More than ever before, community associations are coping with financial shortfalls. Two issues which associations frequently encounter are short sales and foreclosures.  This Blog post will discuss the implications of short sales and foreclosures as each relates to the community association.

Short Sales

A short sale occurs when a home is sold for less than the amount of the outstanding mortgage on the home, with the explicit agreement of the bank.  In other words, the purchase price of the home is “short” of the remaining balance due on the existing mortgage.  

Short sales are being used by owners in an effort to avoid foreclosure and possibly preserve the owners’ credit rating.  While the home that is being sold via a short sale is not bank owned, the bank must approve (and ultimately determine) the sale price of the home as they are agreeing to reduce the amount owed on the mortgage.  Banks generally prefer short sales over foreclosures because a short sale is accomplished in a much shorter period of time than a foreclosure and because the cost of a short sale is far less than that of a foreclosure.  

Because community associations can possess a statutory lien on a particular property for past due assessments (which are usually present if the unit gets to the point of short sale), the association will be asked to approve the short sale.  As a general matter, when a short sale is proposed and the association is contacted about the outstanding account balance, the association is offered only a percentage of the total amount it is owed so that the short sale can be accomplished (sometimes, the association is offered the full amount owed, but this generally occurs only when the total amount owed is proportionately very small when compared to the short sale price, and even then, such an occurrence is a statistical rarity).  At this stage, the association must decide if it will accept less than the entire amount owed on the account or if it will “hold out” for the entire balance (it is noted that the amount the association ultimately accepts can and should be negotiated as the first offer provided is usually a “low ball” offer).  

In making this determination, the association should consider the fact that after the short sale, a new owner will be present in the unit and will begin to pay assessments; therefore, the financial “bleeding” the association is facing will ultimately come to an end. Should the association refuse to accept a compromised offer on the amount owed, the likely result is that the short sale will not be consummated and the unit will end up in foreclosure. In a [Pennsylvania] foreclosure situation, the association is statutorily entitled to receive unpaid assessments, fees and costs that come due during the six (6) months immediately preceding the date of judicial sale of a unit.  All other amounts owed to the association are divested in the foreclosure. Thus, community associations may actually end up in a more favorable financial position if a unit is sold in a short sale rather than in foreclosure.   Of course, because each situation is factually unique, outcomes will vary.  Associations should therefore seek the advice of a qualified property manager and/or counsel when they are faced with a short sale in the community.

Foreclosures

In general terms, a mortgage loan provides that the mortgagee (lender, usually a bank) possesses a security interest (lien) in a home purchased by the mortgagor (borrower).   The foreclosure process begins when the mortgagor defaults on the loan, and the mortgagee begins legal proceedings to repossess the property.

As it pertains to community associations, and as previously indicated, in a [Pennsylvania] foreclosure situation, the association is statutorily entitled to receive unpaid assessments, fees and costs that come due during the six (6) months immediately preceding the date of judicial sale of a unit.  All other amounts owed to the association are divested in the foreclosure.  Once an Association learns that the property has been listed for Sheriff’s Sale, the Association should contact the Sheriff’s office to advise of the (1) existence; (2) nature; and (3) amount of the Association’s statutory lien.  This being said, the association should always seek out the advice of counsel in order to determine a legally permissible course of action as Fair Debt Collection Practices Act (FDCPA) issues may arise in this setting.  

Associations should also be aware that if the foreclosure process is completed and the foreclosing bank takes title (or if the bank takes a deed in lieu of foreclosure), the association should verify if a Sheriff’s deed has been issued to the bank and, if so, contact the bank and request payment of the prior assessments and other charges the association is entitled to receive.  The association should also ensure that the bank, as [new] titleholder of record, will be promptly paying assessments going forward, as required by the community’s controlling documents.  As a general matter, associations should stay on top of their collections efforts and apply them uniformly to all owners, including banks.

Associations should also be aware that federal law and federal programs have provided borrowers with additional options to be utilized in response to foreclosure proceedings and/or in an attempt to avoid foreclosure altogether. As a result of all of this, the foreclosure process is taking longer than ever before to get from start to finish, and Associations are waiting longer than ever before to see some sort of finality with respect same.

For example, the Home Affordable Modification Program (HAMP) provides borrowers with the possibility of lowering their monthly mortgage payments to make their homes more affordable. The population of homeowners that may be eligible for HAMP was expanded to include: 

•     Homeowners who are applying for a modification on a home that is not their primary residence, but the property is currently rented or the homeowner intends to rent it.

•     Homeowners who previously did not qualify for HAMP because their debt-to-income ratio was 31% or lower.

•     Homeowners who previously received a HAMP trial period plan, but defaulted in their trial payments.

•     Homeowners who previously received a HAMP permanent modification, but defaulted in their payments, therefore losing good standing.

Moreover, other federal agencies, such as the Consumer Financial Protection Bureau (CFPB) and the Department of Treasury’s Office of the Comptroller of the Currency (OCC), are involved in the residential mortgage market from a regulatory perspective and can get involved on behalf of a homeowner whose home is in foreclosure.  Accordingly, associations should be educated in and made aware of the various programs that exist and how each may impact the financial position of the association.

Finally, “other” issues occur during the foreclosure process that associations must handle in the best interest of the association.   For example, when a unit is in the foreclosure process and the owner abandons the unit (and the foreclosing bank has not yet taken title), the association must examine its controlling documents and/or other legal requirements to determine what duty the association has to ensure that the unit is kept in good repair.  It is noted that a foreclosing bank will often take similar action when a unit is abandoned by its borrower in an effort to protect its investment; however, the bank’s concern about preserving its collateral is different than the association’s potential responsibility in this regard because the association must examine its duty to keep the unit in good repair as it relates to the potential impact of the abandoned unit on all of the association’s owners/members and their units, not just the abandoned unit itself.

Because of all of the complicated financial and legal issues involved with short sales and foreclosures, and because each situation may be factually different than the those which have preceded it, associations dealing with these situations should seek the advice of both a qualified property manager and counsel to determine the best course of action for each specific situation.

Edward Hoffman, Jr., Esq.

* The content for this Blog post is based upon the prior written work of the author as originally published in the July/August 2012 issue of the CAI PA-DelVal’s Chapter’s Community Assets magazine.