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“Negative equity, often referred to as ‘underwater’ or ‘upside down,’ means the borrower owes more on their mortgage than the home is worth. Near negative equity is when mortgages are within five percent of being in a negative equity position. Negative equity can occur because of a decline in value, an increase in mortgage debt, or a combination of both.” -Summary of Second Quarter 2009 Negative Equity Data from First American CoreLogic, released August 13, 2009.
By Greg Schmid • Special for ‘The Review Not to overstate the obvious, but the real estate market has gone from bad to worse, with no end in sight. We have finally reaped the bitter but inevitable harvest of ill-advised government intervention in the residential real estate market. Economically unsustainable government homebuyer programs artificially increased demand in the market, and in turn home prices inflated. The inevitable failure of the government program loans, and the under-funded mortgage insurance meant to back them, caused the bubble to burst. Demand for new housing is now non-existent, and even people who could afford a mortgage and want to buy your house can’t do so until they find a buyer for their existing home. They can’t find a buyer for the same reason.
Time honored banking standards dictate that no loan should exceed 80% of total collateral value, so by that measure almost no Michigan homes would be eligible today for a new mortgage in the full amount of the current balance owed. Now government policy is to slow foreclosures down, and keep the supply of foreclosed homes down, in order to reduce oversupply and prevent the market from collapsing further. Actually, the banking industry is slowing foreclosures too, for the same reason. The residential home sales cycle seems hopelessly out of whack; there is a bottleneck that must break before the private market can reassert itself and start the healing. A recent report of a one-month increase in prices was only the result of the artificial inventory holdback of foreclosed homes. The lucky folks who are not upside down, nor already trapped in their own house, are not willing to become buyers unless they get really great deals. Would you? They are looking for REO (Real Estate Owned) bank foreclosures or short sales. One tenth of all sales in America are now short sales, according to the national association of realtors. A short sale is the sale of a home for less than the amount of all money owed on the property. Short sales buyers are not trying to steal your house. The rip off has already occurred. Mortgage originators, appraisers, real estate salespersons, well- intentioned government meddlers, unscrupulous sub-prime lenders, and overeager buyers all contributed to the real estate bubble. Today’s buyers just don’t want to end up like you did, with a house they can’t resell. It’s not like they are buying without risk, either, since the residential housing market is likely to plummet even further. Even the commercial real estate market has tanked, so there is no assurance that the floor has been reached. Everyone has paid a price in this market collapse, but it is the buyers who paid too much for their homes that are still legally stuck with the tab with their home that is worth less than the money they owe on it. The problem is that the lenders, whose loans are under collateralized, seemed until very recently to be unwilling to let go of their stranglehold on borrowers. They were clinging to traditional notions that borrowers would repay their debts because they promised they would. Until those borrowers (mortgagors) and the mortgagees who loaned them too much money decide it is time to take a bath together, there will be no sustainable recovery.
Walking away, Strategic Default, and Bankruptcy You can walk away from your home and start over. Putting your house keys and a quitclaim in an envelope addressed to your bank may seem tempting. New foreclosure laws can slow foreclosure sales by 3 months, and even more. Playing that game out, forcing a bank to eventual foreclose sale, and then living in the home through the (generally) 6 month redemption period (without paying) might seem like a way to get some of that lost equity back. Some banks even pay “cash for keys” to get you out, but this enlightened pragmatic approach only happens after foreclosure, when the loss mitigation teams are in play. However, the consequences of these strategies can make your situation even worse than you might imagine. You have to live somewhere, and most people rely on credit for cash flow. Free flow of credit is what sets America apart from most of the world. Without credit you can’t get started, and you can’t keep going when bad luck strikes. Lose your credit, and your options are limited. Harm your credit score, and it will take years of conscious effort and good luck before you can buy a house again. It is popular these days to talk about living within your means, and without credit cards, but ask anyone who has done it for a while and they will warn you to keep just a little bit of credit going just in case. That’s good advice. Lack of credit makes you struggle and go without, and that is why everything seems to cost poor people more money, and take more time. Digging out from complete financial failure is a very hard thing that you would do well to avoid (if you can). Michigan law allows deficiency judgments after foreclosure, so technically a bank can chase you for the difference between an adequate foreclosure sale price and what you owe. This is rarely done in a foreclosure by advertisement setting, but is a reasonable consideration. A home foreclosure will stay on your credit report for about 7 years (though the damage is at its worst for about 2-3 years). It can lower your credit score by about 250-300 points. That is devastating in many ways. First, you may not be able to borrow at all. You likely won’t get a big loan for 5-7 years. But even if you can borrow, it will cost you much more to do so. A “paper rate” is, and it fluctuates with time. The worse your score, the more you pay over “paper rate,” which is the best rate that exists in the market at the time of a loan. A moderately bad credit score could easily cost you an extra 2% interest, or about $4,000 every year on a moderate home loan. In addition, landlords, insurance companies, and even potential employers check your credit score to determine whether a prospective employee is trustworthy, and some run a credit report before giving a high-level job promotion to answer the question: Can someone who cannot handle his or her own financial business be fiscally responsible enough to handle company finances? Chapter 13 Bankruptcy can be a better option for those who have actual financial hardship, even though it stays on your credit report for 10 years. At least in Chapter 13 Bankruptcy you can try to keep your car and your house, if you qualify and file in time, and you get to unilaterally write down your loan balances to the point where you are solvent. That can come in handy when you can’t borrow the money to get a new place to live. Some call Bankruptcy an easy way out, and it is a robust an inexpensive tool for a fresh start, but major chapter 13 repayment plans take 5 years of steady repayments. There are several local lawyers who are very clever bankruptcy practitioners, and some that I know even offer payment plans. All of them will try to find another way for you, and if you can afford to get out of debt without defaulting on a loan or filing bankruptcy, you will end up the richer for it. There is a new school of thought on this, practiced by people known as “Strategic” defaulters, who maintain perfect payment histories before suddenly going 60 days late on their mortgages. After default they remain current on other debts. Two-thirds of strategic defaulters bail out on primary homes, not investments. However, strategic defaults are growing among owners of all homes. In 2008, almost 600,000 homeowners engaged in this practice. Clever moves and timing suggest these are high-end borrowers employing foreclosure as a calculated financial strategy to cut their equity losses rather than as a reaction to financial hardship. These strategic defaults generally occur in higher prices homes, where 25-35% in negative equity adds up to real money. Their theory is that their credit will repair itself before they could recover the equity would lose by honoring their home loans. There is certain logic to this. For some people foreclosure is the worst-case scenario, but for “strategic” defaulters the stigma of foreclosure has lost its bite. They cannot file bankruptcy and still keep their wealth, so they surgically cut out the financial cancer they have; their overpriced home. They would try arson, but the prospect of mere probationary sentence renders uncertain the benefit of free room and board in prison. Seriously, though, it is hard to lay down a moral judgment in this market, where everyone sinned. Keep in mind that they did not create the real estate bubble, nor did they make it pop. Thank government interventionists, mortgage originators, appraisers, real estate salespersons, and unscrupulous sub prime lenders for that. An unrelenting downward spiral in the real estate market has made home loans go bad; but that does not necessarily mean that the borrowers are bad. Borrowers and lenders, and other professionals, relied on unreliable appraisers to tell them the value of the collateral. Of course, anyone who has ever been on the inside of a home loan deal, and watched the games that so-called professionals played to make it seem to the lender that the loan was sound, knows that everyone has blood on their hands. The banks knew this was going on; they were willing victims. So did buyers, and sellers. There is plenty of recrimination to go around, so I am not suggesting that borrowers play the perpetual “victim” card, like so many do in our society. Just recognize that there is too much moral grey area for the players to point fingers at each other. The blame game is fine for framing future public policy that avoids artificially inflated markets and easy credit rip offs, but before the real estate market can function again the lenders have to learn to take a hit right along with the you, the borrower. For the lenders (investors and servicers alike) it’s just the way it has to be, and it’s better than spending thousands on foreclosures, property preservation, and commissions only to sell the same home for pennies on the dollar, or waiting for crumbs after the borrower is forced into a Chapter 13 bankruptcy. It is the processing cost and the time involved in foreclosures that drains value from collateral to the point where investors net only 30-40 cents on the dollar. These “strategic” defaulters who are the key to turning the real estate market around. They have income and hope, and that is what it takes to turn a market around. If the lenders would let them sell short, they could sell at a breakeven point and would pay off most of their loans rather than just walk away from them, and they would buy a new place to live, too. Demand would rise, and with it prices. The market could seek its equilibrium.
Short Sale: It may be a long shot, but it might be the least bad alternative for all involved. The main feature of a short sale is that your agent or lawyer negotiates with a lender to accept less than the amount owed in return for a discharge of the loan. In many cases, there are at least 2 mortgages in place. The “junior” mortgagee recognizes that a foreclosure by the “senior” mortgagee will eat up all the equity in the home, and that they will ultimately have to look to the borrower (and not the collateral) for repayment. They are basically an unsecured lender, and they know it. They know, therefore, that they are the borrower’s last priority, and that they may end up spending thousands trying unsuccessfully to chase an uncollectible borrower. Therefore, if played right, they are willing to take less than they are owed and still discharge the mortgage, so that your buyer takes the property free and clear of the debt. Short sales are nuanced, and require patience, but they are a real answer for buyers, borrowers, and lenders alike. Static unrealistically high sale prices prevent buyers from even considering the purchase of your home. On a macro-economic level, short sales can break that bottleneck that prevents housing supply and housing demand to reach market equilibrium. Something has to give, and too often the buyer shoulders all the burden of the collapse in home prices. They are forced into bankruptcy, which doesn’t help the bank. Once it gets that far, the bank wishes it had taken a discount in a short sale, but banks are surprisingly stubborn in this respect. Why? Partly it is a misguided outrage that you would expect them to accept less than you agreed to pay. Mostly it comes down to human nature and job protection. Jobs are scarce. Someone in the bank has to make the decision to discount a loan for you, and what mid-level bank officer wants that hot potato when job evaluation time comes along? Fear of making a decision that might later be perceived as a mistake by some Monday morning quarterback a few rungs higher up the corporate ladder is the biggest roadblock to short sales. This is why, in order to effectuate a short sale, you must first sell the bank’s mitigation department.
Caveats to Short Sales Short sales take time, and proper timing. Expect 4-6 months to make a successful play, and make sure you take the right steps at the right times. Don’t expect short sale cooperation after the foreclosure sale, even though this would seem a logical time. Don’t expect cooperation before you are in default, either. Don’t expect the bank to take the first offer – they will want to see that you have tried to sell the property at a break-even price for 30-60 days before you bring them a short sale. Don’t be surprised if they expect you to bring at least a little money to the table to mitigate their loss, unless you can show that you don’t have it. Do not expect to make money on the deal. Your profit is in losing less than you otherwise would by saving your credit rating and avoiding liability. Expect them to negotiate a real estate broker to discount the commission to 5% too. Short sales are often a paper chase nightmare, where 3 or 4 different entities with different interests must assemble and agree to terms. It can be rough just finding who holds the paper, and who can sign the loan discharge if they do agree. Good news is coming, though, as just last week Bank of America made a move to facilitate short sales by adding to its short-sale staff, and adopting the highly efficient “Equator” Internet portal format to allow all the players real time access and input in the short sale process. This move signals a sea change in institutional attitudes, and capabilities, with regards to short sales. One should expect others to follow suit. This should make short sales faster and more users friendly. Many real estate agents who shunned short sales will be back in the game because of this breakthrough. See www.reotrans.com - Currently 51 Mortgage Servicers, 15,000 Default Vendors and 625,000 Real Estate Agents use the platform to manage over 150,000 transactions daily. Beware the discharge of mortgage that is not also a full satisfaction of the loan. A mere discharge will free up the sale for the buyer, but the bank can chase you on the underlying promissory note unless you also negotiate a satisfaction. This is not automatic, but the time to negotiate this is definitely as a package deal with the short sale. It is also important to your credit rating that the loan forgiveness not be reported as merely “resolved”. Where the loan is “satisfied” it should be reported as “satisfied”, so as to start the healing process on your credit reports. Beware of Income Tax consequences. Loan forgiveness by a bank that writes off a portion of your debt is generally considered taxable income to the borrower. Under the Mortgage Forgiveness Debt Relief Act of 2007, now extended through 2012, a discharge of "qualified principal residence indebtedness" is excluded from taxable income That is good news for now, but you must keep in mind that this is a temporary measure and only applies to acquisition indebtedness. If you got a line of credit, or consolidated other debt into a mortgage, that part is considered taxable income before the exemption kicks in. Short sales would be a perfect solution if banks were more foresighted about the process, allowing you to keep your payments current thought the process without going into default. Unfortunately, the fact is most banks will not consider a short sale negotiation unless you are 2 payments behind, meaning you get a negative credit report which may cost you about 100 points on your credit score. That is better than a foreclosure or bankruptcy, but still far worse than it should be when you, as the seller, are willing to leave your home in order to help the bank minimize their loss.
Step-by-Step Process First, resolve yourself that you are ready to walk away and take a loss. Look at your situation, and have someone you trust give you a reality check. This is your lawyer’s role, as the lawyer has no conflict of interest (since you pay a fee regardless of whether you sell). Make sure a short sale is right for you – it might not be. Generally, you may be looking at shorting the second mortgage only, and will want to assess what they might take in full satisfaction. The will probably insist on 80 cents on the dollar or more. Make no assumptions on this. Each lender is different, and their policies change every week. They need to keep their bad debt portfolio below 3%. Look on the internet, and google “short sale” and the name of the bank. You will see what people are saying about their experiences with a particular lender. Information is power at this stage, so take advantage of the vast amount of information you have at your disposal. This initial assessment process involves a lot of soul searching, and is surprisingly similar to a death in the family. When you have experiences the stages of grief denial, anger, bargaining, depression, and ultimate acceptance, then you are ready to move on with your life. Make a contingency plan for what you would do, where and how you would live, in six months when you are out of your house. Of course, none of this will likely happen until you are behind in your payments. Not surprisingly, banks generally will not consider a short sale for a person who is not 2 payments in arrears. This is unfortunate, and in my opinion is bound to change soon, as a bank strategy to accommodate the “strategic defaulter.” Pava Leyrer, president of Heritage National Mortgage in Michigan, was quoted saying that some now are considering non-delinquent borrowers because they don’t want them to walk away from their mortgages. That has not panned out yet, but it looks like it soon might, as it must. Don’t let the fact that you struggle to make your payments each month hold you back. If you are on a sinking ship and you know it, then make the short sale play. You don’t have much to lose. Next get a referral to a real estate broker. Many brokers and agents will not touch a short sale property, believing they are too speculative to spend time on. This is cat-on-a hot-stove syndrome. They wasted time on an unsuccessful deal in the past, so why bother. Professionals who have learned to work short sales are happy to do it in this slow market, and you will find that if you give the savvy ones the time and flexibility they need, they can often get you into “preapproved short sale” status. This is not a “Do It Yourself” project. A broker is more likely to invest money in marketing your property if they know you have a lawyer helping you with the technical details, as these details are beyond the training and experience of most real estate professionals. The trick for the buyer is to keep their own expectations under control, and cooperate with the disclosure homework you will need to generate to justify a short sale approval. Next, develop your short sale strategy and your presentation package. Determine your breakeven point; the price at which you could pay off all liens and costs of sale (including broker fees). Your listing price should be at or just over this price. If someone will buy the property at this price, you don’t need to get approval from the bank. It won’t be a short sale. Unfortunately, no one will pay this price, which is why you don’t bother to start at a higher price in hopes of making some money. You need to leave the property listed at breakeven price for a month or two before you can expect a bank to cooperate with a short sale. You may want to indicate “motivated seller” in the listing advertisement, but do not mention short sale yet. Once you go below break even pricing, and unless the buyer is will to make up the deficiency, a short sale listing on an MLS must include the disclosure that any offer is subject to approval by the lender. Get the home ready for showing, cleaned and uncluttered, without spending much money. Keep it that way for the duration. Get an offer and submit it, with your package. A bank won’t consider an offer that isn’t on the table. With so many short sale proposals to process, they won’t bother with you unless you have a bona fide offer. This means a signed purchase agreement (of course, the offer should state that it is subject to bank approval). The bank will want “proof of funds” for a cash deal, or an approval letter from the buyer’s lender (or the loan application, at least) before it considers the offer bona fide. Submit the listing agreement, and an authorization for the bank to discuss your financial affairs with your agent(s). Prepare a “Seller Net Sheet”, generally a so-caller HUD-1 form, to demonstrate the net proceeds that the bank would receive from the sale. This is essential! Get a Broker Price Opinion or a Comparative Market Analysis and submit this with the package, along with current photographs of the property, highlighting repairs that are needed and repair estimates from contractors. This will help the bank judge the value of the collateral. Submitting neighborhood foreclosure statistics is also a good way to convince the bank that their first loss is their best loss. Include a copy of the MLS history to prove that property has been on the market for a significant period of time. Include proof of other active listings that are listed below the offer price (to support the price offered by the buyer). This can help justify the offer price to the loss mitigation officer. You may also consider submitting a preliminary title report update, so the bank knows about any other liens or title problems that would increase the cost of a foreclosure, or to assure them that the deal will go down without incident if they approve it. Your job will be to develop a short but convincing one page handwritten letter asking politely for consideration, and explaining why there is no way you can honor your commitment to the lender due to a financial hardship. It is important to humanize you proposal, and to be honest and humble. The further your hardship is removed from your immediate control, the better your chances. Drinking or gambling problems will likely not be considered a financial hardship, nor will your child support or college tuition commitments be met with understanding. The loss of property value is not a hardship either, from the bank’s perspective. The lowered value of your home has nothing to do with your ability to honor your commitment to pay your loan. Unforeseen illness, divorce, business downturns are common hardships, but even gas prices were considered hardships for a short while after they doubled a couple years ago. You know what your hardships are, sole express them. Be able to demonstrate depletion of savings accounts and other investment/assets, show your efforts to liquidate other assets to make money available, and summarize how you have reduced your own living expenses. Be able to back up your claims, because you will need to do so. The lender will want your last two tax returns, two pay stubs or other proof of income for each borrower, and a complete breakdown of your income, assets, and liabilities. You may simply wish to fill out a “Uniform Residential Loan Application”, like when you applied for the loan in the first place. The questions are all the same. Beware of a misstep here! If you mislead the bank on your first loan application, and demonstrate this to them in writing, you are providing evidence that could be used against you. Have your attorney review this with you (not your broker and not your accountant – only your attorney can offer you advice and keep your secrets under the protection of attorney-client privilege). If you cannot make full disclosure, and provide documentation to support disclosure, then a short sale is not for you. It will not happen without you committing to take this step. One strategy to consider involves accepting the first viable offer you get, even if the offer is so low that you expect the bank to reject it. By going through the motions, even knowing that the bank will refuse, you have at least started the process. This gets you past the reluctance of a bank to even consider a short sale proposal where no offer is in place. In a slow market, this can save you time. The bank might make a counter offer. The benefit to a counter offer is that it will tell you what price the lender would be willing to accept. Even if the buyer is not willing to accept, a the counter offer lets you market the property as a "pre approved short sale" at that price, since the lender has now put in writing the price at which they would be willing to approve a short sale. In any event, the balance of your short sale proposal package is already done, and you probably have a better idea of whether the bank will cooperate at all. Even if the bank simply rejects offer, a savvy professional can ask why the bank did not accept. This will expose perceived weaknesses in your presentation or your price. Perhaps they are uncomfortable with your hardship, or the level of your disclosure. You can work on that. Sometimes a loss mitigator will be willing to discuss the net figure they would approve. The bank’s agent may make a frank statement like, "We need to make up at least 75 cents on the dollar to discharge, " or make other informative comments. If they do, then you have a roadmap to success. You need to reconstruct the HUD-1 from the bottom up to determine what selling price will net that desired amount for the lender. If you are able to determine the price it would take to satisfy the lender, then you could tell buyers that the property was "verbally pre approved" for the short sale at that price. The hard part about short sales can be that you cannot reliably predict the lender’s behavior. It is like fishing. They hold their cards close, feeling that the line between a tough but necessary loss mitigation decision, and simply being taken advantage of, is narrow. There is one bobber in this pond, though, and that is the outside appraisal. The bank won’t ultimately rely on the BPPO in your short sale presentation package for its final decision. They will order their own appraisal or BPO. When you learn they have ordered the appraisal, you know they are nibbling your bait. They haven’t bit yet, but they might. This registers a huge psychological shift on their part. They are getting into the game, and investing some money in determining the real value of their collateral. How do you know when they have done this? Ask. They have no reason to hold back this information, and every reason to tell you. Every day they leave you out on the ledge is another day you might jump off into bankruptcy or worse. Once they have the appraisal, an answer is soon to follow. It might be no, but you might find that they will give you all the signals you need to know what kind of offer that will be acceptable, and that is worth a lot. The startling news of a recession and real estate market collapse was nothing new to our area, for in this respect we are ahead of our time. While recovery is uncertain, given a Stimulus package that rewards bad decisions, there is hope that the private sector can work its healing power in the form of short sales in the market. The sooner borrowers and lenders start getting together before default to share the pain of collateral shortfalls, the sooner the market will unfreeze. By making peace with borrowers, and letting them sell short without first forcing them into default, lenders could transform these down and out borrowers into make robust buyers once again. Recovery might not come as a result of more government intervention, but in spite of it as lenders relearn the old lesson that “Your first loss is your best loss.” To make this recovery happen, they will also need to remember another old saying; “Forgive and forget!” |
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According
to the CoreLogic study, one-third of mortgagors nationwide are
upside down in their home mortgages. 12% of homes that are upside down
are worth less than 75% of what is owed the bank. In Michigan,
48% of mortgaged homes are worth less than is owed on them.
Virtually every other mortgage in Michigan is in a “near negative
equity” position.