Short Selling: A Luxury of the Past?

Sources: Businessweek.com: Short Sales: A Fraying Lifeline for Homeowners; Reuters.com: U.S. Treasury set to finalize home “short sales” plan; WSJ.com: Are Distressed Homes Worth It?

Since the financial crisis devastated the housing market, short sales have become important as a last resort for distressed homeowners in lieu of foreclosure. Now that banks are seeing profit increases, reliance on the possibility of a short sale can prove disastrous for all parties to a potential sale.

A short sale is the sale of a home for less than the amount owed on the mortgage. The lender accepts the proceeds from the sale as full repayment of the home loan. Short sales are fairly complicated transactions. In order to satisfy lenders’ requirements for short sales, both buyers and sellers must provide a detailed accounting of their financial situations. Additionally, the homeowners have to prove financial hardship to qualify for the process. Once the lender is satisfied with the proposed settlement, the mortgage investors (individuals or organizations who fund mortgage lenders) have a chance to review the sale. Often, this process is held up by second and third lien-holders (persons who have a legal interest in the assets of a property that is inferior to the interest of a first lien-holder), who demand a larger amount of the settlement. This year, 12% to 18% of national home sales were short sales. In areas of the nation where the housing market was hit hardest, cities like Phoenix and Miami, almost one-third of listings involve situations where the homeowner owes more on their mortgage than the property is worth (so-called “underwater mortgages”).

Short sales have been preferred by all parties to foreclosure. Homes in short sales will generally be more profitable for banks than those in foreclosure, short sales are less damaging to the seller’s credit, and are also much cheaper for lenders than paying legal and maintenance fees on distressed properties that sit vacant. The mutually beneficial nature of short selling would seemingly create a willing negotiation framework between homeowner and lender; however, now that banks are experiencing mild profit increases, they are increasingly less willing to negotiate. For instance, today, banks take an average of 9.5 weeks to respond to a request for short sale versus 4.5 weeks a year ago. With waiting periods this long, many sales opportunities are lost due to either the seller or buyer backing out and moving on.

The U.S. Treasury has announced that it is working on a plan to further incentivize mortgage companies to include the possibility of short sales in their management strategies. Fearful that short sale opportunities are being lost in the time it takes banks to respond to requests, the Treasury has proposed to pay lenders up to $1,500 in closing costs, plus $1,000 for allowing the homeowner to sell for less than the amount owed on the mortgage. The Treasury has also proposed to pay second lien holders up to $1,000 to relinquish their claims in these types of transactions. A finalized plan from the Treasury is expected soon.

Discussion Questions:
1) Short sales may keep the housing market afloat by keeping the foreclosure rate down, but don’t they also allow homeowners to “cheat the system” in the sense that they can walk away and leave lenders to bear substantial losses? What about second and third lien holders who suffer even further losses and who might not see any of the profits from the sale? Is $1,000 from the Federal Government going to help those who have lost $10,000 on a sale?

2) Does short selling without penalty encourage low income buyers to continue to reach outside of their financial limitations or does it give them an incentive to be more practical in future home purchases?

3) Do banks have an obligation to reduce loan principal and interest during the crisis to support economic growth? Should hard times confer a duty onto those with more economic might to soften the blow?