estate agent proposing a short-sale to a skeptical lender (is there any other kind?) needs to demonstrate – and document – that the proposed sale is at the best obtainable price compared to the expense, delay and holding costs of a foreclosure. The lender needs to be satisfied that the borrower is genuinely unable to meet the obligations contracted for.
With careful preparation and forethought, it is often better for a lender to take a short-sale rather than either a foreclosure or a deed in lieu.
This is an article that previously appeared in the Utah Banker's Newsletter.