Strategic Short Sales: What’s Happening?

Strategic Short Sale Stats

As predicted here and elsewhere, strategic short sale, that is to say voluntary, non-hardship short sales, are increasing. Analysts for Morgan Stanley say that strategic short sales represented about 12% of all defaults in February 2010 as opposed to 4% in 20007.

Further, the higher the borrower’s credit score and the larger their loans, the more likely they are to stop paying their mortgages. Possibly, that reflects both the greater financial acumen of these high-dollar homeowners as well as their greater range of housing options once they are out from under their loans.

Across the country, about 15 million homeowners are either behind in their payments or in some stage of foreclosure.  Across the country, about 20% of all homes are underwater, pointing to an endless surge of foreclosures for years to come unless something is done.

Obviously, with a tsunami of pre-foreclosures  waiting in the wings, home prices will not recover. Analysts are now predicting it will take at least 3 to 5 years for the current distressed home mortgages  now in the pipeline to clear. At that rate, ever more homes will join in.

What Is Causing the Strategic Short Sale Logjam?

Why would so many homeowners bailout on their mortgages and their homes? People do not like to give up their homes and will do anything to keep them, short of financial suicide. Homeowners take money from retirement accounts and run up credit card bills before finally realizing they can’t catch up.

Of course, most of the high-dollar homeowners have asked their mortgage holders for help. As discussed many times here, banks take many months to make their decisions, often outright refusing to help at all. Offering what these homeowners really need, a principal reduction, almost never happens. Banks really do not like to “forgive” a debt or any part of it. A contract is a contract, right?

Cognitive Dissonance: Banks and Strategic Short Sales

“Broad-based principal reductioncould result in decreased access to credit and higher costs to consumers because lenders will price for forgiveness risk,”  that piously intoned by  JPMorgan’s mortgage unit.

Not mentioned–Morgan Stanley defaulted on a a $2 billion loan two years after it bought Crescent Real Estate Equities Co. and handed over 17 million square feet of office buildings to lender Barclays Capital. Morgan Stanley also agreed to hand over  five San Francisco office buildings to its  lender, Blackstone Group, two years after buying purchase.

The biggest strategic short sale of all, though, occurred in January 2010 when , Tishman Speyer Properties LP and BlackRock Inc. defaulted on a $3 billion mortgage on Manhattan’s Stuyvesant Town and Peter Cooper Village apartments, the largest residential enclave in New York City. Its sale in 2006 for $5.4 billion marked the biggest U.S. real estate transaction.

The big financial entities so reluctant to help homeowners are themselves  the beneficiaries of taxpayer largesse and, clearly, have no problem walking out on their own mortgages.  Perhaps, when the big financial institutions stop talking out of both sides of their mouths, we can start to find solutions to this huge problem.

Short Sale v Short Payoff…What’s the Difference?

In an earlier post, Short Sale v Foreclosure, we saw the difference between a short sale and a foreclosure, but there is another option for a distressed  homeowner. This is the Short Payoff. This option makes sense only under special circumstances.

What’s the difference between Short Sale v Short Payoff?

In our current real estate environment, short sales are becoming more common. A short sale occurs when  the lender or investor agrees to accept an amount less than actually owed on the property. The lender sells the property “short.” In this case, it’s up to the homeowner, usually using a real estate agent, to market and sell the property. The new buyer usually gets a bargain. The previous homeowner gets out from under an unmanageable mortgage by giving up the house.

In order to qualify for a short sale, generally speaking, the homeowner must demonstrate a verifiable long-term hardship rendering him unable to pay the mortgage. These days,  many homeowners, especially those who bought within the last several years or those who refinanced and took big chunks of equity out of their properties, becoming “upside down” in their home loans or owing more than the home is worth. Now, more and more often, these homeowners are also doing short sales.

So far, this doesn’t sound like such a bad deal. The house I bought loses value, so I sell it at current market rates and the lender takes the loss. Well, true, but the homeowner no longer has a home. And, the former homeowner will probably be a renter for several years to come as his credit report’s FICO score will immediately drop by about 300 points. The newest loan guidelines from Fannie Mae and Freddie Mac specify that after a short sale, a prospective borrower must wait for 2 years to qualify for any  FHA- or government-backed loan.

So, what’s the alternative that will NOT damage credit to such a degree?

That option is called a Short Payoff. It also carries some tough restrictions. If the homeowner is upside down by a smallish amount, say $10,000 to $50,000, depending on his  financial perspective, he might try to negotiate a short payoff with his lender.  In this scenario, the lender agrees to release the lien, his interest in the property, allowing it to be  “conveyed” or sold to a new owner.  The lender agrees to accept less than the amount owed on the property to release the lien, thus “short payoff,”   However,  in return, the former homeowner signs a promissory note for the difference or some of the difference agreeing to “pay off ” this unsecured line of credit according to the terms of the note.

To do a Short Payoff, the mortgage must be  current, the borrower must have  great credit, and must demonstrate the ability to pay off the debt.  The upside of this situation? The former homeowner keeps his great credit and can purchase another home or anything else he desires.

When is a  Short Payoff appropriate? A homeowner might  request a short payoff when the home has lost value dramatically or even just enough to make it impossible to sell, and he does  not have the ability to pay the large amount to get completely out of the property.

Not all lenders will allow for a Short Payoff; however,  you will never know if you never ask.
Of course, the advantages of short Pay-offs are the borrower are able to move out of the property and get on with his life, there SHOULD receive no negative feedback on the former homeowner’s  credit.

If for some  reason down the line, the borrower’s  ability to pay changes and cannot pay on the note, the credit ramifications are significantly smaller.

For further clarification of the entire short sale, foreclosure and short payoff differences, I have just posted an E-Book, Should I Short Sale My Home or How To Survive the Worst Real Estate Market in History, available as a free download, on my website. Plus, it appears in Links to the right of this post.