The Credit Collapse-What went wrong, and how it pertains to Short Sales

The term "short sale" has been tossed around the media a lot lately, and many homeowners are confused as to what it means, and whether it can apply to them.  As a former lending executive and Licensed Realtor who is a short sale expert, my goal is to educate homeowners so that they may make the right selling decision for whatever their personal financial situation is.  Many people make the mistake of believing that short sales are a real estate issue, but this is not true.  Short sales are a banking issue. We will first explore how the lending industry collapsed, and then we will examine how this affects the homeowner attempting to sell their property in this environment. 

 

How did we end up in this mess?

There are several factors at work here, and no one single entity or organization can be blamed.  A combination of speculative values, reckless lending, and inflated appraisals all contributed to this unprecedented situation.  Underlying all of this was the assumption that everyone should be able to get a mortgage, the belief that property values would continue their double digit rise, and the fact that there was no accountability-Because the lenders did not lend their own money.  For the last ten years, lenders figured out that instead of using their own cash assets to lend on mortgages, it was more profitable to borrow money from other institutions, mark it up, and sell it to consumers.  Once you signed the note, it was immediately sold to an investor, who then sold it to another investor, who sold it to a fancy Wall Street firm, who packaged it up into a huge pool of mortgages.  These pools were then sold as Mortgage Backed Securities (MBS's) and then sold to the public.  Who bought these MBS's?  Big institutions, such as pension funds, insurance Companies, foreign and municipal governments, etc.  Why did they buy them?  Well, for one thing, property values were rising at an unprecedented rate, and the rates of returns on these MBS's were staggering.  Also, those fancy Wall Street firms didn't accurately disclose the risk on these MBS's.  The conservative loan pools like Fannie Mae, were rated AAA, while riskier pools that contained "Alt-A" and Sub Prime, were rated lower.  The higher the risk, the higher the return.  Unfortunately, many of the so called AAA pools actually contained lower graded loans, so the risks were never properly disclosed.  The "Alt-A" and Sub-Prime loans were truly scary.  Mortgage originators tried to outdo one another with unsustainable but highly marketable loan programs, such as no income or credit qualifications, no appraisal reviews, etc.  These lenders were making so much spread lending funds that weren't theirs that risk aversion went straight out the window.  After the "Refinance Boom" of 2000-2005, fueled by historically low rates, trillions of dollars worth of MBS's were bought and sold across the world markets while the Fed looked the other way.  With the housing and lending boom single handedly shoring up the economy, then Fed Chairman Alan Greenspan was loath to derail the money train, so he continued his policy of artificially low interbank lending rates, further fueling the fire.

 

 

 

The Bubble Bursts

A perfect storm of rising defaults fueled by resetting of adjustable rate mortgages, falling property values that prevented borrowers from refinancing out of risky loans, and a contracting of mortgage credit markets combined to burst the mortgage/housing bubble in late 2006.  Virtually overnight, investors were no longer willing to buy MBS's from Wall Street, who then cut off the cash to lenders. Since lenders were relying on these funds to lend instead of their own cash, they in turn stopped funding loans.  The first to go were the Sub Prime and "Alt-A" lenders, who had no actual assets and relied entirely on investors to fund loans.  Without money to lend, these multi-billion dollar funding machines went out of business literally overnight.  The collapse of these "Pass Through" lenders such a New Century and Argent, started a media blitz that proclaimed that the sky was falling on the mortgage markets.  This caused investors to start re examining the MBS's that they had already bought, and they discovered, to their horror, that they were exposed to a lot more risk than they realized.  These larger lenders then disclosed this information, and the panic that this revelation set off caused these bigger banks to fail.  These failures in turn worked like a reverse domino effect, and roared up the money ladder like an avalanche to bury the big Wall Street brokerage houses that had bought and sold the MBS's.  When it was disclosed just how much risk these big investment banks were on the hook for, they too, either failed, were absorbed for pennies on the dollar by other banks, or were forced out of business by the Fed.  This is what happened to Lehman Brothers, Indymac, and Countrywide.  Ultimately, those left holding the bag-the pension funds, local, state, and foreign governments, and insurance companies are finding their balance sheets battered by these defaults, and more failures are expected.

 

What does this mean for the average homeowner?

The extremely tight credit market, which dictates who can get a mortgage, coupled with falling or "correcting" property values make it a perilous sellers market.  I say "correcting" market because throughout much of the US, property values were artificially high, fueled by rampant speculation.  Areas such as Chicago, which generally enjoys a stable, if modest appreciation rates of 5-8% annually, were seeing vales appreciate at double that.  Truly speculative markets such as south Florida, California, and Nevada were seeing appreciation rates approach 50%.  This, of course, was completely out of line with reality.  As this correcting market realization set in, homeowners began discovering that if they needed to sell, chances were good that they owed more than what their properties are worth - Enter the Short Sale.

 

What is a short sale?

Simply put, a short sale is when a homeowner is attempting to sell in a negative equity situation.  In other words - you owe more than your house is worth.  We all know that the real estate market values have come down over the last few years, and sellers with high mortgage balances can be left "upside down."  If you need to sell in this situation, you will be faced with asking the lender to accept a "short payoff," which means that the lender accepts a payoff that is less than the mortgage balance owed.  Depending on your hardship, and the severity of the loss, the lender may or may not elect to retain collection rights-This means that some lenders just let you go, and others will try to collect the amount of loss, called a "deficiency balance."  When you apply for a short sale with your lender, you will be asked to disclose your current income and assets.  The lender will review these, along with your mortgage balance and current property value to determine if you qualify for a short sale.  The lender may reserve the right to retain collection rights if you show significant income or assets.  This can be offset by offering the lender a promissory note for some or all of the deficiency.  A promissory note can also be used to avoid credit damage if the seller is not currently delinquent.  Final approval by the lenders' investor or insurance company may be required.

 

Steps to a Short Sale

The following steps are a condensed version of how to complete a typical short sale.

 

Step One is determining if you are eligible for a short sale.  There are some misconceptions about who qualifies, and the answer is simply, anyone that can demonstrate any kind of "hardship."  Hardships can include sickness, loss or reduction of income, divorce, upward adjusting payments, or simply a need to sell.  The common denominator is a lack of equity to pay selling costs and the full mortgage balance due to depressed property value.  The seller may or may not be currently delinquent on their mortgage, and the much mentioned "fact" that a seller must be delinquent to be granted a short sale is simply not true.

 

Step Two is compiling a complete and detailed short sale package.  Documents needed will be current pay stubs (or unemployment/alternative income) documentation, recent bank statements, a personal financial statements, and tax returns.  Your submission must be complete, because lender loss mitigation teams are overwhelmed with files, and they will simply throw your file away or put it at the bottom of their ever growing stack if all documentation is not submitted.  Loss Mitigators frequently have caseloads of 500 or more active files at any given time.  A purchase contract from a buyer is included in your submission if you have one, but contrary to popular belief, it is not necessary to start the short sale process.  Most critical is the process of determining the lenders actual net proceeds and many factors are considered in this calculation.  Remember, you never negotiate the purchase contract price, you negotiate the net to lender value. This is where the amateurs separate from the pros.  Mess this up and you will be short at close, and your buyer will be forced to pay extra or walk away.  This is also where real estate agents end up with little or no commissions if these calculations are not carefully done.

 

Step Three is valuation.  Once your file is received by the lender, they will order a broker price opinion (BPO) or an appraisal.  A BPO is where a local real estate agent will look at the subject property and comparable sales to come up with an opinion of market value.  The problem with this is that the lenders pay agents only $20-$50 for these reports, so how thorough of a job do you think these agents do?  If you answered "not at all," you would be correct.  Agents sometimes will not even physically inspect the property, instead relying on MLS or zillow.com (Please...) for their values.  Not surprisingly, lender BPO's usually have no basis in reality.  Worse yet are when lenders have appraisers value a property, because let's not forget that inaccurate and ridiculous appraisals helped lenders make these bad loans in the first place.  I use advanced techniques to control the lenders BPO process to ensure realistic values placed on the subject property by the lender.

 

Step Four is negotiation.  Once the lender has valued your property, they will usually counter offer your offer with an amount usually equal to their BPO value.  Many agents assume that this is the lenders bottom line, but I know that there is still a lot of room for negotiation if needed.  The key here is getting to talk with an actual negotiator at the lender, and without the proper contacts or experience, most agents and attorneys end up spinning their wheels trying to negotiate with some underling with no decision making ability.  Once the negotiator is satisfied, they may need to send it for investor/insurer approval if the lender sold the loan on the secondary market.  This adds extra time to the deal, and more negotiation may be necessary to receive a short payoff.  Once a short payoff is received, review it carefully because the lenders sometimes try to sneak in additional terms or fees that weren't agreed to.  Fight any payoff discrepancies until the outcome is satisfactory to you.

 

Step Five is the closing. Once a short payoff is received, it must be submitted to your attorney or Title Company and they will set up a closing.  The close should no different than any other closing, except for the lender will need to review and approve of final closing documents before the payoff is accepted.  If this is not done properly, the lender will reject the funds and the deal will collapse.  Once this step is complete you will receive a release of lien and your sale will be complete.

 

Conclusion

It is extremely important to have a seasoned short sale negotiator assisting you in this process.  The vast majority of real estate agents and attorneys do not have the experience to properly negotiate short sales, and this is too important of a process to leave to someone who is learning as they go.  This is not the time to give Cousin Larry his first real estate listing.  Thoroughly interview your real estate agent and attorney to determine if they are qualified to handle your short sale.  The first question to ask is if they are Illinois HB 4611 compliant.  If the answer is a blank stare, find someone else to work with.  HB 4611 is an Illinois law designed to protect homeowners from foreclosure rescue scams and it forbids anyone doing short sales or loan modifications from taking any money from you up front, as well as requiring certain legal contracts and disclosures to be signed.  In closing, a short sale is an extremely complex and demanding transaction, so chose your negotiator wisely.  Many other states have adopted similar legislation-check with your staes regulatory boards for more information.  This is serious stuff, and your License is not worth you "winging" a short sale.

 

To Contact me for more information, please visit my website at www.icgshortsales.com or e-mail me at joe@icgshortsales.com  Joseph C. Alfe is a licensed Realtor and professional short sale trainer, and is always happy to answer your questions.