This happens in some short sales. Either the lender or the mortgage insurance company will grant approval of the short sale and they’ll forgive most of the debt, but they’ll want the seller to sign a promissory note to repay some of the remaining balance. We have seen promissory notes range from $1,000 to $40,000. Many of the promissory notes have no interest at all.
There are several options for a seller who receives a short sale approval where they are asked to sign a promissory note as part of the deal. Below are the options:
- Refuse to sign the promissory note and allow the property to be foreclosed. In many states, the lender could foreclose and pursue the borrower after the sale for some or all off the remaining balance. Some owners take a chance when they allow the lender to foreclose, and those owners hope the lender will not come after them for the balance. Foreclosure is more damaging than a short sale with regarding to one’s credit and ability to obtain future loans.
- Refuse to sign the promissory note and renegotiate. There are instances where a lender or mortgage insurer might consider removing the stipulation for the promissory note. Sometimes raising the sale price might work. Sometimes offering a lump sum paid at closing instead of a promissory note for a larger amount might do the trick. For example, instead of signing a $10,000 promissory note, perhaps the seller might offer to pay $2,500 at closing. Sometimes the lender or mortgage insurer might be willing to take less money now than hope to be paid more in the future.
- Sign the promissory note and make the payments. Some people agree to make the payments since they are having most of the debt forgiven while achieving their goal of selling the house. The monthly payments on promissory notes are typically affordable.
- Sign the promissory note and do not make the payments. Some people choose to sign the promissory note to move forward with the short sale, and then they do not pay the promissory note later on. It may be advantageous to avoid the foreclosure and agree to the promissory note, as the owner will no longer be liable for the house or a much larger debt obligation. Furthermore, avoiding foreclosure is much better for the seller if they have plans to borrow money in the future. The promissory note is an unsecured debt, so defaulting on it does not constitute a foreclosure. It will be harder for the note holder to collect on the note since it is unsecured. Some sellers plan to declare bankruptcy after the short sale, so the bankruptcy may wipe out the unsecured debt of the promissory note. It is possible for the note holder to file a judgment against the borrower. It may also be possible for the borrower to negotiate a settlement payment on the promissory note for less than the full balance.
- Consider a deed-in-lieu of foreclosure. Also known as a friendly foreclosure, a deed-in-lieu of foreclosure involves the lender taking back the property prior to a foreclosure auction. However, a deed-in-lieu of foreclosure must be carefully negotiated, as some lenders will reserve their right to pursue the seller for the entire remaining balance of the mortgage. Some lenders may not be willing to take the property back via a deed-in-lieu of foreclosure. In some cases, a promissory note will still be expected from the borrower.