Second mortgages hold short sellers hostage
Why do short sales take so long? Basically, banks don’t want to take a loss, and short sales cause them to lose money — a lot of money.
Short sales come in two basic varieties; properties with second mortgages and properties without. If a property does not have a second mortgage, short sales are generally quicker and easier to approve. The first mortgage is often covered by mortgage insurance, and as a percentage of the total loan amount, any losses are generally small. If a property has a second mortgage — and millions do — then the situation becomes much more complicated.
In lien priority, when a property sells in a short sale, the first mortgage holder gets paid in full before the second mortgage holder gets a penny. There is no sharing of losses by law. Therefore, if the first mortgage is underwater, the second mortgage has no collateral backing, and if the property goes to foreclosure, the mortgage is worth nothing — a 100% loss. During the housing bubble, banks often held second mortgages on HELOCs on their own books and sold off the first mortgage to MBS pools. As a result, the major banks hold billions of dollars in underwater second mortgages worth basically nothing. Of course, thanks to mark-to-fantasy accounting, that’s not how they record them on their books.
When borrowers want to sell their underwater properties, holders of second mortgages have a huge problem. Approving the short sale is tantamount to recognizing a huge, if not total, loss. Obviously, lenders don’t want to do this. On the other side of the transaction is a seller who took out a second mortgage with the assumption some future take-out buyer would pay it off for them when they sold their house for more money than they paid. It never occurred to them they might have to sell for a loss and pay off that second mortgage out of their own pockets. In their world, the debt was associated with the property, and whatever the property sells for is what that mortgage holder gets. Unfortunately, that isn’t how reality works. Second mortgages are real debts owed by the short seller, and the holders of those second mortgages want to get paid.
The main reason short sales take so long to complete is because short sellers don’t want to pay off their second mortgages (and often they can’t), and the only leverage a second mortgage holder has to compel repayment is to say no. The leverage a short seller has is the threat to quit paying and force a foreclosure where the second mortgage holder gets nothing. The two parties enter into this dance where the seller pleads poverty and attempts to shelter assets, and the second mortgage holder scrambles to make a deal where they get some or all of their money either in cash or in future promises to pay on an unsecured basis. Since these two parties are often very far apart in what they believe is a reasonable settlement, the negotiations drag on and on, and nearly half the time, a sale never occurs.
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Proprietary Irvine Housing News home purchase analysis
$549,000 …….. Asking Price
$765,000 ………. Purchase Price
10/8/2007 ………. Purchase Date
($216,000) ………. Gross Gain (Loss)
($61,200) ………… Commissions and Costs at 8%
============================================
($277,200) ………. Net Gain (Loss)
============================================
-28.2% ………. Gross Percent Change
-36.2% ………. Net Percent Change
-6.8% ………… Annual Appreciation
Cost of Home Ownership
——————————————————————————
$549,000 …….. Asking Price
$109,800 ………… 20% Down Conventional
3.55% …………. Mortgage Interest Rate
30 ……………… Number of Years
$439,200 …….. Mortgage
$113,775 ………. Income Requirement
$1,984 ………… Monthly Mortgage Payment
$476 ………… Property Tax at 1.04%
$217 ………… Mello Roos & Special Taxes
$137 ………… Homeowners Insurance at 0.3%
$0 ………… Private Mortgage Insurance
$125 ………… Homeowners Association Fees
============================================
$2,939 ………. Monthly Cash Outlays
($311) ………. Tax Savings
($685) ………. Equity Hidden in Payment
$125 ………….. Lost Income to Down Payment
$89 ………….. Maintenance and Replacement Reserves
============================================
$2,157 ………. Monthly Cost of Ownership
Cash Acquisition Demands
——————————————————————————
$6,990 ………… Furnishing and Move In at 1% + $1,500
$6,990 ………… Closing Costs at 1% + $1,500
$4,392 ………… Interest Points
$109,800 ………… Down Payment
============================================
$128,172 ………. Total Cash Costs
$33,000 ………. Emergency Cash Reserves
============================================
$161,172 ………. Total Savings Needed
The property above is available for sale on the MLS.
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