Advertisement He’s never missed a mortgage payment, but he lost his job with a Madison remodeling contractor last July when business dried up, and he hasn’t been able to find new work. For the past several months, he’s been living on credit cards and unemployment insurance, he said, and this month, the unemployment ran out.
“Right now I just need to let this house go and go to where I can find work,” he said, noting an old employer in Colorado has promised to hire him back if he can get there by August. “You take the best option you can get.”
For Ronne, and for a sharply growing number of area homeowners tottering on the verge of foreclosure in the continuing housing slump, the best option in cases like this may be a “short sale” — basically, a compromise payoff that protects a seller’s credit score better than a foreclosure would while satisfying the bank and giving the buyer a below-market deal on a house.
And increasingly, these deals are being done for people who aren’t in trouble because they bought a lot more house than they could afford or because they made purchases with little or no money down using subprime mortgages with adjustable rates.
Defaults on risky mortgages started the housing downturn beginning in late 2006, but now more people with good loans and good credit are needing to sell their homes in a hurry because of job losses or other factors, real estate agents said.
“This is a reality for normal people with abnormal problems,” Madison real estate agent Sara Alvarado said. “This is happening in every price range, and it’s happening to every kind of person.”
In a short sale, the bank holding the mortgage signs off on a purchase producing less than it’s owed so the home can be sold quickly, while forgiving the deficiency either entirely or in part and often spreading out any remainder over several years in a no-interest or low-interest loan for the seller. Banks also can benefit from a short sale because it typically costs them more time and money to foreclose on a house and then try to sell it.
Pitfalls and perils
But there are potential pitfalls and perils for all involved, real estate experts said, making it paramount that buyers, sellers and real estate agents understand what’s at stake, especially as short sales become more common.
Over the past year or so, many local and national banks have become markedly more willing to negotiate short sales in the face of mounting foreclosures and pre-foreclosures that are straining bank resources, agents said.
“Banks are starting to understand there is a way they can help out homeowners and help them cut their losses,” Madison-area real estate agent Deirdre Vanko said. “It definitely has picked up more since the beginning of this year.”
From December 2008 through the end of May, so-called “distressed properties” — generally defined as bank-owned foreclosures or foreclosure-avoiding short sales — made up 27 percent of the home-sale closings processed at Homestead Title Co. in Madison, according to company president and lawyer Peter Zarov. That’s up from fewer than 2 percent in 2006 and previous years, Zarov said.
And as foreclosures and unemployment continue to rise, fueling the recession, short sales are likely to become an even bigger factor, experts said. Foreclosures in Dane County were up 22 percent through the first six months of 2009 compared to the same period last year, including a 36 percent jump in June alone, while unemployment in May was 5.9 percent, up from 5.6 percent in April and compared to 3 percent last May.
“Short sales are a huge, growing part of the market, but it’s sort of the Wild West out there, because there’s not that many agents who’ve done them or done a good job on them,” Zarov said. “It is important that Realtors (and other professionals) get training and either focus on these transactions as a real part of their business, or stay away altogether — it is no place to dabble.”
Ronne’s real estate agent, Michela Terrazino, has completed industry-sponsored certification in distressed-property transactions, and there is more such training on tap for agents through the Wisconsin Realtors Association in late August in Madison.
“You need to know how to handle these kinds of properties,” said Terrazino of Keller Williams Realty. “If you don’t, you’re creating such a problem, not only for your seller, but for your buyer, too. Bankers have a stack that’s probably two feet high on their desks of these mortgages that they have to consider. Every time you make a mistake (with the required paperwork), you’re back at the bottom of the stack.”
It can be a ‘win-win’
When a short sale does work, it’s because all the parties have more to gain than lose by doing it, experts said.
“Depending on how bad the situation is for the distressed seller, you can end up with a win-win,” Zarov said. “The seller walks away from a foreclosure and hopefully salvages their credit, and the buyer gets a great deal.”
In Ronne’s case, the bank could write off $20,000 of the mortgage debt through a short sale expected in the next month or so. Such an action would have no tax consequences for Ronne, according to new federal rules, and while he wouldn’t make any money off his investment, he also wouldn’t owe anyone anything.
And because short sales don’t get reported on a seller’s credit history, his credit score is likely to dip hardly at all, compared to a 250 to more than 300-point drop for a foreclosure, which can remain on a person’s credit history for 10 years or more.
“I’m not going to ruin my good credit,” Ronne said. “I’m probably not going to get a dime out of this house, but it beats never being able to buy a house again, and it beats having to deal with the IRS and everybody else who is going to want blood.”
But short sales aren’t for everyone, experts said.
Depending on circumstances, some distressed sellers might be better off declaring bankruptcy, which delays but doesn’t stop the foreclosure process, and virtually every seller should ask the bank to consider modifying or refinancing the loan before pursuing a short sale, Zarov and the agents said.
An average buyer could expect to save 5 percent to 7 percent below market price on a short sale, agents said, while banks will usually take a 15 to 20 percent loss, including the sale price savings, closing costs and agent commissions they must pay. If it’s more than that, they usually would be better off foreclosing on the property, Terrazino said.
Mortgage holder must agree
In any case, there’s no guarantee that the mortgage holder will agree to a short sale.
Although banks typically don’t want to be in the business of managing and selling homes, they won’t accept a short sale for just any property, and there are no set rules requiring them to do so in any case. Usually, struggling homeowners with otherwise decent credit and a verifiable financial hardship — such as a messy divorce, serious illness or extended job loss — have the best shot, real estate experts said.
Taking action early, as Ronne did, also helps.
“He was wise enough to come forward before he got into trouble (on late or missed payments),” Terrazino said.
“If you know there’s a problem, work on it now because time is of the essence,” agreed Alvarado, who, like Terrazino, has distressed-property certification. “If you’re going to go into foreclosure in 30 days, there’s not much I can do about it.”
Jim Bradley, president of Home Savings Bank in Madison, said borrowers having trouble should keep communicating with their lender.
“Our experience is that often borrowers don’t want to talk with their lender, for a whole host of reasons,” he said. “That’s really unfortunate. The lender wants to understand what the circumstances are.”
On the buyer side, people interested in a short-sale property need to be flexible about when they can move in, because it may take a long time for the deal to be approved, especially when complications arise like a second or third mortgage, back taxes or liens.
“I’ve had some people wait six months to buy a short-sale property, and then the deal fell through,” Terrazino said. “It’s very depressing.”
And even when it works, the atmosphere at a short-sale closing is rarely celebratory for anyone. The seller is still losing his house and making no money, the buyer is often frustrated by how long the deal took, and the bank may be getting less than it’s owed.
“You don’t say congratulations at the end of a short sale,” Zarov said. “It’s often so far from what they want to hear. You say something like, ‘Hey, I’m glad that’s all settled, and good luck to you all.’ ”
FORECLOSURE VS. SHORT SALE
Homeowners face different consequences regarding their credit rating, future employment and future loans, depending on whether they experience a foreclosure or a short sale. Here are some of the effects:
On credit — After a foreclosure, a person’s score can be lowered from 250 to more than 300 points, typically for more than three years. Foreclosures also remain on one’s credit history for 10 years or more.
Short sales are not specifically listed on a person’s credit record. If any late payments precede a short sale, those will show up on the credit history, but they will lower a person’s credit score for as little as 18 months and by as little as 50 points if all other payments are made.
On employment — For workers in sensitive positions, a foreclosure can be grounds for immediate reassignment or termination. Because a short sale does not show up on a credit report, it isn’t a threat.
On future loans — After a foreclosure, a homeowner is ineligible for a Fannie Mae-backed mortgage for five years. After a short sale, the homeowner is ineligible for two years.
Similarly, a foreclosure on an investment property prevents a Fannie Mae-backed investment mortgage for seven years; after a short sale, it’s two years.
For loans from any other kind of mortgage company, prospective borrowers must disclose any foreclosures in the past seven years, which will affect the interest rate. The form doesn’t have any questions about short sales.
*Source: From Realtor training provided by the Distressed Property Institute
CLASS FOR AGENTS
Training on short sales for real estate agents will be offered Aug. 27 and Aug. 28 at the Wisconsin Realtors Association building at 4801 Forest Run Road in Madison. The course, offered by the Distressed Property Institute, results in an industry designation of Certified Distressed Property Expert. For more information, call 608-240-2800 or go to distressedpropertyinstitute.com and click on Upcoming Events.
