In a logical world, a lender should approve a short sale and waive the deficiency judgment, if the benefits gained outweigh the risks and costs.
THE LENDER PERFORMS A COST BENEFIT ANALYSIS
The lender will decide to approve a short sale depending on whether or not it makes financial sense. As part of its analysis, the lender considers the message it will send to homeowners if it approves too many short sales, too easily, and thus, encourages too many homeowners to stop making their payments and short sell their homes.
Conversely, the lender is concerned with each weeks’ verbal threat from the state or federal politician to “do more.” Furthermore, Las Vegas judges, believe it or not, are reasonable, and lambast unreasonable lenders. Foreclosures are risky and costly- especially if the house value plumments.
A BAD TENANT CAN COST A BUNDLE
According to federal law designed to protect renters, lenders must honor an existing “bonafide” lease agreement. If the short sale fails, the lender usually ends up with title and possession, which may include a live-in renter on possibly, a five year lease.
Bad tenants suck. They trash your rental property, leave you with months of unpaid rent (and mortgage, insurance, tax & utility bills), cook crack in the basement, invite a rat infestation by leaving their kids’ half-eaten pizza lying around, and leave crap in the closet as a going away present for you to find. Not cool.
The lender, then, must be a landlord for the term of the lease- potentially for several years. The lender-now-landlord incurs the same risks and costs all landlords face- chronic financial drain ultimately causing financial ruin- again.
RENTING YOUR HOUSE DURING A SHORT SALE IS GOOD BUSINESS
Theoretically, before the house is sold at a foreclosure trustee sale, the homeowner can move out and rent out the home. A renter, arguably, could benefit the lender, since she prevents damage resulting from vacant homes, such as someone stealing the copper plumbing, or moving into the house to sell drugs. Thus, renting out the house is justifiable, reasonable and legal.
THE MARKET LEASE RATE OF A HOME IN FORECLOSURE IS ROCK BOTTOM
If the lender gets stuck with a bad renter it will try to get out of the lease. First, it will offer the renter money to break the lease agreement and move out. If that doesn’t work, the lender will claim the lease is not “bonafied” and ask a judge to render it void.
If the lease is at market rate, and there are no obvious signs of fraud, the court should validate the lease, although as of the date of this article, no court has ever ruled whether or not a lease is bonafide. We will have to wait and see what happens.
The renter will require a deep discount to rent a home if it is in foreclosure, thus the market rate will be low.
Under one unbelievable scenario, leasing a home in foreclosure could be discounted by 50%. In other words, a home leasing for $1,000 a month could lease for $500 a month once it goes into foreclosure.
If the lease agreement is challenged, and the court subsequently validates it and approves the terms at a (hypothetical) rate of $500 a month for 5 years; the leasor could than sub-let the house out for the non-foreclosure rental rate of $1,000, because the sub-leasee has no risk of eviction resulting from a foreclosure. The lessor makes a gross profit of $500.
THE RISK OF A CATASTROPHIC LOSS RESULTING FROM A BAD TENANT TILTS IN FAVOR OF APPROVING A SHORT SALE
The homeowner in an effort to mitigate her loss during the short sale negotiation, should consider renting out the house, and advise the lender of her intention. The lender, in an effort to manage its risk, should approve the short sale to avoid getting stuck with a bad tenant.