Subprime, Wallstreet, Bonds...Oh My!

A sad, yet interesting phenomenon has been happening with greater frequency in the realm of real estate.  That's the talk of and acceptance of short sales as a way to sell a home.

Short sales, in the "Cliff Notes" version, are the way for sellers to negotiate directly with a bank or note holder the difference in sales price and amount owed on the loan. In other words, a short sale is when a seller realizes that they cannot continue to make payments, cannot get out of the house what they owe in the current market, yet negotiate with the holder of their mortgage note to "forgive" the difference between the loan balance and the sale price of the property.  It is the final option, in many cases, prior to outright foreclosure.

Many of the foreclosures that Michigan is seeing is a result of a higher unemployment rate, coupled with a high number of subprime mortgages.  A subprime mortgage is a loan that has a higher interest rate attached to it due to the buyer's risk level.  For example, the buyer might have had bad credit scores, didn't have a huge down payment, or any down payment.  Those subprime notes, once executed, were then sold on the secondary market.  This means that the bank that initiated the loan recognized that they could sell that 8.5% note on the secondary market to some entity that wants an 8.5% return on their investment.

Oftentimes, banks will bundle batches of these notes for sale to the secondary market.  Some the purchasers of these notes have been Real Estate Investment Trusts (REITs), who purchase these notes by way of Wall Street and the bond market.  Those markets have some pretty stringent terms that dictate what level of performance they expect to see out of their investment.

The recent intractability of the note holders to consider short sales is likely a direct result of the bundling and sales process that happens on Wall Street.  No longer is the performance of the note directly tied to a bank, rather it is under the scrutiny of bond holders in the form of REITs and other investors.

Credit given to Paul Starner, coach and mentor, for his ability to stare at an issue and think it over a few different ways.  His recent chat enlightened his students and got the tired synapses firing again!