How the Short Sale Arm’s Length Can Backfire on a Seller

Some Sacramento short sale sellers could be headed for a big surprise down the road after signing an arm’s length. I know this because I’ve talked with a Sacramento short sale agent here and there who see nothing wrong with letting the parties to a short sale make agreements outside of the closing. They can agree to all sorts of things that are against the law and without the bank’s knowledge, but a common happenstance is over possession. Sellers sometimes have a hard time moving so they want to rent back, but most of the short sale arm’s length agreements prevent a rent back. Therein lies the problem.

Now, you can ask the bank for an extension but a short sale extension is not always possible. Especially if the bank has already issued an extension. A bank is not always eager nor willing to issue a second extension. I’ve had banks say they would close the file and start the short sale over. In some instances, that solution would be OK with a seller because not every seller is in a rush to move — especially if the seller isn’t making a mortgage payment. Free rent doesn’t come along every day.

I can tell my sellers we are closing on a certain day but that doesn’t necessarily mean they understand that they have to move out. Doing a short sale is an overwhelming process for many people. Each is different and can be convoluted, so it’s sometimes difficult to predict what a seller may or may not understand. But one thing is for certain. If a seller violates an arm’s length agreement and works out some kind of rent-back with the buyer, it might seem innocent but it can cost the seller big-time. If the parties agree to a lease back, for example, and the arm’s length prohibits such a lease back, it’s possible the bank could rescind the deficiency waiver.

There is a little clause in CA Civil Code 580e that says the deficiency waiver does not apply in the event of mortgage fraud. If a seller intentionally defrauds the bank, the bank might demand that all of that forgiven debt be repaid. Apart from the ethical implications, there could be legal ramifications and consequences to violating the arm’s length. My advice is just don’t do it. Don’t go through the headache and heartache of a short sale just to end up with the deficiency back in your lap.

It’s in a seller’s best interest to plan to move out on or before closing in a short sale. The agents don’t set the closing date, the banks do. And right now, because of the expiration of the mortgage debt relief act, many approval letters are coming in with fewer than 30 days to close. Everybody and their uncles are trying to hit that December 31 closing date.