According to ManageCasa data from 2019, the median price of a home in California is $575,160, with homes lasting about 31 days on the for-sale market. Long story short, a cocktail of low supply, low interest rates, as of early 2020, and huge housing costs makes the Golden State's real estate market a grab bag of good and bad. And short sales are a mixed bag of their own. While short selling a home can effectively stave off foreclosure and help the seller get back on the path to stabilizing finances, credit scores usually take a substantial hit, and the seller may find it difficult to buy another home in the aftermath.
What Is a Short Sale?
Whether you're in California, Colorado or Connecticut, a short sale of a home is the same thing: It's what happens when a home is sold for less than what is owed on the mortgage loan at the time of the home's sale. Short sales only occur when the outstanding mortgage balance is greater than the home's current market value. In typical short sales, the sale price is roughly comparable to how much the home would net in a foreclosure sale.
To move forward with a short sale, the homeowner — in this case the mortgage loan borrower — must express to her mortgage lender that she is legitimately enduring financial hardship, and she must eventually provide various forms of documented proof of the circumstances. If the borrower is eligible for other methods offered by the lender to potentially catch up on her mortgage payments, such as refinancing the mortgage loan, forbearance or some other form of loan modification, the lender might not approve the short sale in favor of these options.
The Short Sale Process
When a short sale of a home does become the option on the table, the mortgage lender must approve the short sale and agree to ultimately accept the lower sale amount as the full and final payment on the mortgage loan. So, yes, it is a financial loss for the lender, but lenders often find that losses are preferable to the alternative: foreclosure of the home. It's worth noting, however, that in California, lenders are not required to approve a short sale or accept a loan payoff for less than the amount owed.
When the lender does approve of the short sale, the homeowner and lender work out a timeline together, which will, of course, be greatly expedited if the home has already entered pre-foreclosure proceedings, and even more so if the foreclosure sale date has already been set, as short selling is a foreclosure remedy. From here, the typical short sale process looks something like this:
- The seller submits required paperwork to the lender to prove hardship, usually including documents like the last two years' tax returns, recent bank statements and pay stubs, and a hardship letter.
- The seller or agent orders a title report to ensure that the home does not have multiple liens against it, such as a second mortgage or a home equity line of credit, which can delay or inhibit a short sale, as each lien holder must agree to the short sale.
- The seller and/or agent set a price for the home, typically based on current market value or appraisal.
- The home is placed on the market, with the homeowner often working alongside a seller's agent to advertise and show the property to prospective buyers.
- Once offers are made, the seller reviews and ultimately chooses an offer.
Short Sales: The National Landscape
In the big picture, short sales in 2020 in California are a relatively uncommon way to sell a home, as they often result from life events and hardships that cause genuine upheaval, resulting in a homeowner's inability to pay the mortgage, even with whatever financial remedies the lender can offer. Nationally, U.S. News and World Report notes that 18 percent of single-family home sales were short sales in 2009 at the peak of a historic housing crisis, but by 2018 short sales made up only 1 percent of all home sales in the United States due to the rising values of many home markets across the country.
Short Sales in California
In comparison to the national landscape, short sales in California are similarly scarce in 2020, but may be on the rise once again. In 2013, roughly five years following the point that Los Angeles Times writer, Alejandro Lazo, says "housing prices first went off the cliff," short sales of homes actually surpassed the number of foreclosed homes. After a period of some stabilization, Intempus Property Management reports in 2019, the number of homes in California that were underwater — meaning the homeowner owes more on the mortgage balance than the total value of the home — had increased for the first time since 2009.
While neither of these trends guarantees that short sales will increase in number, factors such as these naturally put homeowners in a more likely position to make short sales in an effort to avoid foreclosure. Reflecting broad real estate trends, California isn't alone; this, too, may be indicative of national real estate trends.
Short Sales in California: Anti-Deficiency Laws
The state of California has more than a few things to say about short sales, legally speaking. In 2011, legislation sponsored by the California Association of Realtors came into effect, particularly regarding short sale deficiencies. A deficiency, in this case, is the difference between the amount of the loan owed and the amount received or collected when the loan is closed. A deficiency judgment is a court ruling that places a lien on the debtor for the collection of that deficiency. So in terms of short sales, a deficiency judgment makes the former homeowner personally liable for paying that difference. They can face consequences such as garnished wages, major hits to their credit rating, or even liens against other property they own.
Perhaps most important, state law prohibits mortgage lenders in California from collecting a deficiency or obtaining a deficiency judgment for a short sale involving any loan secured by a one-to-four residential unit property — real estate lingo for a property with one to four residential units. California Code of Civil Procedure Section 580(e), doesn't end with short sale deficiencies. It also prohibits lenders from requiring borrowers to pay any additional compensation to attain approval for a short sale, apart from the proceeds of the sale itself. In passing this law, SB 458, California legislators aimed to ease the impact of the then-current foreclosure crisis, protecting short sales as an alternative to foreclosure. Before Senate Bill 458, Senate Bill 931 had the same effect, but was only temporarily valid from 2009 to 2010; the newer bill makes these protections permanent.
Protection From Liability in California
While SB 458's anti-deficiency protections help protect Californians from even more impactful financial fallout after a short sale, sellers must meet numerous qualifications to be protected from personal liability for a short sale deficiency. These qualifiers include:
- The mortgage loan must be solely secured by a deed of trust or mortgage.
- The mortgage loan must not be for a dwelling unit of more than four living units.
- The borrower must sell the property for less than the current outstanding loan balance.
- The mortgage lender must provide written consent for the short sale.
- The title must voluntarily transfer to a buyer via grant deed or other document of conveyance, which must be recorded in the county of the property's sale.
- The proceeds of the sale must be tendered to the lender of the lender's agent.
While California anti-deficiency protections broadly apply to properties with up to four residential units and do not specifically extend to properties like commercial units or vacant lots, some legal experts interpret the law more broadly. For instance, the fourth edition of "Miller & Star California Real Estate," the most widely used and judicially recognized real estate treatise in California, says that "the anti-deficiency legislation applies to preclude a money judgment against the trustor even when there has not been a foreclosure sale under either a senior lien or the lien securing the purchase-money note.”
Anti-Deficiency Exceptions in California
Similarly, certain factors exempt Californians from anti-deficiency protections under particular circumstances. Situations that exempt sellers from these protections following a short sale include:
- Waste to the real property, defined as harmful or destructive use or physical impairment of the property by someone in its rightful possession performed in an unreasonable or improper fashion.
- Cross-collateralized loans.
- The borrower is a corporation, limited liability company or limited partnership.
- The borrower is a political subdivision of the state or any state government entity.
Short sale anti-deficiency protections also don't apply to deeds of trust, mortgages or other liens securing the payment of a bond, if there is otherwise evidence of indebtedness authorized by the local Commissioner of Corporations, or to deeds of trust, mortgages or other liens made by a public utility per the state's Public Utilities Act.
California Law: Home Foreclosures
Senate Bill 458's anti-deficiency protection measures also apply to home foreclosures in California, but there are some differences compared to how the law affects short sales of homes. In the case of a short sale, California's anti-deficiency protection normally applies to all deeds of trust on any residential property with up to four living units, whether the home is owner-occupied or purchase-money mortgaged.
When it comes to foreclosures, though, state law ensures that there can be no deficiency judgment after foreclosure of a purchase money, owner-occupied loan for a property with up to four residential units. Deficiency judgments also cannot occur after a nonjudicial foreclosure or after a foreclosure for selling financing, per California Code of Civil Procedure Sections 580(b) and 580(d).
Advantages of Short Sales
One key reason for the relative rarity of short sales among the housing market is that they often serve as something of a nuclear option for homeowners at risk of foreclosure. In addition to staving off foreclosure, a short sale can, at least comparatively, make it easier for the seller to take out a new home loan moving forward. Foreclosure and alternatives like deed-in-lieu of foreclosure can make the foreclosed homeowner ineligible for mortgage loans for a period of up to seven years. A short sale, on the other hand, leaves the seller eligible within four years, or as little as two years in some exceptional cases.
Disadvantages of Short Sales
Despite these very real advantages, the short sale option is an inherently risky route for sellers to take. For one, if the process ends up taking too long, and the home isn't sold in time, the lender might be able to go through with the foreclosure proceedings against the home. And even if the short sale is successful, the difference between the sale price and how much mortgage debt the seller actually owes on the home is considered forgiven debt, which is reported to the Internal Revenue Service. This amount can be taxed as income unless the seller qualifies for exceptions available if the short sale was a primary residence, but is not available for second homes.
Short sales are also a significant negative credit event, commonly resulting in major damage to credit scores, which scale in severity depending on the short sale's deficiency and can mark the seller as a future risk to lenders. Speaking to U.S. News and World Report in 2018, National Association of Realtors president Elizabeth Mendenhall echoes these risks. She put it quite succinctly when she says of short selling, "This is a last resort that most homeowners try to avoid."
- U.S. News and World Report: How Does a Short Sale Work?
- ManageCasa: California Housing Market Report and Predictions 2020
- Lund Team: Short Sale: Common Legal Answers
- Investopedia: Deficiency Judgment
- FindLaw: California Code of Civil Procedure Section 580
- Nolo: What's the Difference Between a Recourse and Nonrecourse Loan?
- Law Library – American Law and Legal Information: Waste
- First Tuesday Journal: California Home Sales Volume Lays Low
- Los Angeles Times: Short Sales in California Surpass Sales of Foreclosed Homes
- Intempus Property Management: For the First Time Since 2009, More California Homes Are Underwater
- Miller Starr Regalia: The Book