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Washington State is a non-judicial foreclosure state, meaning that
the lender is not required to sue the borrower in default in order
foreclose. Most home loans in Washington State are based on a deed of
trust (mortgage instrument) with a “power of sale” clause that
pre-authorizes the sale of the property to pay off the balance of the
loan in the event of a default by the borrower. When this clause
exists, the power given to the lender to sell the property is usually
executed by the lender’s representative, typically referred to as the
trustee.
While Washington State has minimum timelines required by state law, this is the timeline typically followed by most lenders:
90 days after the first missed payment:
Lender sends a “Notice of Default” to the borrower. The notice will be
posted at the property (usually taped on or near the front door) or
delivered to the borrower in person. The notice may also be mailed to
the borrower, usually by certified mail. The borrower has 30 days to
respond before the actual foreclosure process is started and the
property is scheduled for public sale.
120 days after the first missed payment: Lender records a Notice of Trustee Sale with the county recorder, stating the scheduled sale (auction) date. The notice of sale must be recorded at least 90 days before the sale date.
The notice of sale is also posted at the property or delivered to the
borrower in person, and mailed to the borrower and any other affected
parties (such as additional lienholders).
Approximately 7 months after the first missed payment:
Property is sold at public auction to the highest bidder, who must pay
in cash at the time of the auction. If nobody bids the minimum bid
amount set by the lender, ownership of the property will revert back to
the lender. The winning bidder, or the lender if there were no bids, can take possession of the property 20 days after the foreclosure sale.
The borrower has no right to redeem the property after the foreclosure
sale. Foreclosure sales are usually held on the county courthouse
steps each Friday, or the next business day if Friday is a holiday.
The timelines above are the most common timelines. Actual timelines specified by Washington State are:
- The foreclosure sale must be scheduled a minimum of 190 days from the date of default.
- The borrower has up to 11 days before the foreclosure sale to stop the foreclosure process by paying the past due payments, plus expenses and legal fees.
- The lender may postpone the foreclosure sale at their discretion.
This will often times occur when loan modification, short sale, or
other agreement is being negotiated with the bank.
- The lender or the high bidder at the foreclosure sale can take possession of the property 20 days after the foreclosure sale.
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 I’ve received many calls from prospective buyers
interested in my short sale listings asking if the listing price has
been approved by the bank. On a short sale, the seller
owes more than their house is worth, so the seller’s lender(s) must
approve the sale price and accept a discounted loan payoff in order for
the house to be sold. However, is it not common in these situations
for banks to pre-approve a listing price for a house. Because
there are so many short sales on the market, buyers are searching for
short sale information on the Internet and finding a wealth of
information and advice on how to handle short sale situations. I did
some searching myself, and while there was some good information
available, I found a lot of incorrect or incomplete information.
Many websites advised buyers to ask the listing agent if the list price
had been approved by the bank. However, buyers aren’t necessarily
getting the whole story. Here are some situations
that may lead a listing agent to claim that the bank has approved the
listing price, along with some things to consider:
- The seller’s loan is an FHA loan, and HUD has sent the
seller a letter stating the minimum net payoff proceeds that they would
accept. This can be fairly reliable as long as all of
the conditions set by HUD are satisfied. In this situation, you also
need to know the following:
- When is the deadline for obtaining a signed Purchase and Sale contract from a buyer? The HUD pre-approval is only valid for a specific period of time, usually around 90 days.
- What is the appraised value of the property? The
pre-approved price set by HUD is based on a percentage of the appraised
value, usually 88%. Since this is the net amount after all selling
expenses (including commissions and closing costs), that translates to
a purchase price of approximately 97% of appraised value. However, HUD
will often times accept less than the pre-approved amount depending on
how long the property has been on the market—A buyer’s agent
that specializes in short sales will know when you can make a lower
offer that will net HUD less than their pre-approved amount and still
have it approved by HUD. If your agent doesn’t know this, you could be paying more than you should for the house.
- How long has the property been on the market?
This relates to Point (b) above—HUD may accept a lower payoff than
their pre-approved amount depending on how long the property has been
on the market.
 The bank has verbally approved a listing price or has verbally disclosed the minimum payoff that they’ll accept.
This is possible, but rare. Banks want the property sold at the
highest price possible and don’t want to leave money on the table. If
they approve a listing price of $300,000 and the property could have
been sold for $320,000, then they haven’t done their job of mitigating
the loss. Most banks prefer to receive an offer, then determine if the
price offered is acceptable. Also, if the price approval was not in writing, there’s no guarantee that they’ll follow through with their verbal commitment (banks are notorious for “forgetting” verbal commitments that they’ve made).
- The bank has given written approval of the listing price.
As in Point #2, banks rarely approve a price prior to procuring a
bona-fide buyer for the property. If the listing agent claims to have
written approval of the listing price, ask them to send a copy to you
in writing. If they say they can’t because it contains confidential
information, ask them to black out the confidential information with a
marker and send a copy to you (make sure they don’t black out the
borrower’s name or property address). If the letter states an approved
price, make sure it also states the net payoff proceeds that the bank will accept.
The bank is less concerned about the sale price—They’re concerned about
the amount of money they’ll end up with after the deal is done. You’ll
want to avoid potential situations where the bank approved a listing
price but comes back in the eleventh hour and says something like,
“That price was based on 4% in real estate commissions, not 6%,” or
“That price didn’t account for prorated real estate taxes, homeowner
association dues, etc.”
- A previous buyer’s short sale offer was approved by the bank, but the buyer backed out or could not complete the transaction.
This situation would seem like a slam-dunk since the bank had already
approved another buyer’s offer. But beware—Just because the bank
approved another buyer’s offer at the same price doesn’t guarantee that
they’ll approve your offer. The previous buyer may have had different
financial qualifications and the terms of the previous offer may have
been different than the terms that you’ll offer. Maybe the previous
offer didn’t include an inspection contingency, and that made it
desirable to the bank. Also, short sale approvals are usually good for
up to 30 days, or sometimes 45 days. If the bank finds out that a different buyer was substituted, they could reject the short sale.
I
had a recent transaction where we had a short sale approval (approved
specifically for the original buyer), we sent in a new offer to the
bank for approval at the same price, and the bank changed their mind
and decided they wanted a higher price. We had to fight with the bank
for the next month to get them to come back down to the original price
that they approved the first time around.
My point here is that
just because the bank approved an offer from another buyer doesn’t
necessarily mean that you can just substitute a new buyer and expect
the deal to go through. The only way to assure that the bank will go
through with the deal after the approved buyer backed out is to submit
the new offer and get a new approval. Depending on the bank, this
could take anywhere from several days to several weeks.
If you find yourself in this situation, ask the listing agent to send you a copy of the short sale approval letter. Make note of the deadline.
Many banks will issue an updated approval letter for the new buyer but
won’t change the date that the approval expires (the deadline for
closing).
Keep in mind that I’m not saying that you should completely discount
any claim that the price of a property has been approved by the bank.
Just make sure you know the facts behind the claim, so you’ll be able
to set the proper expectations. Most banks won’t start short
sale negotiations or discuss any price they’ll be willing to accept
until an offer is received from a buyer, although there are
exceptions. As time goes by, we’ll probably see more banks opening up
to the idea of pre-approving prices for short sales to speed up the
process.
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Many real estate agents in Washington State use unlicensed third-party negotiators to handle their short sales. I have always discouraged that practice (see my March, 2009 blog post, Is Your Real Estate Agent Breaking The Law?).  The Washington State Department of Licensing has now taken an official stance on this. On their website under “ New Real Estate Law Frequently Asked Questions”, they state that short sale negotiators must hold active real estate licenses or be appropriately licensed by the Department of Financial Institutions, and
work under the authority of their designated broker. The department of
licensing is currently investigating complaints of unlicensed short sale negotiators (see Real Estate Commission Meeting Minutes). Real
estate agents who are using unlicensed short sale negotiators can be
charged with aiding or abetting unlicensed activity and are subject to
disciplinary action, according to the Department of Licensing. Unlicensed third-party short sale negotiators
are responding by stating that they’re really “facilitators”, not
“negotiators”. That may technically be true, but that doesn’t mean
that the state sees it that way. I certainly wouldn’t want to be
standing in front of a judge trying to explain the difference between
“facilitating” and “negotiating”. And as a real estate licensee, I
wouldn’t want to risk my license being suspended while my relationship
with an unlicensed short sale negotiator is being investigated. I use an experienced short sale attorney
to handle my short sales. My attorney also happens to have a real
estate license, in addition to being an escrow attorney. He was
working with short sales before most real estate agents even knew what
a short sale was. If you’re a real estate agent in the Seattle-Tacoma-Everett area reading this, I would be happy to refer you to the short sale attorney that I use, no strings attached--I can’t receive any payment for an attorney referral. (See Short Sales For Real Estate Agents
for more information.) As real estate agents, we need to keep our
business practices above-board and eliminate opportunities for any bad
press relating to real estate agents. Would you put your license at
risk?
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Is there such a thing as an unsellable house?
There’s a wealth of information available on preparing and staging a
house to sell, but what about situations where the house can’t be
properly prepared or fixed up to sell? I work a lot with short sales and pre-foreclosures,
and in many of these situations the houses aren’t in great condition.
Often times the seller has no motivation to fix up or clean up the
house.
One house I recently sold was no exception. It was in
foreclosure and we had to sell it quickly. The house was only 13 years
old and needed new flooring, interior paint, and some landscaping work,
but it looked much worse. The owner had multiple large dogs that were
allowed to go in and out as they pleased and the house smelled like a
wet dog. Nearly every room in the house had boxes, clothing, and other
personal belongings stacked floor to ceiling, and some of these rooms
were so cluttered that it wasn’t even possible to get inside the room.
In the listing, I requested that agents contact me prior to
showing so I could warn them of what they were walking into and help
set the proper expectations. I could see the potential of this house,
but most buyers and their agents could not. Some buyers turned around
and walked out as soon as they opened the front door.
Critical Feedback
I
always request feedback from agents that show my listings. I received
several scathing comments about this house from other agents: “Get it off the market!”, “You should be embarrassed for listing this house”, “It stinks!”, not to mention some of the direct insults to the seller even though the agents had never even met the seller.
Seller In Distress
The seller was actually a very nice, thoughtful, intelligent, and
hard-working couple. They got in over their heads on a couple
projects, and as a result had a lot of distress in their lives. They
were spending so much time putting out fires in their lives that taking
care of the house became a low priority. Many people are quick to
judge because they’ve never been in true distress. They don’t
understand that most people make different decisions when in distress
than they would in normal situations. In the end, this house did sell—The short sale was approved and the bank took a $190,000 loss. It was sold to a retail buyer, not an investor as many people might assume. This buyer saw great potential in this house and ended up getting a great deal.
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Consider this scenario: You paid off your house a
few years ago now you’re selling it for $300,000. You figure that you
would make a better return on your money by offering owner financing
instead of cashing out and investing the money somewhere else. This is a big part of your retirement, so it’s a very important investment decision.
A buyer is willing to pay your asking price of $300,000. Here’s a snapshot of the buyer’s situation:
- The buyer can only give you $11,000 down.
- The down payment is part of a $17,000 gift received from the
buyer’s parents, the remainder of which will be used to pay closing
costs. The buyer has no savings outside of that.
- The buyer has marginal credit with a credit score of 620 and had a
couple 30-day late payments on credit cards just over a year ago when
they had some unexpected car repairs.
- Based on conventional lending guidelines, the buyer has just enough monthly income to make the mortgage payments.
- The buyer has been pre-approved for an FHA loan (assuming a seller
contribution toward the buyer’s closing costs), but they figure they
can save on some of the closing costs and FHA insurance costs by going
with the seller financing.
- The buyer loves the house, wants to live there forever, and assures
you that their mortgage payment will always be the first check written
every month.
Based on that information alone, would you do the deal? FHA would. I would not.
Let’s look at the statistics. Edward Pinto, a former Fannie Mae chief
credit officer, recently testified before a House panel that that an
estimated 20 percent of FHA’s entire portfolio will end up in
foreclosure, which was also supported by estimates that FHA provided to
Congress. That’s one in every five loans. If you have to foreclose, you could be looking at $15-$20,000 in legal fees and lost interest,
not to mention that you may have to make repairs before putting it back
on the market, and if the market has declined, you would lose more
money in the form of a lower selling price. Why do we expect our government to take financial risks that we’re not willing to take ourselves?
Is it because it’s not money? Well, it is our money. And if we don’t
support responsible lending, we’ll end up bailing out the FHA program
as well. Adding to our national debt to bail out FHA will lead to
higher taxes, which will lead to less disposable household income,
which will lead to less available money for home purchases, which will
lead to declining housing prices. Instead of blaming the
government for damaging the housing market because of the more
stringent FHA rules that were announced, perhaps we should be thankful
that a low down payment program such as FHA exists at all.
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We’ve all seen the horror stories relating to short sales, and some
of us have experienced them. As a short sale specialist, I often times
find myself questioning the logic of banks.
The government has
even stepped in on occasion, passing legislation that is supposed to
improve how banks handle the short sale process. However, each time,
banks find loopholes and nothing really changes. The legislation isn’t
specific enough, because the people writing the legislation don’t
understand the short sale process.
Here Is My Proposal
Establish required timelines for each specific step in the short sale process:
- Acknowledge receipt of short sale package and assign to a negotiator (3 business days)
- Negotiator introduction call to seller, agent, or third-party negotiator (3 business days)
- General property evaluation and appraisal or interior BPO (10 business days)
- Mortgage insurer and/or investor approval (10 business days)
- Decision letter issued (2 business days)
Total time required for short sale approval: 28 business days (5 ½ weeks).
The bank should allow Steps 1-3 to occur prior to receiving an offer
from a buyer, as long as the property is listed for sale. This way, only 12 business days are required for written approval once an offer is received from a buyer.
Loan servicers are currently required to forward all buyer offers to
the investor, but that often times does not happen. A bank negotiator
may prevent an offer from reaching the investor because they don’t want
to go through the hassle, or they have a personality conflict with the
seller, agent, or third-party negotiator. I propose
establishing a requirement that all bona-fide offers must be forwarded
from the loan servicer to the investor within 3 days after receipt, or
be fined at least $5,000 for each failure to comply. A
bona-fide offer is a valid Purchase and Sale Agreement with a
pre-approval letter from the buyer’s lender or proof of funds for a
cash offer.
Loan servicers would receive $1000 for each short sale approved within the required 28 day timeline,
in addition to any other fees established in the contract between the
loan servicer and the investor. The only problem here is that the
$1000 really should be paid by the investor that owns the loan (not the
government), but it would be difficult to force all investors to revise
their contracts with their loan servicers even though it would be in
their best interests to do so.
Lenders would be given 60 days
to start complying with the new short sale regulations, which would
give them sufficient time to hire and train additional staff if
necessary. The additional $1000 per approved short sale would more
than pay for the additional labor and office expenses.
The End Result
- Short sales would no longer have the bad stigma currently associated with them.
- Short sales would sell for higher prices, because buyers wouldn’t
require significant discounts to compensate for an indefinite short
sale approval period.
- Real estate values would stabilize, because short sales and foreclosures wouldn’t have as much of a negative impact on prices.
- Banks would reduce their losses, because short sales would sell for
closer to market value. With a defined short sale approval timeline on
all short sales, the buyer pool for short sales would expand since many
buyers who are avoiding short sales now would be likely to consider
short sales with a guaranteed short approval period.
In an effort to keep this blog post from running on, I left out many
other details that would need to be included. However, this should
serve as a general starting point.
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 I specialize in short sales, and I’ve observed many actions by banks
that seem to defy logic. This particular experience is no exception.
A while back, I had a short sale listing that was being negotiated with
the bank at $300,000. The buyer ended up backing out right before we
received the short sale approval, because their financial situation
changed. We received the short sale approval letter, and the approval
was conditioned upon the seller signing a promissory note for $20,000
or coming up with $10,000 cash at closing. We managed to quickly find another buyer who was willing to pay $10,000 more, but the bank refused to even consider the offer and asked to have the offer rewritten at $300,000.
They also said that regardless of the price offered, the seller would
still be required to sign a promissory note unless the bank was
receiving a full payoff. Since full payoff would have been $450,000,
that wasn’t going to happen. We gave the bank what they asked for -- $300,000 plus an additional $10,000 cash at closing, but the bank said they wouldn’t accept the additional $10,000 from the buyer—It had to come from the seller. So what was the motive here? To punish the seller?
In the end, the offer was reduced to $300,000, the seller signed the
promissory note (at 0% interest, payable over 10 years), and the deal
closed. I typically don’t like the idea of sellers signing promissory
notes in these situations, but this seller’s situation was a bit unique
and they felt it was in their best interest to do so. They’ll most
likely file for Chapter 7 Bankruptcy, which will wipe out the note.
The money was on the table and the bank refused it. Now they’ll end up
with nothing.
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 If you were asked who your lender is—who actually owns your
mortgage, what would your answer be? Your mortgage statement may come
from Wells Fargo, Aurora Loan Services, Select Portfolio Servicing, or
some other lender, so they must own the loan, right? It’s easy to
assume that the company listed on your mortgage statement is the owner
of your loan, but it’s usually not.
The Loan Servicer / Investor Relationship
- The company listed on your mortgage statement is the loan servicer. The loan servicer doesn’t
own the loan. They are paid to collect, monitor, and report the loan
payments, handle property tax and insurance payments, collect late
fees, and foreclose on defaulted loans.
- The entity that actually owns the loan is the investor. The investor pays the loan servicer a fee to service the loan for them.
Why Is This Important In Short Sale Situations?
On a short sale, the investor takes a loss, not the loan servicer. However, a short sale must be “negotiated” with the loan servicer,
and the person or entity handling the short sale for the seller is
typically not allowed to communicate directly with the investor. Also, loan servicers are typically paid more to foreclose than to facilitate a short sale. So, if this is the case, you’re probably wondering why a loan servicer would ever consider a short sale over foreclosure.
The contract between a loan servicer and the investor requires the loan
servicer to act in the best interest of the investor. Since a short
sale will usually net the investor more money (a smaller loss) than
foreclosing and selling the property as a bank-owned property, the loan
servicer will usually entertain a short sale as part of their
contractual requirement with the investor. However, because loan
servicers typically get paid more to foreclose, they will often make
the short sale process difficult, sometimes even trying to find small
technicalities to kill the short sale deal.
First and Second Mortgages With the Same Bank
If you have a first and second mortgage with the same bank, they are
probably owned by different investors. This generally means that each
loan is negotiated separately ( with different short sale negotiators at the bank), and there may be different short sale requirements and timelines
for each loan. Even the information contained in the short sale
package that is sent to the bank could be different on a first and
second mortgage serviced by the same bank. If a short sale is
necessary to sell your home, it’s important to make sure you’re working
with someone who has short sale experience. Someone who has experience
dealing with difficult lenders will typically have more success and be
able to prevent unnecessary delays better than someone who doesn’t
specialize in short sales.
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 Can investors help stop foreclosure in Seattle? There are many real estate agents and investors offering to help stop foreclosure in Washington State. Have you been approached by an investor claiming that they can help you stop foreclosure?
The general concept is that the investor will help you stop foreclosure
by purchasing your house. This usually involves you owing more than
your house is worth, which is the situation I’ll be addressing here.
The investor will make an offer to purchase your house, then negotiate
with your lender(s) to get them to approve a discounted payoff on your
mortgage(s). This is known as a “short sale”. When the bank approves,
you get to sell the house, get out from under the debt, stop foreclosure, and save your credit. Sounds pretty simple, right? Not necessarily.
First, I’ll clarify that investors are an important part of our real
estate market. I’m an investor myself, as well as a real estate
agent. Most investors I know are honest people trying to make a
reasonable living. However, it’s important to realize when an investor
is your best option and when it is not.
When selling to an investor to stop foreclosure may be worth considering:
- The foreclosure auction is just around the corner:
If the foreclosure auction is less than two or three weeks away and you
don’t already have a retail buyer in place, an investor may provide the
best option (and possibly the only option) to stop foreclosure by getting the auction postponed while the bank evaluates their short sale offer.
- Your house is a fixer: If your house needs a
significant amount of repairs, a retail buyer may not be able to secure
conventional financing, and a cash buyer may be required. Investors
need to make a profit, and purchasing a fixer at a discount and fixing
it up can be a good way for an experienced investor to make a profit.
When a house needs a lot of repairs, the bank will often times accept a
larger discount in a short sale situation.
When selling to an investor to stop foreclosure may not be a good option:
- Your house is in good condition: If your house is
in reasonably good condition or only needs some minor cosmetic
upgrades, the bank may not be able to justify accepting a large
discount that an investor would typically require. The bank will
attempt to mitigate their losses, so they may feel that the house could
be sold to a retail buyer, thus reducing their loss on the loan.
- You haven’t received a foreclosure notice or the foreclosure auction is more than 60 days away:
If there is enough time to find a retail buyer, the bank may not be
willing to accept a heavily discounted offer from an investor. The
bank may believe that less of a discount would be required if the
property is listed for sale and sold to a retail buyer.
- Your loan is an FHA or VA loan: HUD is now using
a minimum threshold net receipt to lender percentage of the market
value as a basis for short sale approval on FHA and VA loans. For
example, they may accept a different minimum percentage of market value
depending on whether your home has been listed for sale less than 30
days, 30-60 days, or over 60 days. If the short sale proposal does not
achieve the minimum threshold, it will not be approved. If your home
hasn’t not been listed for sale and an investor offers to purchase it,
HUD may calculate the minimum amount that can be accepted based on a
time-on-market of less than 30 days, causing the bank to require a
higher net payoff.
Also, many investors offering to help stop foreclosure
are wholesalers. They don’t actually purchase the property
themselves. They “flip” the contract to another investor for a fee
(usually several thousand dollars). This means that they need to
negotiate a discounted payoff with your bank that’s low enough for them
to make their profit as well as the investor they’re flipping the
property to. The success rate of short sales in this situation is
fairly low, except when the house is in very bad condition.
If an investor claims to be a cash buyer, ask them for proof of
funds. If they’re negotiating a short sale on your home, they will
typically need to provide proof of funds to the bank to get the short
sale approved. If they really are cash buyers, they shouldn’t have a
problem providing proof that they can actually purchase your home. If
they don’t want to show you their bank account balance, sometimes
seeing proof of other recent cash property purchases they’ve made can
be sufficient.
While the information here may apply in most situations where an investor is offering to help stop foreclosure,
it’s difficult to condense all possible scenarios into a single blog
post and address every exception. I encourage you to seek legal
counsel from an attorney if you have any legal questions. Also, I
would be happy to share my experience if you contact me.
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 Do you qualify for a short sale? You may have determined that you
wouldn’t be able to sell your house for a high enough price to pay off
the existing mortgage(s), and you’re now considering a short sale. You
may be in foreclosure or just one or two payments behind, or maybe
you’re current on your mortgage but unable to continue making the
payments. You know you will not be able to stay in the home and you
need to get out from under the debt. First, make sure you know all of your options for avoiding foreclosure. I recommend downloading the special report, 8 Ways to Avoid or Stop Foreclosure, if you haven’t reviewed all of your options. Doing
a short sale will take some work and cooperation on your part, even if
you use a professional to assist you. However, the benefits of a
successful short sale compared to foreclosure are significant enough
that it should be well worth the effort. Here are some questions to ask yourself (and be honest):
- Do you have a legitimate hardship that prevents
you (or will soon prevent you) from being able to pay your mortgage?
Valid hardships include out-of-area job relocation, job loss, pay cut
or other income reduction, divorce, significant home repairs needed
that you can’t afford, and sudden increase in monthly expenses. There
are other acceptable hardships as well, but you will need to be able to
demonstrate to the bank that you cannot afford the house.
- Is your hardship short-term or long-term? If your hardship is
short-term (maybe you lost your job, but you were able to regain
similar employment a few months later), the bank may require that you attempt a loan modification or other workout plan first.
- Can you produce two months of bank statements, two years of tax
returns, two months of pay stubs, a personal financial statement (a
list of what you own, what you owe, your income and expenses), and
write a hardship letter when you put your house on the market? This could take a couple hours or more depending on how organized you are.
- Are you willing to review and accept a reasonable offer on your property within 24-48 hours of receiving it?
- If you’re still occupying the house, are you willing to allow the property to be shown at all reasonable times?
- Are you willing to do some basic things to help your house sell, like clean the house, de-clutter, and clean up the yard?
If a buyer expects a significant discount just because the house is a
mess, the bank may think they can better mitigate their losses by
foreclosing, cleaning up the property, and selling it at a higher price
as a bank-owned property.
- Have you filed bankruptcy? If so, you’ll need to ask your
bankruptcy attorney if it would be helpful sell the house in a short
sale.
If your hardship is caused by you moving out of the area, the bank
usually will not consider it a hardship until after you have moved. If
you’re being relocated in two months, the bank may not look at your
situation as being a hardship now.
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 Is a deed in lieu of foreclosure a viable alternative to foreclosure? I don't usually spend a lot of time discussing the deed in lieu of foreclosure option, because it isn't used very often for homeowners in Washington State, but several people have asked me about it recently, so I thought it would be something worth explaining.
With a deed in lieu of foreclosure, you give your house to the bank instead of going through the complete foreclosure process. This may seem like an easy way out, but it often isn't as easy as it sounds.
First, let's look at the primary advantage for the homeowner. If the bank agrees to accept the deed in lieu of foreclosure and agrees in writing not to pursue a deficiency judgment or put a foreclosure on your credit report, this could be a way to get out of the house and out from under the mortgage without the bank foreclosing.
However, there are a few things that you would need to consider:
- The bank will usually require that your house is listed for sale by a real estate agent for at least 60-90 days. They want to see that you’ve made an effort to sell it first. If there isn’t that much time before the foreclosure auction, this option may not be available to you.
- If you don't have enough equity, the bank may pursue you for more money.
- The bank may still record a foreclosure on your credit report.
- The bank will generally not approve a deed in lieu of foreclosure if there are any other liens against the property, including a second mortgage.
- The bank will usually require that the property is owner-occupied, not abandoned or an investment property. However, exceptions may include vacating the property due to job loss, job transfer, divorce, or death.
- You must be at least 31 days delinquent on your mortgage.
- You will usually need to prove a hardship (income reduction or increase in living expense).
- You would have to move immediately.
- There may be income tax consequences.
- You’ll most likely be on your own when negotiating with the bank, because the bank will rarely compensate an attorney or real estate agent for assisting you as they would in a short sale.
A deed in lieu of foreclosure is most beneficial for the lender in states where the foreclosure process is very long (usually in judicial foreclosure states where the lender is required to file a lawsuit against the borrower in order to foreclose). When foreclosure is a very long and expensive process for the lender, they would benefit by getting the property back several months earlier than they would have by foreclosing, and most likely in better condition (especially if the house is vacant). This would typically save them thousands of dollars in legal and administrative fees, and allow them to sell the property as a bank-owned property to get it off their books sooner.
Washington State is a non-judicial foreclosure state, and the foreclosure process only takes a few months. The foreclosure auction, or trustee sale, can be scheduled for roughly six months after the date of default, so the lender doesn’t have as much to gain from a deed in lieu of foreclosure. Also, lenders typically lose more money by taking a house back and selling it as a bank-owned property than they would from a short sale, which is one reason why they will usually require that you attempt a short sale first.
In some cases, the deed in lieu of foreclosure is a viable option. However, by knowing all of your options, you'll be able to make an informed decision and know whether this option is best for you.
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It's the Internet age, and more and more homeowners are searching the Internet to find out how they can save their home if they’re in foreclosure. One strategy I’ve been asked about several times is the “Produce the Note” strategy. Some articles have been written that have led many homeowners to believe that this strategy is the “silver bullet” to delay or stop foreclosure, or even get your mortgage wiped out completely so you own your house free and clear.
The “Produce the Note” strategy requires the lender to prove it has the actual authority to foreclose, by requiring it to produce the original promissory note. The goal is to make certain that the foreclosing lender is, in fact, the owner of the note. There is only one original promissory note for your mortgage that has your signature on it. This is the document that proves that you owe the debt.
During the lending boom, many mortgages were sold off to other lenders or servicer or sliced up and sold to investors as securitized packages on Wall Street. In the frenzy of turning these over as fast as possible to make the most money, many of the new lenders did not get the proper paperwork to show they own the note and mortgage. This is the key to the strategy—Lenders are foreclosing on homeowners, but don’t have the proper paperwork to prove they have a right to foreclose.
Sounds pretty simple--If they can’t produce the original promissory note, then you don’t really owe the debt, right? In Washington State (and other non-judicial foreclosure states), that’s not necessarily the case.
Judicial Foreclosure vs. Non-Judicial Foreclosure
In a judicial foreclosure state, the bank must sue the borrower and go to court in order to foreclose. The “Produce the Note” request is done as part of the lawsuit. Washington is a non-judicial foreclosure state, meaning that the lender doesn’t have to take you to court in order to foreclose. You can request that the bank produce the original note, but they’re likely to disregard the request completely, leaving you with only one other option--File a lawsuit against the lender and request that they produce the original note. This could become very time consuming if you try to do it yourself, or expensive if you use an attorney. I don’t recommend filing a lawsuit without the help of an attorney. Also, this strategy is more effective when your loan has been sold off on the secondary market. If it hasn’t, then your lender most likely has the original note and can easily produce it.
My Own Experience With Lost Promissory Notes
I have been in situations with my own properties where original promissory note was lost. I've worked with notes from private lenders and seller carry-back notes, and these non-institutional lenders sometimes lose the original note. The seller carrying back a note may scan the original note and Deed of Trust into their computer then discard the originals, not realizing that they were supposed to keep them. When the note is being paid off and the lender cannot produce the original note or Deed of Trust, the escrow company just has them sign and notarize an "Indemnification of Lost Deed of Trust and Original Note". Then everything is fine.
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 You’re a few house payments behind, and one day you find that the front door lock and deadbolt have been drilled out and replaced with new ones and the garage door opener has been disconnected. Now you can’t even get into your own house! Who is responsible for this? This must be illegal, right? After all, you still own the house.
Before you call the police (who will explain to you that they can’t do anything about it), you’ll need to understand that your lender isn’t trying to deny you access to your house. Here’s an explanation of what happened and why: The Deed of Trust (part of the mortgage documents from the lender) that you signed at closing or when refinancing has a paragraph that states something like, “If the Borrower fails to perform the covenants and agreements contained in this Security Instrument…” (i.e. making the payments), “…or Borrower has abandoned the Property, then Lender may do and pay for whatever is reasonable or appropriate to protect Lender’s interest in the Property… including securing and/or repairing the Property… including but not limited to… entering the Property to make repairs, change locks, replace or board up doors and windows, drain water from pipes, …” You remember reading that, right? (Let’s be honest now…) So the Deed of Trust, which identifies the property as collateral for the loan, allows the lender to change the locks. The lender typically contracts out to a national field service company which contracts out to a local independent contractor to change out the locks. Some field service companies have a policy to contact the real estate agent if there’s a sign in the yard and offer them a new key for the key box, and other companies have a policy not to contact the agent (which is a bad business practice in my opinion). The problem is that if the field service person calls the agent, it’s after the lock has been changed and damage done to the door and/or frame. Also, the field service person will often times keep the old hardware (which is usually nicer than what they replaced it with). I had a situation recently where the field service person removed a $150 lock set from the door, replaced it with a $20 doorknob, and refused to return the old lock set to the owner. What happens when they change the locks and don’t contact you or your real estate agent? Usually, calling your lender will get you the information needed to gain possession of the new key. However, some people just drill out the new lock and install a different one. This generally doesn’t take a locksmith—The doorknob can be easily removed once the door is open and replaced with another cheap model from a local hardware store. The next time the field service person goes out to check on the property and their key doesn’t work, they’ll typically call the agent’s phone number on the yard sign. If that happens, just remember that they were just following orders from the field service company and they often times may not agree with all of the company’s policies. They’re usually willing to work with you if you treat them with respect. Also, keep in mind that the local field service person may have to cover the cost of a new doorknob out of their own pocket if you drill out their lock. This may make it more difficult to get your old doorknob and lock set back from them if it has some value. The lender will take measures to secure the house if they believe it has been abandoned. They need to protect the asset that is securing the loan. If you mention to your lender that you moved or if your house looks like it could be vacant, the lender will generally take measures to secure the house. To assure that this doesn’t happen to you while you’re still living there, here are some things to consider: - Make sure the lawn gets mowed occasionally,
- Pick up flyers and newspapers from the porch and driveway,
- Park your car in the driveway instead of the garage,
- Think of anything else that could make the house appear to be occupied.
If you have already moved, locking the doorknob lock and leaving the deadbolt unlocked could prevent the risk of damage from drilling out the deadbolt. However, you may not want to do this if you still have valuables in the house or you’re in an area where the burglary risk is high. A damaged door could be a turn-off to some buyers if the house is otherwise in good condition, as it’s one of the first things they see. The bottom line is that there’s very little you can do to prevent the lender from changing the locks if your house is vacant and you’ve fallen behind on your mortgage payments. However, knowing the process and how to deal with it may help reduce stress levels if it happens to you.
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 Has a real estate agent offered to negotiate a loan modification or a short sale for you, or are you a real estate agent that has offered these services to your client? The purpose of a loan modification is to get the bank to modify the mortgage terms to reduce the interest rate and/or monthly payments on an existing mortgage. On a successful short sale, the bank agrees to take a payoff that is less than what is owed.
As a real estate agent in Washington State, I specialize in short sales. I’m not an attorney and I can’t give legal advice, so if you have any legal questions about the information provided here, I recommend that you seek independent legal counsel. If a real estate agent or another third party negotiates a loan modification or short sale, they may be practicing law without a license according to Washington State law. The Washington State Supreme Court adopted General Rule (GR) 24 in 2001, defining the practice of law, which includes negotiation of legal rights or responsibilities on behalf of another entity or person(s). Anyone negotiating with the borrower’s lender on their behalf is negotiating the legal rights and responsibilities on the borrower’s original loan agreement with the bank, which would fall under the Supreme Court definition of the practice of law. Some real estate agents use a third-party short sale service to negotiate short sales on behalf of their clients. Under the same rules, the third-party short sale service would need to use negotiators that are licensed to practice law (i.e. attorneys). Most don't. I know there may be some real estate agents that are furious as they’re reading this, thinking that this cannot be true they’ve been negotiating their own short sales for months or years and they’ve never heard of this. However, just because you aren’t aware of it doesn’t mean it doesn’t exist and that it cannot affect you. Also, if you’re not in Washington State, you may not be off the hook. Other states most likely have similar laws, so I would encourage you to check your own state laws. Attorneys are currently using the Washington State Supreme Court General Rule 24 mentioned above as a primary argument against real estate agents and investors in lawsuits when a short sale client is unhappy with the results of a short sale. In one case I’m aware of, an agent outsourced short sale negotiations to a third-party short sale service that wasn’t attorney-driven. The short sale was approved, but after the transaction was complete, the seller claimed that they weren’t aware that they were still liable for the deficiency-- the difference between what the bank was owed and what they received from the short sale. (Short sale negotiators will usually request that the bank forgive any deficiency.) The seller sued the real estate brokerage and named the third-party negotiation service in the lawsuit. The settlement ended up being paid by the broker’s errors and omissions insurance. This is an example of a case where there may have been failure to properly disclose all material facts, but you could potentially be a target of a lawsuit even if you did everything correctly but weren’t able to produce the desired results for the seller. The seller’s attorney playing the “unauthorized practice of law” card could kill your case regardless of whether there was any wrongdoing on your part. Now I’ll also mention that there’s an unwritten assumption that real estate agents are allowed to negotiate a short sale as part of the real estate transaction. However, real estate agents are licensed to perform limited real estate law which involves filling in the blanks on pre-written real estate forms and contracts. I have not found anything in our laws stating that a real estate agent can negotiate a borrower’s legal rights and responsibilities with their bank, even as a part of the real estate sale transaction. The Promissory Note and Deed of Trust are legal contracts between the borrower and the bank. I use an experienced attorney to negotiate all of my short sales. I wouldn’t consider doing it any other way. Also, using an attorney with significant short sale experience is imperative. A good attorney will have proven negotiation strategies that may only be available to an attorney. They’ll also be familiar with the different loan products and the loss mitigation rules associated with those loan products (which even the banks’ loss mitigators are often not aware of). An inexperienced attorney will typically have a much lower short sale approval rate. I know there are a lot of real estate agents negotiating their own short sales, and in my opinion, this carries less risk than outsourcing to a short sale negotiation service that’s not attorney-driven. It’s not my place to tell other agents what they can and can’t do. However, I think it’s important for agents to understand their risks, and to make their own decisions based on the level of risk they feel comfortable with. I tend to have a low risk tolerance, so my business model reflects that.
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