Having more than one lien on a property can slow down the short sale process. If liens are going to be more than the sale proceeds, each must be separately negotiated as a short sale and there are a few additional steps and considerations to be made.
Recently, many 2nd lenders are requiring a short sale approval letter from the primary lender, prior to issuing their approval. Generally, the 2nd lender receives $3,000-$5,000 toward the balance of the mortgage, regardless of the amount owed. Each lender has their own approval process and they may delay the process. Occasionally 2nd lenders will grant complete debt forgiveness for the amount the 1st lender offers, however many times they are only willing to release the mortgage lien.
In the event the lender only release lien, the borrower is still responsible for payment of the balance owed. Although full waiver of the deficiency judgment is the goal, when this is not permitted, the process turns into a negotiation with the 2nd lender to obtain debt forgiveness. In order to do so, the lender typically requires a contribution from the seller. The seller contribution typically ranges from 10-30% of the unpaid balance of the loan. Once an agreement is reached, the 1st lender must be notified and must revise the approval letter permitting the seller contribution to the 2nd lender. Often, problems can arise during this part of the negotiation process. If the 1st lender does not allow this arrangement (yes they have the right to do that!), then the seller would have to pursue a debt settlement with the 2nd lender after the short sale is completed. If the 1st mortgage and 2nd mortgage are held by the same lender, the likelihood of approval may be greater.
When a homeowner stops paying on a second mortgage, the loan can be charged-off or foreclosed upon. Most of the time a charge off would occur before a foreclosure due to cost of the foreclosure filing process. Once a charge-off occurs the homeowner will most likely begin to receive phone calls from the collection company wanting to settle for less than they owe. In some instances this presents an opportunity to negotiate a fair settlement. However, if the homeowner is also not paying the 1st mortgage, it is best to have a comprehensive strategy for the property prior to accepting any settlement offer on the 2nd mortgage regardless of how good the settlement is that is offered.
The collection agency will make it sound as though the offer is a once in a lifetime deal and they have to have the money by 5 p.m. or the deal is off the table. The person calling is paid an incentive on these types of settlements and can be quite aggressive. There really is more time to think this through and make an educated decision than what may be implied.
As with any short sale or debt settlement, potential tax consequences must be considered. If a lender chooses to release a borrower from some, or all, of an outstanding loan obligation, it is required to issue a Form 1099-C which reports the cancellation of debt. Not only does the lender have a reporting obligation, but the borrower must also report this liability on their tax return for that year. (Article: Know the Difference Between a 1099-A & 1099-C)
