As a preliminary note to the reader, please understand that this article is about short sales and discusses related topics such as foreclosures and is simplified for ease of understanding and omits more technical yet still very important information that is critical if you are a party to a short sale transaction. This article is not intended to be legal advice and should not be relied upon if you are or may be a party to a short sale transaction.
A depressed real estate market has given rise to a many unfortunate situations (or depending on your point of view, opportunities) where properties may be worth less than the mortgage. The term “mortgage” means a lien or encumbrance on a property that secures repayment of a loan. Typically, the mortgage is held by a bank and in some cases, it can be securitized. When a mortgage has been securitized, this generally means that a number of loans secured by mortgages are sold by the original lender, sometimes called the originator, bundled together, and sold to investors. The investors usually receive a certificate evidencing their interest in the mortgages. When a loan has been securitized, there is typically one person designated to represent all the investors and this person is called a special servicer. The special servicer is usually responsible for holding the original loan documents and for receiving the mortgage payments and distributing them to the investors.
Suppose a bank or special servicer has a loan where the property is worth less than the unpaid balance of the loan and the owner wants to sell the home. Under such circumstances, the bank or special servicer might be willing to allow the home to be sold short of or sold for less than the unpaid balance of the loan. This would be a short sale. The “short” means the property is short or worth less than the unpaid balance secured by the mortgage. Typically, a short sale involves three parties, the owner or seller (who is the borrower), the bank and the buyer. If you plan via a short sale to purchase residential property in foreclosure as a second home or as an investment, Colorado law regulates how the sale will take place.
In situations where the property is worth less than the loan balance, the owner may have stopped making payments. There can be various reasons for a borrower to stop making payments even if the property is worth more than the loan balance (e.g., loss of employment, divorce, etc.). When payments stop for whatever reason (and subject to certain Colorado statutes regarding foreclosure deferment), the bank may decide that it needs to obtain title to the property. Typically, banks obtain title to the property through a procedure called a foreclosure, which generally means a public sale of the property to the highest bidder. Each county in Colorado has an official called a Public Trustee who conducts the foreclosure sale. When the foreclosure sale occurs, the bank’s bid is often the unpaid balance of the loan; however, where the property is worth less than the loan, the bank may reduce its bid to the value of the property. The difference between what the bank bids in at the foreclosure sale and the unpaid balance of the loan is called a “deficiency”. For example if the property is worth $10 but there is $15 due on the loan, the bank will bid $10 at the foreclosure sale and the difference of $5 is the “deficiency” for which the borrower remains liable (unless the bank agrees otherwise). Unlike Colorado, some states do not allow a deficiency to be taken against a borrower. If the bank is the successful bidder at the foreclosure sale, it becomes the owner of the property. If a third party is present at the sale and offers to pay more than the bank’s bid, the bank gets the money and the third party becomes the owner of the property. Many but not all short sales occur while the property is “in foreclosure.” By the words “in foreclosure” we mean the period of time between when foreclosure proceedings are first commenced and when the foreclosure sale actually occurs which in Colorado for non-agricultural property is between 110 and 125 days.
The Colorado Foreclosure Protection Act (the “Act”) includes provisions that regulate short sales to second homeowners or speculators of residential properties. The Act does not apply to commercial property and the applicable provisions regulating short sales to second homeowners or speculators do not apply where a person acquires the property as a personal residence or where a person buys the property at a foreclosure sale. Further, the Act does not apply unless the property is already “in foreclosure”. Where the Act does apply, a buyer can comply with the Act by simply attaching to the offer to buy the property an approved form promulgated by Colorado’s Real Estate Commission called a “Short Sale Addendum” or by adding provisions to the offer that comply with the Act. The requirements of the Act include a three (3) day right of rescission in favor of the seller (i.e., the homeowner/borrower). If you are buying or selling property in a short sale, it is recommended that you consult with an attorney regarding your rights and obligations and the proper documents that should be used.