It's come to this: a lender hijacks its own short sale.

It's come to this: a lender hijacks its own short sale.

The only two things buyers need to know about short sales is that they're almost always

a waste of time, and
an exercise in frustration

Why? Because short sales usually don't close. Sure, they'll go into contract, but they hardly ever close. Ever seen an MLS listing that says, "Regular sale! Can deliver property!" That's a claim no short seller or short seller's agent can make.

But for buyers who simply can't resist those non-existent "short sale opportunities", the only thing they need to know is that most short sales are killed by the holder of the second mortgage, called the second lienholder. Ever seen an MLS listing that says, "two loans, but both with same lender"? That's to assure you and your agent that the second lienholder won't make trouble, because first and second lienholders are one and the same financial institution, and no financial institution would shoot itself in the foot. Right?

Hold that thought.

So why are second lienholders known for sabotaging short sales? The long answer is complicated and messy, so we'll start with the short, clean answer and crawl slowly and painfully toward the long, messy answer: because there are Big Problems with short sales.

Most short sales are doomed to fail—they'll never close. You can make a great offer on a short sale, and you probably will, because these days many are priced below market to get multiple offers. In fact, the quickest way to tell a short sale is to look for a home priced far lower than you expected. Ka-ching? Not necessarily and not often, because no matter how great your offer, the odds of you getting the keys to the home are slim.
Many short sales involve two lenders, the first and second lienholders. Why two lenders? Because the short seller often bought during the boom with no money down, using not the customary 80 percent loan and 20 percent down payment, but an 80 percent first loan plus 20 percent second.
Home prices in local neighborhoods where short sales are common—in some, they make up most new inventory—have declined steeply, by as much as 50 percent.
That means a short sale won't net enough money to pay off even the first lienholder, let alone the second. That's why they're called "short sales": the lender or lenders have to agree to accept what's called a "short pay-off", a loan pay-off short the full balance, or the home doesn't sell.
The second lienholder invariably stands to be wiped out by a short sale, because the sale proceeds go first to the first lienholder, with anything left over going to the second. And there's never anything left over.

However, the second lienholder has an ace in the hole, which is the ultimate Big Problem with short sales: if it doesn't approve the short sale, the short sale doesn't go through.

So the second lienholder has leverage—not much, but enough, especially if it doesn't mind a little high-stakes hard-nosed bluffing that often isn't bluffing at all. Second lienholder tells first, "I won't approve the short sale unless I get something". First may agree to pay second some token amount; 3 percent of the balance of the second is typical. Second may say "okay, fine", because, remember, if it stands in the way of the short sale, the sale falls through, the home probably ends up in foreclosure and second lienholder gets nothing. But often second lienholder holds out for more, looking either to first lienholder and/or seller and/or buyer and/or the agents. If any or all of these parties don't mind chipping in, second approves the sale.

Which brings us to Big Problem #7: if the extra money to the second lienholder goes through escrow, it's legal; but if seller and/or buyer and/or the agents chip in, outside escrow and under the table, it doesn't show on the closing statements so the first lienholder never sees it. Which means first lienholder doesn't know about it. And if first lienholder doesn't know about it, everyone involved is guilty of mortgage fraud. Which, according to the FBI's Mortgage Fraud Warning Notice, "is punishable by up to thirty years in Federal prison or $1,000,000 fine, or both".

Fortunately(?) Big Problem #8 eliminates the possibility of mortgage fraud by bringing its own considerable baggage to this train wreck: often there is no extra money for second lienholder, or not enough. Buyer refuses to pay more than the home is worth (or gets tired of playing games and moves on to a regular sale). Or seller doesn't have the extra money. Agents may or may not agree to take a haircut, but it may not be enough. Second lienholder withholds its approval, short sale withers on vine and dies, home goes to foreclosure.

Which in turn causes Big Problems #9 through #14:

borrower has a foreclosure, not just a short sale, on her credit history
buyer not only doesn't get the house, after making a good offer and waiting months for a response, but may be reluctant to make another offer on a short sale, thereby shrinking the pool of short-sale buyers and making it that much harder to sell the next one
listing agent isn't paid for the months of grief and drama he's gone through
nor is buyer's agent, who will regard short sales with an even more jaundiced eye
first lienholder incurs an even greater loss, since foreclosures cost lenders more than short sales (I've heard it's an additional 10 percent)
second lienholder gets nothing, but by now we're not feeling sorry for second lienholder

Which could all be avoided if second lienholder agreed to play ball. Which would undoubtedly happen if the first and second lienholders are the same institution. Right? Because it stands to reason that when first and second lienholders are the same, second won't hijack the first.

You'd think.

Unless you'd read an email sent last month by a South Bay Coldwell Banker agent to all local offices. His tale of woe:

one lender (let's call it Old Stagecoach) has both the first and second loans on a short sale, making it one of those "easy short sales" I read about in the MLS, and sure enough
first lienholder Old Stagecoach approves the short pay-off on the first, and
offers second lienholder Old Stagecoach the customary 3 percent of the second, which
second lienholder Old Stagecoach indignantly refuses (I don't really know if Old Stagecoach was indignant at Old Stagecoach's offer, but let's say it was), so
second lienholder Old Stagecoach shakes down first lienholder Old Stagecoach for 10 percent of the balance of the second, which
first lienholder Old Stagecoach agrees to (pause here while everyone shakes hands over narrow escape) except that
second lienholder Old Stagecoach then demands that first lienholder Old Stagecoach fork over an extra $10k, then on second thought
second lienholder Old Stagecoach demands that first-lienholder Old Stagecoach fork over 20 percent of the second's loan balance, and furthermore
second lienholder Old Stagecoach wants agents to reduce their total commission from the 6 percent profligate first lienholder Old Stagecoach approved, to a more cost-efficient 4 percent (after all, it's not like this is a particularly challenging transaction) and
head spinning yet?

Not the head attached to this agent's body, who shows either a gift for irony or the patience of Job by asserting that "the biggest problem[?!] is that we cannot get anything in writing from the second to present to all parties". In other words, second lienholder Old Stagecoach isn't willing to put its shakedown of first lienholder Old Stagecoach and the agents in writing. "They do not send out anything via email whereas the first wanted everything in email form and was quick to respond." Now, what upstanding on-the-level organization wouldn't be willing to put its demands in writing? Not second lienholder Old Stagecoach, apparently, who instead wants the parties "to go to [it] and say this is what we want to do".

Yes, that's right, second lienholder Old Stagecoach thinks that anyone reviewing this transaction (like who? like someone looking for evidence that second lienholder Old Stagecoach is unduly hard-nosed with distressed sellers?) is going to say, "of course the first lienholder agreed to kick in a few more bucks of its own free will, and of course the agents volunteered to reduce their commission without prompting. That's what first lienholders and agents do".

Old Stagecoach, meet Franz Kafka.