The Economics Of Why Short Sales Take So Long
Nothing is more frustrating in today’s real estate scene than short sales. No one can-fully explain why it remains such a difficult task to complete one short sale — the process by which a lender agrees to accept less than is owed on a home — while another sails through. The only certainty as to why lenders do what they do: their bottom line.
Understanding a bank’s financial motivations will help buyer’s grasp why short sales seem to take so LONG and why often the banks seem to be operating contrary to market conditions. Just because a property is a short sale does not always mean it will sell at or below market value.
Sometimes short sales bring more cash than foreclosures, and vice-versa. Which one it is depends on a host of factors, not the least of which is whether a lender has an agreement with the Federal Deposit Insurance Corporation for reimbursement of most losses on a bad loan like those sold short.
Multiple liens on a house and fat home-equity lines of credit that must be dealt with first are easy explanations for why a short sale languishes. Another is that lenders cases each year are now overwhelmed with hundreds or more short sale offers in a month and are significantly understaffed to handle the demand.
Then there are the complexities of the post-boom world: loans that have been bundled with hundreds of others, then securitized and sold to an investor, and scores of banks on the verge of insolvency that do not want to account for losses on a short sale. Even with those hurdles, there are short sales that can take 90 days or less from offer to consummation; but not many.
Simply put, the decision an individual lender or investor group makes — even if that is not to make a decision — is laden with a convoluted mix of what-ifs, if-then, no-ways and sure things.
The real estate community is keenly focused on short sales because distressed properties are the new normal. Mortgage lenders and services were caught unequipped to deal with the crush.Â In the worst straits are those borrowers, usually through sub-prime loans, who have had their mortgage wrapped into an investment pool like those held by Citigroup and Bank of America; about 25 percent of boom-time mortgages are contained in such securities.Â The process of bundling notes and selling them to investors as a security was a boom-time staple, said Irv DeGraw, a banking professor at St. Petersburg College. AIG, Citigroup, Lehman Bros. and others backed, or insured, these so-called “credit-default swaps.” When the housing market began tanking in 2006 and foreclosures began piling up, pay-outs to the investors skyrocketed. Eventually the federal government stepped in with the multibillion-dollar bailout.
“It was an absolutely maniacal problem,” DeGraw said. “Nobody understood exactly what we were dealing with and then it exploded. Those taking the risk did not understand the amount of risk they were exposed to.” In a counter-intuitive move, many investment groups preferred a complete collapse of the security rather than agreeing to short sales. “When the mortgages start to get into trouble an insurance policy kicks in and they are made whole,” DeGraw said. “If they grant a short sale they are not made whole. It’s one of these bizarre nightmare scenarios where people got too sophisticated.”
Some banks are urging federal regulators not to come in and force them to admit all of their problem loans, he said.
“Most banks are trying to buy time. It is called the ‘delay and pray strategy,'” Thomas said. “You delay valuating the house at market and pray the value will come back. If you mark it down for short sale and do that deal you have to take a hit to your capital.”
Others employ what Thomas calls the “extend and pretend” strategy to keep regulators from noticing a delinquent mortgage, whether that be lengthening the term, lowering the interest rate or allowing a distressed homeowner to skip a few payments. “Banks will say there is nothing wrong with that because we have one on the books for a million dollars and the market will come back in a year, so why we should we hurt our shareholders,” Thomas said.
Banks are hoarding assets to avoid the fate that Thomas described, said Matt Augustyniak of Bradenton’s Horizon Realty, Horizon Title and Horizon Financial. “They have to show as much assets as possible to balance the books,” Augustyniak said. “That is why these banks are dragging their feet on short sales.”
When Bank A takes over failed Banks B’s assets, usually laden with risky mortgages, the FDIC often agrees to a “loss-share” agreement to minimize the acquiring bank’s risk. The agreements cover anywhere from 80 percent to 95 percent of any losses on the bad loan portfolio. In some cases, that prods lenders to agree to a short sale, especially if they can make more with the FDIC cash than the banks would if the house fell into foreclosure. But the opposite can be true as well, with the lender actually making more from a foreclosure if the loan has a private mortgage insurance payout and can be resold at a good price.
The Committee for a Responsible Federal Budget, a Washington, D.C.-based think-tank, reports that the FDIC has taken over 203 failed banks since 2008, many with a loss-share agreement. Total deposits so far this year equaled $18 billion. In 2008, it was $389 billion, and at an estimated cost to the FDIC of $64.4 billion. Seventy-eight percent of the existing loss-share agreements have no deductible, so the FDIC starts paying banks for their losses immediately.
For single-family mortgages, the loss-share agreement stays in effect for 10 years and covers losses when the loan is modified, foreclosed upon, when a second mortgage is charged off, or when the property is sold short. “It has helped us sell a considerable amount of assets that we normally would have had to keep,” said FDIC spokesman David Barr. “We audit the loss-share agreements to look that they are modifying the loans in a timely manner and not just opting for foreclosure or short sale. They have to choose the option that makes the most economic sense to the FDIC.”
Despite the efforts of the Obama administration to speed and streamline the short-sale process, experts say banks do whatever will provide the best outcome for their bottom lines. Buyers cannot understand why they do not hear back from the bank when they put in an offer on a short sale. Oftentimes the banks are delaying until they can take the proper y through the foreclosure process. A bank can sell the property for significantly less in a foreclosure sale that it would have if they had accepted the short sale process, BUT from the bank’s financial perspective they look to the interest payments they received from the Seller before they defaulted, the payout from the private mortgage insurer, and the proceeds of the foreclosure sale. Often the bank is not really losing much and sometimes can actually make money on these deals so they have little incentive to take a short sale offer.
A Buyer can wait an long time anticipating the acceptance of their offer only to find that they will never actually hear back from the bank, much less receive a counter offer.