As a real estate professional negotiating short sales on behalf of underwater property owners, your chances of success are directly tied to the laws that apply to your client’s situation. In other words, if a lender won’t approve your client’s short sale, what leverage do you have to “push back” and change that decision?
We start by analyzing the client’s foreclosure rights. That is, what will happen if the short sale doesn’t get approved and the client instead lets the lender foreclose? California has “anti-deficiency” laws that lay out exactly what happens when a lender forecloses. In most cases, the answer depends on the type of loan (or loans) involved.
A loan that is used to buy a borrower’s primary residence is considered a “non-recourse” loan. If a lender forecloses on such a non-recourse loan, all it gets is the property. The law bars the lender from collecting the balance still owing, commonly called the “deficiency.” (There are some rare exceptions to this rule, typically involving income or commercial properties; those are not addressed here.)
If the borrower took out a second loan as part of the original purchase money financing, that loan is also considered “non-recourse.” If the first mortgage (known as the “senior lien holder”) forecloses its loan, the second lender (the “junior”) is barred from collecting its deficiency.
In contrast, if the second mortgage was not purchase money but instead was added later (often as a home equity loan or “HELOC”), the loan is considered a “recourse” loan. In that situation a foreclosure by the senior lien holder usually does not bar the junior lender from collecting its deficiency. However, there is a very important exception to this law. That exception is known as the Simon rule (named for a 1992 case called Simon vs. Bank of America).
The Simon rule comes into play where senior and junior liens were issued by the same lender; e.g., Bank of America first and Bank of America second. In that case, the law bars the junior from collecting its deficiency if the senior forecloses. The rationale is that the senior has the ability to protect its own junior loan; and where the senior decides not to do so, Simon says that it gives up its right to collect the deficiency on the junior.
If your client has a Simon loan situation, you now have much stronger leverage in negotiating a short sale. If the lender denies the short sale, you simply advise that your client will let the property go to foreclosure. In that case, the lender will get zero on its second loan. And in most situations, lenders would rather get something for their junior lien than nothing.
With the recent changes in California short sale laws – in particular the new SB 458 – many realtors I’ve talked to are afraid that second loans won’t approve short sales. For that reason, it’s more important than ever to know what exactly cards you can play on your client’s behalf when seeking that approval. In some cases, the Simon card may just be your “ace in the hole.”
If you suspect you may have a potential Simon situation, first locate copies of the deeds of trust for both the senior and junior liens. Then give me a call and I’ll help your clients and you analyze those documents to determine if in fact Simon applies.
Finally, I’d like to thank Kim McAtee of Coldwell Banker’s Orinda, California office for suggesting the blog topic. I always welcome readers’ suggestions on topics they’d like to see. Thanks, Kim!
