1. Short Sales in 2010: Navigating Confusion
By Joel Broyles
Lonergan Law Firm, PLLC
12801 North Central Expressway
Suite150
Dallas, Texas 75243
www.lonerganlaw.com
In today’s real estate environment of flux and uncertainty, the topic of short sales seems to elicit plenty
of discontented groans. While there are many reasons for such reactions, the situation could be far
worse, and in our estimation, it will be. We offer this article as a means not to make the process simpler
– nobody can do that – but rather, to deconstruct the moving parts and then reassemble them piece by
piece. We want to show you how this black box really works, and why it often doesn’t.
Grab some coffee and roll up your shirt sleeves.
What is a Short Sale?
Technically, this is the process of negotiating the reduction of a payoff to a promissory note attached to
real property via a mortgage, deed of trust, etc. for the purpose of a release of lien(s) to allow for an
insurable transfer of title. Simply put, it’s getting a bank to take less than they’re owed so a homeowner
can sell their home for less than full payoff – “short” of what they owe. Remember, the “mortgage” is
just the glue that holds the debt to the asset. We’ll talk about the importance of this distinction and its
implications to future liability later.
Why do banks do that?
The lien holder or their agent – the servicer – attempts to mitigate further, larger losses through an
agreement today in lieu of foreclosure sometime in the future. That is, a bird in the hand beats a
foreclosure. While this is conceptually straightforward, it’s remarkably difficult in practice. We won’t go
into net present value calculations in this article, but the idea that a dollar today is worth more than that
same dollar in the future guides the short sale decision‐making engine.
What do short sales look like?
Short sales can manifest in a thousand unique ways, but there are some attributes present in every
instance. Knowing these traits can then guide our ability to uncover what the true financial picture looks
like for a homeowner. To simplify, we’ve broken into two groups the attributes which comprise a good
short sale situation: (1) the loan details and (2) the borrower details.
Loan Details

2.  Current interest rate: if a borrower has a 9% interest rate in a 5% environment, ask why
 Down payment amount: if a borrower has less to lose, they’re more likely to
 Time since purchase: most foreclosures happen in the first few years.
 Servicer/Investor: not all mortgages are serviced equally.
First, let’s discuss the typical short sale loan: An interest rate markedly above current rates
demonstrates that the borrower cannot refinance; the borrower has most likely and unsuccessfully tried
to do so. This could be due to credit problems, underwater value, lack of income to procure a new loan,
etc. Statistics guide the next two characteristics. If a borrower puts no or little money down on a
purchase or refinance, they’re statistically more probable of going into foreclosure. Tangential to a low
down payment (due to the subprime and alt‐a era) is the time since the last origination. That is, the
amount of time since the borrower purchased or last refinanced the home. Predominately, we see
borrowers heading to foreclosure in the first five years since their last origination. Finally, let’s review
the quality and manner in which the loan was serviced. While we all hope for excellent loan servicing,
the reality is that loan servicers often play a large role in the resolution of the loan breaking down.
If a borrower has a difficult loan servicer, then the longer the resolution time and the more frustrated
the borrower will be with the servicer. Ironically, these same servicers are quick to trigger a foreclosure
because it is easier to foreclose than to properly service the loan. Further, different investor types have
drastically different underwriting guidelines for accepting a short sale offer. We will discuss
underwriting guidelines later in the article. By knowing these attributes of the loan, we can predict with
higher certainty the likelihood of this borrower needing a short sale.
Borrower Details
 Geography: market values have some impact on short sales, but less than you think.
 Hardship: a financial hardship must be caused by a real‐life hardship, not a decline in home
value.
 Income: a demonstrable, verifiable reduction of income.
Next, let’s review the borrower profile. We understand that California and Florida steal the headlines
when it comes to declining home prices, but that doesn’t mean homes in relatively stable markets don’t
fall into the short sale classification. Any time a home cannot sell and yield a full payoff to the lien
holder(s), a short sale is required. Whether the shortage amount is $10,000 or $100,000, the processes,
negotiations and results are quite similar.
The real‐life reasons, on the other hand, tend to be very different. Often, these are undervalued if not
completely overlooked. While nobody wants to lose his or her home, there is a real‐life reason that
causes an individual or family to sell. Understanding what this real‐life reason is will help us know if the
situation is temporary – such as the loss of a job for a few months – or permanent – such as a death or a
divorce. The temporary reason can be a legitimate short sale hardship if the replacement income is less
than what the previous job was earning. In fact, in all cases, a non‐recoverable financial hardship will
satisfy the lender’s requirement that a real hardship exists. However, a situation that does not qualify

3. as a real‐life hardship is a home underwater by $100,000, owned by a doctor making an annual salary of
$300,000, and fully capable of making payments.
The Underwriting Process
When the short sale process begins, just like when the borrower applied to obtain the mortgage in the
first place, the short sale requires fully documented underwriting of financial information. Ideally such
information was fully documented when the loan was originated. During this underwriting process, the
demonstrable reduction of income must be proven. In order to be considered a real short sale
borrower, an individual must have a reduction of income to the degree that it becomes untenable to
continue making payments. Here again, each investor or bank will have different guidelines. As was
the case with loan details, knowing the nuts and bolts of a homeowner’s financial situation can help us
determine if this borrower is in need of and would qualify for a short sale.
In the next part of the series, we’ll cover the complex and esoteric relationship between investors and
servicers and how that relationship dominates the short sale process and therefore, the results.
Part II
The Servicer/Investor Relationship
Aside some technical exceptions, perhaps the most important factor that influences the success of an
individual short sale transaction is the contractual relationship between the servicer and the
bank/lender/investor. Strangely, this relationship is not only misunderstood but one that most
borrowers, realtors and buyers are unaware exists. Therefore, let’s illuminate this relationship and
understand how it functions.
Typically, investors don’t get their hands dirty by servicing the mortgage assets they own. As a result,
they tend to employ large retail banks and mortgage servicing firms to handle the payment collection,
taxes, insurance, payoffs and default mitigation. That is, lenders/investors loan the money and collect
their principal and interest, while some other entity interfaces with the borrower. These investors
come in all types: individuals, companies, hedge funds, governments, pension funds, etc. Their core
business is the allocation of capital, not the day‐to‐day maintenance of mortgage assets. At the same
time, large retail banks and mortgage servicing firms (collectively, we’ll call them “servicers”) have
recognized that servicing the nation’s mortgages can be a profitable business in its own right. Thus, the
two form a mutually beneficial relationship.
But how do millions of mortgages get serviced without the servicer calling the investor each and every
time a decision needs to be made regarding a single mortgage? Contractual servicing agreements spell
out and manage all aspects of the investor/servicer relationship. To make the relationship efficient,
specific guidelines dictate what can and cannot be done for a particular mortgage, mortgage‐backed
security or other type of collection of mortgages.
In reality, less than 20% of all mortgages are both owned and serviced by the same entity. So when a
borrower says, “My lender is Bank of America.”, a more likely scenario is that the borrower’s servicer is

4. Bank of America, while the actual investor/lender of the loan is unknown to the borrower. Sometimes a
borrower may be confused when an investor buys or sells the asset. As a result of such a transaction,
the servicer can and many times does change. Now that we have a better understanding of the
relationship between the investor and the servicer, we can better understand why a borrower may face
such confusion in the event of a purchase or sale of the mortgage asset. Note, investors actively buy
and sell assets within their community, and the servicing often changes along with the sale. Such a
change of servicer can manifest in multiple ways, but the end result and process for servicing remains
the same.
To compound matters, a particular servicer will likely service mortgages for numerous investor types,
each with their own set of guidelines on how their particular assets can be and cannot be managed. You
can see how such a situation quickly becomes complex and why servicing firms are constantly having to
make sure they maintain compliance with their own agreements.
Now that we understand how and why the relationship exists between investors and servicers, we can
apply this framework to short sales. When a borrower becomes delinquent on his or her mortgage, or
demonstrates a reasonable foreseeability that he or she will be delinquent in the near future, a servicer
has specific underwriting guidelines as to how it must manage and respond to that loan. These rules
govern everything from the occupancy status, income, valuation, delinquency, marketing period,
hardship qualification, net acceptable payoff calculation, realtor commissions and many other factors.
By knowing the particular type of investor (private investor, government investor, etc.) behind the loan,
we can determine what kind of guidelines we will need to meet in order to transact a successful short
sale. Though some guidelines are public – FHA, Fannie/Freddie, VA – many private investors keep their
guidelines unpublished and tightly held between themselves and their servicers. Over time, however,
the majority of private investors have emulated one another’s best practices, so by reverse engineering
enough approved transactions, we can estimate a close range of guidelines for non‐GSE mortgages.
The scope of this article is too narrow to go into these specifics, but the important point is knowing that
not all short sales fall into a standardized set of guidelines.
Current Issues
Recently the federal government has started a government‐based approach to short sales. Home
Affordable Foreclosure Alternatives (HAFA) began in April of this year as an attempt by the US Treasury
to help speed up and lessen the confusion of short sale transactions. It is far too early to tell what the
results from HAFA will be, but we certainly welcome any attempt to make the process more efficient.
HAFA is designed to help borrowers who were ineligible for the Treasury’s HAMP (modification)
program to employ a short sale or simply give back their home to the lender (deed‐in‐lieu) to solve their
delinquency. Note that a deed‐in‐lieu has no specific benefit for the borrowers other than those
outlined in HAFA, which also apply to short sales. By far the better solution for both the homeowner
and the lender is the short sale, as the short sale is more likely to reduce the deficiency amount – the
amount of the loan unpaid after the transfer of title.

5. Additionally, a house that is a short sale candidate is less likely to be a vacant because the bulk of short
sale sellers remain in the home until it is closes, just like a regular real estate transaction. As a result,
the cost of vandalism and maintenance are reduced, and the community weakens less. Again, the
scope of this article doesn’t lend itself to outlining full HAFA guidelines, but they can be found online.
Here are a few of the highlights:
 Waiving of deficiency judgment option by lender (more on this in Part III: Liability)
 Up to $3,000 to borrower at closing for moving expense
 Must be borrower’s primary residence
 Must have been originated before January 1, 2009
 Must be listed by a real estate agent
 Mortgage insurance company must waive any right to deficiency judgment or promissory note
Part III
Liability: Servicer, Borrower, Agent
Mortgages are litigious instruments. When they lose money, the blame becomes amplified, and
litigation ensues. This leads us into the liability section of short sales. By its very definition, the short
sale is a purposefully accepted loss of money on a mortgage asset. That loss has the potential to raise
legal liabilities for the servicer, borrower and agent involved in the transaction.
Servicer Liability
Having an understanding of the investor/servicer relationship gives us a foundation for discussing the
potential liability that rise for the servicer. The servicer employs hundreds if not thousands of people
who navigate guidelines and execute the day‐to‐day operational needs of its short sale department. In
recent years, the demand for servicing short sale transactions has grown significantly. As such, an
increase in hiring and the re‐allocation of existing workers have acted as a temporary measures for short
sale negotiators, processors and managers inside the loss mitigation departments of major retail banks,
mortgage banks, and mortgage servicing firms. However, the training doesn’t always match real‐world
needs or pressures.
When employees of servicers conduct real‐world transactions, two things tend to happen: mistakes
occur as a result of the fear of making mistakes, and the short sale is frozen or foreclosed upon. That is,
when a new processor, negotiator or manager (each of these works for the servicer) faces a problem
which he or she does not know how to solve, most of the time no action is taken or worse, the file is
sent to foreclosure due to some ambiguous reasoning. The reasoning is hard to pinpoint and therefore
the blame is hard to assign. Neglect, therefore, is perhaps the single largest potential source of liability
for a servicer. If investors knew what truly occurred in the servicing of their assets, there would be a
paradigm shift in how the mortgage world functions and likely, a tremendous reduction in the number
of mortgages originated. Though hard to isolate, neglect is a very real servicing liability.

6. Proof of servicer liability is more readily found by examining the guidelines. The best way to explain this
is by way of an example. Assume an investor owns a note for $500,000, and the guidelines for an
acceptable short sale state that the investor will take 85% of the fair market value. Now suppose that
the fair market value is $400,000. Then, per the guidelines, the servicer would be allowed to accept
$340,000 as payoff on the short sale. If, however, the new or inattentive negotiator issues an approval
letter and subsequently closes the transaction with , for example, a net payoff of $338,000 we have a
problem. In this case, the investor has a number of options to seek to a remedy from the situation.
Though $2,000 doesn’t seem like a lot of money on any particular transaction, the reality is that tens of
thousands of short sales transact each month and the losses can add up quickly.
Borrower, Agent Liability
The improper handling of loans by servicers has come to light in the last few years and will continue to
create anxiety for loss mitigation departments. But they’re not the only ones who stand to inherit
liability with short sales. Borrowers and real estate agents have risks in short sales as well.
We initially covered the distinction between debt (the promissory note), glue (the mortgage or deed of
trust) and asset (the house). That is, the money owed on the home is attached to the home by way of a
mortgage. Unless specifically agreed upon in writing, the promissory note can act as a ticking financial
time bomb. The amount the investor is owed versus the amount they receive at the closing of the short
sale is known as the “deficiency amount.” This is, specifically, the amount that is owed on the
promissory note, which remains unpaid at the conclusion of the transaction. A common misconception
among borrowers and real estate agents is that the short sale agreement is the end of the story.
Sometimes what that agreement lacks can be the beginning of a much more frightening story.
The potential legal nightmare of short sales is the deficiency judgment. When a bank, investor or
mortgage insurance company (an MI company can effectively be viewed as the investor in cases
involving MI), seeks to recoup the balance owed on the promissory note, they can take legal action
against the borrower. In turn that borrower will often seek action against the agent for lack of
disclosure, among a handful of other possible choices. The borrower’s accusation will likely state that
had the agent known, the agent should have informed the borrower of the risk of deficiency judgment
action by their lender and given the borrower an opportunity to seek legal counsel for help in the
decision making process moving forward on the sale of the home.
Though the deficiency cannot always be negotiated away, it is possible to avoid this unpleasant
situation. By obtaining language in the written short sale approval letter regarding full settlement of
debt, the borrower and agent can know that the mortgage investor has waived their future rights
towards a deficiency judgment. In cases where investors do not release their rights to future deficiency
judgments, the agents and borrower should communicate thoroughly about the potential
consequences.
Conclusion

7. We have covered a lot of material and given the high‐level view for understanding the multi‐faceted
mechanism of short sale transactions. There’s a plethora of knowledge regarding this ever‐changing
niche as it continues to expand and demand our constant acquisition and sharpening of skills. It is our
hope that you will use this paper to further your understanding of a sometimes mysterious apparatus.
While no one can claim to know everything given the complexities and speed of changes, our expertise
in the area can help guide and protect you through your next short sale transaction.
LONERGAN LAW FIRM, PLLC
12801 N. Central Expressway
Suite 150
Dallas, Texas 75243
214‐503‐7509
214‐503‐8752 facsimile
www.lonerganlaw.com