I just added an article to www.AustinMarketNews.com about mortgage lenders getting cozier with the idea of doing short sales instead of foreclosures (Banks warming up to short sales to reduce foreclosures). Having worked short sales, representing buyers and sellers over the past several years, I’ll believe it when I see it.
The last sentence of the article highlighted a key issue that most consumers, and many inexperienced real estate agents, don’t understand. That is that just being upside-down in your mortgage and having a hard time making the payments don’t necessarily justify a short sale. You must be able to prove, and document, a genuine financial hardship — usually some change in your life since your mortgage was originated — that makes it impossible for you to continue making house payments. The “short sale package” required by the lender will be exhaustive — I have faxes 75 pages of documents to lenders on behalf of my seller-clients in these situations. If you thought the lender knew a lot about you when you applied for the mortgage, think again. In addition, you must write a “hardship letter” explaining exactly what happened that prevents you from making payments you agreed to previously and what you have done to try to adjust.
There is another important complication that results from the “creative” mortgage industry during the 4 or 5 years before the “mortgage meltdown.” Specifically, the very common use of second liens. Up until 2003 or so, and again in 2009, FHA loans were and are the preferred vehicle for homebuyers without much cash for down payment and closing costs. In between, there were a variety of “80-15-5” (5% down, 80% first lien, 15% second lien) products and others like them: “80-10-10” — 10% down and a 10% second lien. There are even several sources for “80-20” loans, in which the homebuyer borrowed 80% of their new home’s value from one lender and borrowed all of their 20% down payment from a second lender, frequently on the assumption that the second lien would be refinanced at the end of two years to avoid a very significant “rate reset.” In each of these situations, the borrower could generally avoid the cost of Private Mortgage Insurance because, from the perspective of the first lien-holder, they actually made a 20% down payment.
Add to that bit of creative financing the fact that in many cases home purchase prices were “grossed up” so the seller could cover most or all of the buyer’s closing costs. Voila! You now owe $210,000 for a house that was worth $200,000 on the day you bought it, and you have absolutely no “skin in the game.” Sure, nobody wants to have a foreclosure on their credit report, but in this situation if you end up there, it really didn’t cost you anything. You would have been paying rent somewhere anyway!
Back to the short sale: In the $200,000 example above, you owe the first lender $160,000, and you owe the second lender another $40,000 — and they both have to approve the short sale. If that happens at all, it can take months. Meanwhile, you — the homeowner and wanna-be home seller — have a parade of prospective buyers who (a) have apartment or other home leases expiring in 60 days or less and can’t wait for both banks to make decisions, (b) have their own homes on the market or under contract and can’t wait for both banks to make decision, or (c) are investors who can wait, but require a substantial discount from market price in order for their business model to work.
On rare occasions a “typical” homebuyer is willing and able to wait through the long delays that will still be required for short sales, even with new “guidelines” coming from the Federal government. (See New Short Sale Guidelines — Wait and See.) However, we are now in the part of the market cycle in most of the U.S. where prices and interest rates are likely to be rising over the next several months. In Austin and Central Texas, prices probably won’t escalate as quickly as in other places, simply because our home values didn’t decline significantly here as they did in California, Arizona, Nevada, and Florida over the past couple of years. Nonetheless, as a buyer, even in Austin, why would I wait 3 or 4 months (or longer), all the while watching other attractive homes and low interest rates come and go, when I could still get a “no” answer on the short sale and have to start completely over?
As the title of this post suggests, I am skeptical that we will see a massive wave of successful short sales any time soon. We can certainly hope, but I believe this will continue to be a painful process for almost everyone involved.