Lien Release vs Full Satisfaction
Lien Release vs. Full Satisfaction in Short Sales
When buyers purchase real property, they, and the title company insuring title, will ensure that the property is conveyed free and clear of all liens. When your lender agrees to a short sale, they are agreeing to release their lien(s) from the property for less money than what is owed so the property can be sold. So whenever a property is sold in a short sale, the lien is released from the property. Yet the lender generally has two choices.
Lenders can either: 1) Release the lien and declare the debt paid and settled in full (called a "full release and satisfaction") or 2) Release the lien only from the property and still consider you personally liable for any unpaid balance of the loan ("lien release only").
In all situation our negotiators strive to obtain a "Full Release and Satisfaction" of your debt. Obtaining a full release and satisfaction from your lender is best for you, the obligor, but in some instances the lenders will not allow it. In fact, sometimes they present us with two separate amounts, one for a lien release only and another for a full release and satisfaction.
Where does the money go?
Remember, lenders accept short payoffs because they make more money than taking the houses back and selling them later. But in either situation (foreclosure vs. short sale), the lender typically loses large sums of money. With their loss:
If Full release and Satisfaction - They can write the loss off on their taxes as a business loss, but they must report it to the IRS and send you a 1099-C for the amount. IRS says that because you technically received the benefit of the money, and you did not have to pay it back, then it is treated as ordinary income that you need to pay tax on. However, the Federal Mortgage Debt Relief Act of 2007 has put a moratorium on IRS collecting tax on all foreclosure-related 1099's for primary residences through 2010. Additionally, the IRS Form 982 which may also release you from paying the tax if you can show you were insolvent. In all cases you need to consult with your financial advisor or accountant about the tax consequences of foreclosure. We are neither.
If Lien Release Only - The lender (or someone they sell the note to) can choose to sue you to collect the difference from you. The lender has the right in most states to pursue you for the difference between the amount they receive from the sale vs. how much they were owed or just file the 1099. This amount is often called the "deficiency" or the "shortfall." They can do this because even though they released the lien, you signed a "promise to pay" when you received the loan.
Ask you to sign a new "soft" promissory note for all or part of the deficiency as a condition for them agreeing to the short payoff. These notes are usually 0% interest and payable over 3 - 15 years.
Sell this debt (the deficiency amount) to a collection agency or attorney who can pursue collection efforts, obtain a court judgment against you and garnish your wages or assets. This is generally quite unpleasant but fortunately it is uncommon.
Do nothing. After absorbing a big loss, sometimes lenders do not want to spend another minute dealing with it. Thus it is possible you may just receive a 1099.