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At an escrow branch in California an escrow officer closed a "Cash for Keys" short sale transaction involving 1st and 2nd lienholders. The 1st lienholder allowed the seller to receive $20,000 in cash at closing in exchange for his keys. The 1st lienholder allowed the 2nd lienholder to receive $2,700 toward their loan balance at closing. The 2nd lienholder wanted $10,000, however, and put a condition in their short pay letter calling for the additional $7,300 to be paid outside closing by the seller. So we have to ask…who would close with an outstanding condition like that?

The short pay letter found in the escrow file from the 2nd lienholder (addressed to the seller) read as follows:

 
…will accept a settlement in the amount of no less than $10,000…A total of $2,700 will be collected from a short sale of the collateral property. Additionally, you promise to pay $7,300 which will be due in full no later than close of escrow.
 
Upon receipt of the agreed amounts, servicing agent will begin the process to release the lien against the collateral and will grant you a full release of the remaining unpaid principal balance of the debt. However, if settlement proceeds are not received by specified dates or if the funds received are returned by the bank for any reason, the lien and promissory note will remain in place until the account is satisfied in full.

The escrow officer accepted the short pay letter from the seller's real estate agent and proceeded to close and disburse her file. She sent the 1st lienholder their minimum amount and the 2nd lienholder $2,700. Four days later the escrow officer received an email from the 2nd lienholder informing her the $7,300 was not received from the seller. It included an email message from the seller stating the seller had changed their mind and would not be sending the $7,300 after all. The 2nd lienholder notified the escrow officer of their intent to return the $2,700 received at close of escrow and to keep their lien in full force and effect.

The escrow officer was shocked! How could the seller change their mind post–closing? The escrow officer escalated the matter to the National Escrow Administrators, who (after hitting the stroke zone) provided language from the California Statutes prohibiting short pay lenders from demanding seller contributions above and beyond the proceeds from the short sale. The law reads in part as follows:

 
(b) A holder of a note shall not require the trustor, mortgagor, or maker of the note to pay any additional compensation, aside from the proceeds of the sale, in exchange for the written consent to the sale.

The good news is the 2nd lienholder accepted the $2,700 and released their lien, but what if they had not? The Company had insured a new buyer free and clear marketable title. If the 2nd lienholder had elected to ignore the law and keep their lien in full force, the Company would have to protect the insured buyer and either litigate to enforce the California law or pay the $7,300 to obtain a lien release. Both solutions are costly to the Company and bad for the consumer.

 

 
 

MORAL OF THE STORY

We should have never closed this transaction unless the following occurred:

  • The amount the 2nd lienholder demanded matched the maximum allowed by the 1st lienholder; and
  • The "side agreement" for additional cash to be paid outside closing was removed from the 2nd lienholder's demand

Allowing more money to be paid to the 2nd lienholder than the maximum allowed by the 1st lienholder violates the conditions of the 1st lienholder's short pay agreement, enabling the 1st lienholder to return their short pay funds and keep their lien in full force.

In order to release their lien, the 1st lienholder would have to receive payment in full, since the loan investor (FNMA, Freddie Mac, Ginnie Mae) would not reimburse the lender/servicer the shortage amount without the short pay agreement's terms being followed.

As for the 2nd lienholder, closing and allowing the seller to pay a portion of the demand outside of closing is not a condition the Company is willing to accept. It removes all rights the Company has under California statutes that enable the Company to record a Release of Obligation for the lienholder's failure to timely release their lien.

The statute that gives title companies the right to release a lien requires the title company pay the lienholder in accordance with their demand. In this transaction, we only paid a portion of the demand and allowed the balance to be paid (or in this case, not paid) outside of escrow.

And, as stated in the 2nd lienholder's short pay agreement, the seller's non–payment of the additional $7,300 gives them the right to rescind their short pay agreement and demand payment–in–full of the outstanding loan balance.

Whether the 1st or 2nd lienholder exercises their right to rescind their short pay agreement to keep their lien in full force and effect, the Company is liable to its policy holders, and would have to step in and protect them from the assertion of lienholder's rights.

The risk of loss to the Company is the difference between the short pay funds collected at closing and the amounts to pay the liens in full. Here is an example:

1st Lienholder's Payment in Full$368,163
Short Pay Funds Collected at Closing-125,198
Potential Liability$242,965
  
2nd Lienholder's Payment in Full$ 34,500
Short Pay Funds Collected at Closing-   2,700
Potential Liability$ 31,800

The total escrow and title fees collected at close were $1,906.03. Now you do the math…should we have closed this deal?

 
 
 
 
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