If a second mortgage loan is used to purchase the property or there is a refinancing of the existing purchase money mortgage, the homeowner may escape personal liability on the second mortgage under the ruling of Bank One Arizona, N.A. vs. Beauvis, 188 Ariz. 245, 934 P.2nd 809 (App. 1997).

However, where the second mortgage funds were used for college expenses, purchase of a car or a boat, the homeowner has substantial liability on the second mortgage, and Arizona’s anti-deficiency statute does not afford him protection. In such circumstances, an important approach for the homeowner is to consider a short sale, i.e. selling the house for less than the full value of the first and second mortgages.

If the property is listed as a short sale and there is an offer from a prospective buyer acceptable to the homeowner, important action steps must follows. Lenders are increasingly more inclined to consider short sales if the homeowner is able to demonstrate through supporting financial documents his financial distress and the reduced value of the property. Providing financial documents to a lender, however, is a two-edged sword. Careful consideration should be given in providing those documents to the lenders.

The foreclosure process is usually initiated by the first lien holder. If the first lien holder forecloses on the home, the new owner assumes obligations for insurance, maintenance of the property, HOA fees and other costs. The bank, rather than taking a low-ball offer at the foreclosure sale or assuming these obligations in case of its credit bid may be inclined to accept the short sale, if the offer is in line with the current property values in the neighborhood. The short sale, however, cannot be accomplished without the consent of the second lien holder because clear title must be conveyed to the new owner and cannot be done with a second lien on the property.

By the short sale strategy, the aim is for the homeowner to avoid a later lawsuit by the second lien holder for the amount owed. As part of the negotiating process, the homeowner should require a written agreement from the first and second lien holders whereby they waive any deficiency claims against the homeowner. The closing documents must be reviewed, both by the real estate agent and the attorney for the homeowner, to insure that the lenders expressly waive any deficiency claims.

It is not infrequent that the first lien holder—even if it doesn’t receive the full amount of its loans—will make a contribution to the second lien holder in order to convey clear title to the new owner. With the proper written waiver of deficiency claims by the lenders, the homeowner has facilitated a transaction that may be of benefit to all stake holders, especially the homeowner in avoiding a lawsuit from the second lien holder.

Think short sale where the second mortgage is not part of a purchase money mortgage and start your communications early with all lien holders. A knowledgeable real estate agent, who has dealt with short sales, in conjunction with an attorney, will be very helpful in dealing with the lien holders.

Lat J. Celmins