Real Estate Law
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No, there is no law that says that a buyer in a short sale transaction cannot rent it back to the owner, but most banks will have the sellersign an addendum certification(as well as agents and buyers sign) indicating that seller MUST vacate the property prior to and/or at close of escrow and specifically states that the buyer will not enter into a rental contract with the seller after escrow closes as well as being an Arm’s Length Transaction. While a bank may allow for a small transcending period for seller to move you would need to have in writing from the bank stating such is allowable. If the bank finds out a seller has retained possession after close of escrow the bank can rescind the short sale.
Note that this is not a law (in that the legislature did not pass a bill and it was not signed into law by the governor) but it is under contract law if the lender requires the vacating of the premises.
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Can my bank
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Will I need to pay the rest of the loan amount after the short sale?
If you're the buyer, no. The short sale is where the bank agrees to accept less than what is owed on the loan in exchange for a release of lien. If you're the seller, it would depend on whether or not there is a "deficiency waiver" in the contract with the bank.
That if, if there is not a deficiency waiver, they can go after you for the difference between the loan and the agreed amount.
What is a deficiency waiver?
It's merely a statement that the bank agrees that this will be the total amount that they will accept, and that they will not pursue a deficiency from the borrower / seller.
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Are you aware of the law that was passed that the bank can not go after the seller for the difference once they have accepted and approved a short sale?
I am, which is a fairly recent new law (as I see this case is California). California is the only state that has this. In that regard, they cannot pursue the borrower for a deficiency, although they can set conditions upon approval of the short sale. My answer pertaining to your question about there being a law that prohibits renting of a short sale property is what I answered specifically, and that is absolutely the case. There is no law that says that's illegal, although it could be in your contract.
(that it's not allowed)