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Ailing Lenders Now More Willing to Accept Discounted Payoffs - 2007-10-06 |
In years past, home lenders could almost always count on rising prices and the home buyer's cash down payment to bail them out if they ended up having to foreclose on a borrower and repossess the home they financed.
Before just a few years ago, most lenders required substantial cash down payments, which had the dual effect of committing the borrower financially to the transaction and lessening the lender's risk of loss. But in the past few years, things have changed dramatically:
* Lenders began offering so-called "exotic" loans featuring no requirement for any down payment whatsoever. This was often accomplished through "piggy-back" loans of 80% and 20%, with both loans being held by the same lender. Another technique was to label the entire loan "sub-prime" and charge a high rate of interest on the total purchase price.
* In addition, home price appreciation nationwide dropped dramatically to almost zero. And even though all real estate is local, few areas of the nation experienced much, if any, appreciation during 2006. In fact, some are projecting that the typical American home may actually decline in value during 2007. Whatever happens, it is clear that time is no longer the great healer of all real estate mistakes.
* Finally, with values flat and equity in some cases nonexistent, many of the adjustable loans originated in the last few years are now beginning to face rate resets. Most adjustable loans start out with artificially low "teaser" rates, then reset after one, three or five years. Unless the borrower can afford to make the new higher payment, the house may go into foreclosure.
Just to give you an idea of the magnitude of the problem faced here in the Atlanta area, let's review the number of homes listed as "being advertised" for a foreclosure auction in recent years.
In just the 13 county metro Atlanta area, there were an average of about 1,271 homes per month during the year 2000. In 2002, that monthly number grew to 2399, and last year the monthly average hit 3747. This year, I expect the monthly average to approach 5,000. That's a huge increase in foreclosures, and it's more than the system can handle.
A home with a mortgage balance equal to its market value is said to have "no equity" remaining. And homes with no equity are unattractive to investors in a preforeclosure setting. That's because investors are looking for bargains - homes with lots of equity left in them that they can buy quickly and for little or no cash.
Instead, many of these owners actually owe more on their loan than the house is worth, and that makes a preforeclosure sale almost impossible. Until now, that is.
Today, many lenders are beginning to recognize that the poor condition of many of these homes will make them difficult to sell. Add to that the likely high carrying cost of an expected ultra-long marketing period, and you have a recipe for sustaining a financial loss.
The solution is called a "short sale," and it is nothing more than a discounted payoff to the lender. Here's how a typical short sale might work:
1. In 2002, a buyer pays $150,000 for a new house, making no down payment and accepting an exotic loan for the amount of the purchase.
2. The loan is a 5/1 ARM, meaning it is fixed at an introductory rate of 4.5% for 5 years, then the loan resets annually based on a predetermined index such as LIBOR.
3. Over the next few years, short term rates rise, setting the stage for a substantial payment increase at the end of the 5 year term.
4. The borrower gets divorced, cutting family income, and is unable to make the new higher payments when the loan resets at 6.5% or higher.
5. The borrower tries to sell his house, but it won't sell for $150,000 due to deferred maintenance and a slow resale market. Finally, an offer comes in for $120,000.
6. The listing agent contacts the lender and submits a "short sale package," which documents the borrowers financial hardship and offers the lender a discounted payoff of $120,000 minus commissions and other fees.
7. The lender often tries to negotiate with the agents to lower their commissions, hoping to spread the misery among as many parties as possible. The lender also tries to get the buyer to raise their offer, hoping to recover as much of their loan as they can.
8. Finally, rather than risk taking back a property which might sit on the market for months, then sell to an investor at a steep discount, the lender reluctantly accepts the best deal they can get.
In doing so, the lender suffers a known, limited loss and concludes the matter promptly. From the lenders perspective, this charge off is the lesser of two evils. And because the inventory of these unsold repossessed homes is already overflowing, the practice of soliciting and negotiating short sales is booming in the Atlanta area.
NEXT WEEK: Frequently asked questions about short sale transactions.
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