More Lenders Are Accepting Losses on Short Sales-Condominium Associations Shouldn’t

Published on: August 20, 2009

As the housing market malaise lingers, more struggling homeowners are turning to short sales as an alternative to foreclosure.  In a short sale, the lender allows the owner to sell the home for less than the outstanding mortgage, writing off the difference as a loss. Because the loss on a short sale loss can be 30 percent less than the loss on a foreclosure, banks are becoming more receptive to this option.  The National Association of Realtors estimates that 11 percent of the home sales in June were short sales; media reports indicate that number is increasing.  

We’re seeing this trend in the condominium associations we represent, where, reversing the balance from just a few months ago, short sale transactions now outnumber foreclosure auctions.  But short sales raise unique questions and pose particular challenges for community associations. 

As in any real estate transaction, the purchaser in a short sale requires clear title to the property, which, in a condominium sale, includes the assurance that the condominium fees have been paid.  Condominium owners who fall behind on their mortgage payments usually fall behind on their common area fees, as well.  Association boards are often asked to waive these payments so the short sale can go through unencumbered by the delinquency.  In most cases, my advice to boards is, “Just say no.”

No Reason to Blink

This isn’t mean-spirited, it is pragmatic — a matter of fairness to the other owners and essential to protect the interests of the association.  The priority or “super lien” in effect in Massachusetts and 16 other states, guarantees the right of condominium associations to collect up to six months in delinquent common area fees from the owner or from the lender who forecloses on the mortgage.  If the association refuses to waive delinquent common area fees in a short sale, two outcomes are possible:  The sale will go through anyway, in which case the association will collect the unpaid fees from the sale proceeds; or the sale will fall through and the lender will foreclose, at which point, the association will collect the amount due.  The association gets paid either way.  It’s like playing poker with a great hand.  There is usually no reason for the board to blink, hence my “no-waiver” advice. 

As with most rules, there are some exceptions.  I encountered one recently when the delinquent payments owed to the association included a $20,000 special assessment. Because the super lien does not cover special assessments, a foreclosure would have wiped out the entire amount.  Faced with that prospect, the association agreed to contribute $1,000 toward the closing, the short sale went through, and the association collected the remaining $19,000.

Waiving a small portion of the delinquent payments clearly made sense in this case, but fairness to other owners usually requires rejecting these requests.  Why should owners who are paying their share of the association’s expenses be required to make up the difference for those who do not?  This penalizes owners who didn’t do anything wrong for doing everything right.

Who Approved the Loan?

The lenders or real estate brokers requesting short sale fee waivers will usually argue that the owner is losing his/her home and any equity in it while the lender is being forced to take a haircut on the mortgage; the condominium association, they suggest, should also share in the loss.  But why?  The board was not a party to the original transaction. It didn’t check the borrower’s credit or approve a loan the borrower couldn’t repay.  The board had nothing to say about the loan and no authority to prohibit the buyer from purchasing a unit in the community.  There is no reason the community association should get stuck holding this bag or any portion of it. 

A short sale theoretically might benefit an association if it can be completed more quickly than a foreclosure.  Getting a new owner in place will stabilize the association’s cash flow and, with winter approaching, reduce the risk of frozen pipes in an unoccupied unit.  But there is no guarantee that a short sale will be completed more quickly than a foreclosure.  To the contrary, it appears that the same problems delaying foreclosure actions and hampering loan modification efforts nationally – inadequate staffing and overloaded processing systems at lenders and loan servicers – are hampering short sales as well.  Real estate brokers responding to a recent National Association of Realtors survey complained that it can take as long as six months to complete some short sale transactions. 

Deadly Delays

For community associations relying on the super lien to collect delinquent payments, delays can be deadly.  To protect their rights under the super lien, associations must file suit before an owner has amassed more than six months of delinquent payments.  With a prospective buyer in place for a short sale, real estate brokers sometimes ask boards to delay that filing to avoid adding legal costs to the delinquency.  That is not a problem if the sale goes through within the six-month window.  But if the sale is delayed beyond the six-month deadline, or if the lender ultimately forecloses and the suit required to perfect the association’s lien hasn’t been filed, the association will lose its collection rights and may end up with nothing. 

This problem can be solved easily enough by having the owner pay the fees for the sixth month, to keep the association within the super lien window.  Unfortunately, owners facing short sales sometimes refuse to put more money into a property they are going to lose, even though it might be in their interests to do so.  In these cases, the association files suit to protect its interests, because it has no alternative, and the increase in the delinquency total may, in fact, threaten the pending sale.  But that is a problem for the owner and the lender, not for the association. Again, the association has no reason to blink, and every reason not to.

Participants in a short sale transaction also need to be aware that the association’s delinquency clock continues to tick throughout the process.  The delinquency figure quoted initially becomes outdated almost immediately; if the sale occurs two months later, the delinquency total will include two more months of unpaid fees, which, if unanticipated, could threaten the pending sale.   

For condominium boards, the request for delinquency fee information itself can be problematic.   Under federal and state law, creditors are barred from disclosing the amount of a debt to third parties and face potential legal liability if they do so.  Community associations, as creditors, should not provide information about an owner’s delinquent payments to real estate brokers or buyers’ lenders; they should insist that the owners request the information directly and share it with others if they choose.   

As a practical matter, boards and association managers regularly release delinquency information to buyers’ lenders and brokers to facilitate pending sales, and the practice hasn’t created any problems, as far as I know.  But it is not hard to imagine that an outraged owner will sue a board one day, complaining that a buyer used delinquency information the board should not have disclosed as leverage to negotiate a lower selling price, to the owner’s detriment.  I’m surprised this hasn’t happened to any of my community association clients yet, but I’m sure it’s only a matter of time before I get that call.

As a practical matter, boards and association managers regularly release delinquency information to buyers’ lenders and brokers to facilitate pending sales, and the practice hasn’t created any problems, as far as I know.  But it is not hard to imagine that an outraged owner will sue a board one day, complaining that a buyer used delinquency information the board should not have disclosed as leverage to negotiate a lower selling price, to the owner’s detriment.  I’m surprised this hasn’t happened to any of my community association clients yet, but I’m sure it’s only a matter of time before I get that call.

As the housing market malaise lingers, more struggling homeowners are turning to short sales as an alternative to foreclosure.  In a short sale, the lender allows the owner to sell the home for less than the outstanding mortgage, writing off the difference as a loss. Because the loss on a short sale loss can be 30 percent less than the loss on a foreclosure, banks are becoming more receptive to this option.  The National Association of Realtors estimates that 11 percent of the home sales in June were short sales; media reports indicate that number is increasing.  

We’re seeing this trend in the condominium associations we represent, where, reversing the balance from just a few months ago, short sale transactions now outnumber foreclosure auctions.  But short sales raise unique questions and pose particular challenges for community associations. 

As in any real estate transaction, the purchaser in a short sale requires clear title to the property, which, in a condominium sale, includes the assurance that the condominium fees have been paid.  Condominium owners who fall behind on their mortgage payments usually fall behind on their common area fees, as well.  Association boards are often asked to waive these payments so the short sale can go through unencumbered by the delinquency.  In most cases, my advice to boards is, “Just say no.”

No Reason to Blink

This isn’t mean-spirited, it is pragmatic — a matter of fairness to the other owners and essential to protect the interests of the association.  The priority or “super lien” in effect in Massachusetts and 16 other states, guarantees the right of condominium associations to collect up to six months in delinquent common area fees from the owner or from the lender who forecloses on the mortgage.  If the association refuses to waive delinquent common area fees in a short sale, two outcomes are possible:  The sale will go through anyway, in which case the association will collect the unpaid fees from the sale proceeds; or the sale will fall through and the lender will foreclose, at which point, the association will collect the amount due.  The association gets paid either way.  It’s like playing poker with a great hand.  There is usually no reason for the board to blink, hence my “no-waiver” advice. 

As with most rules, there are some exceptions.  I encountered one recently when the delinquent payments owed to the association included a $20,000 special assessment. Because the super lien does not cover special assessments, a foreclosure would have wiped out the entire amount.  Faced with that prospect, the association agreed to contribute $1,000 toward the closing, the short sale went through, and the association collected the remaining $19,000.

Waiving a small portion of the delinquent payments clearly made sense in this case, but fairness to other owners usually requires rejecting these requests.  Why should owners who are paying their share of the association’s expenses be required to make up the difference for those who do not?  This penalizes owners who didn’t do anything wrong for doing everything right.

 

Who Approved the Loan?

The lenders or real estate brokers requesting short sale fee waivers will usually argue that the owner is losing his/her home and any equity in it while the lender is being forced to take a haircut on the mortgage; the condominium association, they suggest, should also share in the loss.  But why?  The board was not a party to the original transaction. It didn’t check the borrower’s credit or approve a loan the borrower couldn’t repay.  The board had nothing to say about the loan and no authority to prohibit the buyer from purchasing a unit in the community.  There is no reason the community association should get stuck holding this bag or any portion of it. 

A short sale theoretically might benefit an association if it can be completed more quickly than a foreclosure.  Getting a new owner in place will stabilize the association’s cash flow and, with winter approaching, reduce the risk of frozen pipes in an unoccupied unit.  But there is no guarantee that a short sale will be completed more quickly than a foreclosure.  To the contrary, it appears that the same problems delaying foreclosure actions and hampering loan modification efforts nationally – inadequate staffing and overloaded processing systems at lenders and loan servicers – are hampering short sales as well.  Real estate brokers responding to a recent National Association of Realtors survey complained that it can take as long as six months to complete some short sale transactions. 

 

Deadly Delays

For community associations relying on the super lien to collect delinquent payments, delays can be deadly.  To protect their rights under the super lien, associations must file suit before an owner has amassed more than six months of delinquent payments.  With a prospective buyer in place for a short sale, real estate brokers sometimes ask boards to delay that filing to avoid adding legal costs to the delinquency.  That is not a problem if the sale goes through within the six-month window.  But if the sale is delayed beyond the six-month deadline, or if the lender ultimately forecloses and the suit required to perfect the association’s lien hasn’t been filed, the association will lose its collection rights and may end up with nothing. 

This problem can be solved easily enough by having the owner pay the fees for the sixth month, to keep the association within the super lien window.  Unfortunately, owners facing short sales sometimes refuse to put more money into a property they are going to lose, even though it might be in their interests to do so.  In these cases, the association files suit to protect its interests, because it has no alternative, and the increase in the delinquency total may, in fact, threaten the pending sale.  But that is a problem for the owner and the lender, not for the association. Again, the association has no reason to blink, and every reason not to.

Participants in a short sale transaction also need to be aware that the association’s delinquency clock continues to tick throughout the process.  The delinquency figure quoted initially becomes outdated almost immediately; if the sale occurs two months later, the delinquency total will include two more months of unpaid fees, which, if unanticipated, could threaten the pending sale.   

For condominium boards, the request for delinquency fee information itself can be problematic.   Under federal and state law, creditors are barred from disclosing the amount of a debt to third parties and face potential legal liability if they do so.  Community associations, as creditors, should not provide information about an owner’s delinquent payments to real estate brokers or buyers’ lenders; they should insist that the owners request the information directly and share it with others if they choose. 

As a practical matter, boards and association managers regularly release delinquency information to buyers’ lenders and brokers to facilitate pending sales, and the practice hasn’t created any problems, as far as I know.  But it is not hard to imagine that an outraged owner will sue a board one day, complaining that a buyer used delinquency information the board should not have disclosed as leverage to negotiate a lower selling price, to the owner’s detriment.  I’m surprised this hasn’t happened to any of my community association clients yet, but I’m sure it’s only a matter of time before I get that call.