REQUIRED READING: Even though Fannie Mae and others have kept foreclosures artificially low in recent months, a wave of mortgage loan defaults continues to flow across the U.S. There is mounting evidence that the Obama administration's Home Affordable Modification Program (HAMP), though laudable perhaps, does little more than prolong the life of most nonperforming mortgage loans.
As a result, there is a rising demand for foreclosure alternatives – such as short sales – that allow homeowners to more gracefully exit a bad economic situation while mitigating much of the costly foreclosure losses to lenders. The protuberance of defaults and mounting losses on real estate owned (REO) sales have caused some lenders and servicers to consider developing more aggressive foreclosure alternatives that might include lender-directed, pre-approved short sales.
A short sale is much more complicated than an REO sale, for a variety of reasons:
- The borrower still owns the property and, thus, controls the outcome;
- Consumer protection laws are still in effect if a foreclosure has not been completed;
- Securitized loans require investors to approve sales for anything less than loan value;
- Mortgage insurance companies can become involved and may become the second-lien holder; and
- Junior liens, such as second mortgages and homeowners' association liens, are not released and, in turn, must be negotiated.Â
Default-industry analysts estimate that only about 5% of all distressed properties have been sold through short sales in recent years. Some believe that the percentage of short sales may have increased to 10% in 2009, will increase to 30% by the end of this year and perhaps to as much as 50% by 2012. The short-sale trend is definitely on the rise; one major loan servicer recently reported short-sale approvals on more than 30% of all the distressed sales in its inventory.
Clayton Holdings Inc., a firm that tracks mortgage loans for investors, found that a short sale can significantly mitigate the losses to a lender or investor. A study performed by the company showed that the average loss on a pre-foreclosure sale (i.e., short sale) was approximately 19% of a loan's value, but the loss on a post-foreclosure sale (i.e., REO) was nearly 40%. One might ask why this upward trend in short-sale approvals has taken so long to materialize.
The desire to be aggressive and mitigate losses through this foreclosure alternative is a step in the right direction, but the key for these lenders and investors is developing the infrastructure, technology and streamlined systems that are required to make the short-sale process fast and repeatable. Unless these processes are implemented in a proactive manner, complete with pre-approved "strike prices," short sales will remain a protracted exercise in futility that many real estate agents and their potential buyers avoid.
A February 2009 study by Campbell Communications showed that only 23% of short-sale offers from potential buyers actually close. More than 90% of the agents surveyed cited a slow response from the lender as the main reason short sales were lost. The slow response is usually caused by a lack of adequately trained staff to handle the dramatically increased volume of requests. Many times, the process can take upwards of six months to complete. Potential buyers, frustrated by the snail's pace, often give up on short sales altogether, finding another property to purchase.
Staff training alone does not explain why so many traditional borrower-requested short sales fail. Borrowers who have stayed current on their mortgage payments despite a hardship may not be allowed to participate, or lenders might not agree that a particular hardship warrants forgiveness of the borrower's contractual obligation. Lenders or investors sometimes refuse to drop the requirement for borrowers to sign promissory notes for substantial sums. Other times, the lender or investor may consider a purchase offer to be too low (only to eventually sell the property through the REO process for much less money).
Add the problems associated with subordinate lienholders refusing to sign off on the transactions, and you get a better understanding of why such a low percentage of short sales have been successful in the past. Had economics been the driver of these transactions, there would undoubtedly be a much higher success rate.
Wachovia, a Wells Fargo company, is among the first major lenders to create an aggressive, proactive short-sale program. While the company continues to process borrower-directed short-sale offers, it has also launched a pre-approved, lender-directed approach that results in greater file velocity.
As a portfolio lender, Wachovia is not hamstrung by investors or others making the decisions on short-sale approvals on its World Savings and Golden West Financial portfolios, which are the focus of this pilot program. Wachovia does not pre-select or direct any particular listing agent to work with borrowers for obvious liability-associated reasons. The company encourages its borrowers to interview at least three agents and select the one with whom they feel the most comfortable.
Pivotal differences of the Wachovia pilot program include the following:
- No hardship letter, pay stubs or financial statements are required.
- Negotiators approve or counter offers within seven to 10 days after the offer is received.
- There is no requirement for delinquent borrowers to have experienced a hardship.
- Generous cash-for-keys payments are used to gain borrowers' cooperation.
- The listing agent is involved to develop a pre-approved strike price at which the property would likely be sold (much like the REO process). If a property doesn't sell at the pre-approved price, reductions may be requested until offers are received.
- The amount of the outstanding loan is not a factor in determining the list price. Unlike many lenders, Wachovia is focused solely on the economic benefit of short sales.
Other major lenders, including GMAC, have implemented or are about to implement more aggressive short-sale programs, as well. Some companies are far better at managing short sales than others, but all of them should focus on proactive communication, adequate staffing and training in order to streamline the short-sale process for both borrower-requested and lender-directed short sales.
GMAC has a special unit called "The Counsel to Sell Team" within its short-sale department that proactively contacts borrowers who have been denied loan modifications. The unit conducts outbound calling and mail campaigns to entice borrowers to consider a short sale, and GMAC reports a higher rate of success through this proactive approach.
Another possible solution being discussed is combining the lender's loan resolution, loss mitigation and REO departments into one cohesive unit. This consolidated team could take full advantage of each employee's skill sets and valuation expertise while benefiting from the synergy of using the same real estate agents for all aspects of the disposition process.
One of the toughest problems to resolve is the payoff expectations of the first- and second-lien holders. A few days prior to foreclosure, lenders should try to revisit the junior-lien holders that previously refused to accept a short-sale payoff. Giving them another chance to accept a short payoff before the foreclosure sale negates their lien makes financial sense.
Another possible solution to settle a stalemate between first- and second-lien holders would be to sell the properties to investors for a higher price than a homeowner would be willing to pay. True investors who take the long-term approach to investing care more about their rate of return and cashflow than they do about the purchase price.
In January, the U.S. Treasury Department disclosed that only 66,500 loan modifications had been converted to the permanent phase of HAMP. The recently introduced Home Affordable Foreclosure Alternatives will prove to be similarly ineffective due to the inadequate "incentives" offered to lenders in return for approving short sales. It's clearly up to the private sector – the lenders themselves – to create and successfully implement meaningful, aggressive and proactive short-sale programs.
Lynn Effinger is senior vice president of Olympus Asset Management, a national outsource company providing management and disposition services. He can be reached at firstname.lastname@example.org. Bob Zachmeier, owner/broker of Tucson, Ariz.-based Win3Realty, can be contacted at email@example.com.