Yesterday the GSEs, Fanny and Freddie, accelerated the switch to short sales that has been underway for the past two years by announcing new servicing standards to speed up and streamline the processing of short sales for borrowers whose mortgages are held by the GSE’s, which is about half of all mortgages in the nation.
The new guidelines, which take effect in November, allow servicers to approve a short sale for borrowers who have certain types of hardships even if they have yet to default. The also remove barriers created by some subordinate lien holders by limiting subordinate-lien payments to $6,000. This essentially cuts off any attempts by the second-lien holders to negotiate for larger payoff amounts. (For more, see Melissa Zavala’s post, Improved Short Sale Processing Time – Fact or Fiction?)
The GSE initiatives are just the latest in a series of steps by lenders and regulators to make short sales, which were virtually unheard of six years ago, the standard way to dispose of properties whose owners are in default. Last year, for example, Citicorp started paying borrowers a $12,000 incentive to complete a short sale. In May, Bank of America upped the ante, offering its borrowers up to $30,000 in cash upon the close of a short sale to help pay relocation expenses.
The Short Sale Attraction
Many lenders initially resisted short sales because of the hit they take on when properties sell far below the value of the principals. However, experience quickly taught them that they fare worse when forced to carry properties for months, even years, during the snail-like foreclosure process only to sell them as REO at losses greater than a short sale would have cost. Lenders have learned short sales can save them money and time. New tools like Equator’s short sale transaction management platform and training programs for agents and loan officers have transformed the short sale into a common practice.
For borrowers, the primary attraction to a short sale over a foreclosure is also time. Today median foreclosure takes an average of 378 days to process, the highest in records dating back to 2007, according to RealtyTrac. In the first and second quarter of 2012, properties averaged 16 months of delinquency before getting foreclosed on, according to a survey of delinquent owners by the YouWalkAway.com web site. This reflects an increase in the number of months a borrower is delinquent before foreclosure starts are filed and foreclosures are completed and implies lenders and servicers are processing older foreclosures and homes that have been in default for over a year. Underwater homeowners in the survey who received a foreclosure start notice were 11 months behind on their payment. Last year, it took an average of 9 months of nonpayment before the foreclosure process started.
Year of the Short Sale
Pre-foreclosure short sales increased 25 percent to a three-year high in the first quarter of 2012. RealtyTrac reported a 33 percent year-over-year increase in pre-foreclosure sales (typically short sales) in January 2012, with annual increases in 32 states, including Georgia (113 percent increase), Michigan (90 percent increase), California (52 percent increase), Texas (48 percent increase), Arizona (44 percent increase), Nevada (36 percent increase), and Florida (20 percent increase). Short sales outnumbered bank-owned REO sales in 12 states, including Utah, California, Arizona, Florida, Indiana, Colorado, New York and New Jersey.
Bottom Line for Investors
The switch from foreclosures to short sales as the leading form of distress sales has several important ramifications for investors.
1. The increase in pre-foreclosure sales is contributing to the decline in foreclosures by moving properties to market faster where they can be absorbed by strengthening demand. Listings of foreclosed properties have fallen in 17 of the last 19 months through July, according to research firm Zelman & Associates. REO listings are down 47 percent from their October 2009 peak and by 23 percent from one year ago. Banks are selling more homes to investors at courthouse trustee sales, rather than taking them back themselves.
2. Shorts sales will exacerbate the differences in distress sale markets by state. Defaulting borrowers in judicial states and states like Massachusetts, California and Nevada that have passed post-Robogate laws (See Legislating Disaster in Nevada and Maryland: Good Intentions Gone Wrong) will opt for short sales more than elsewhere, diminishing future foreclosure volumes. Local distress sale markets will see more move-in ready short sales and damaged long-vacated foreclosures with not much in between. REOs will dry up.
3. Current shadow and visible foreclosure inventories will not be affected directly. Their existence will still extend the Foreclosure Era by three years or so. But they won’t grow as much as they would without a short sale market and the supremacy of short sales will send shadow inventories on a slow decline and eventual disappearance as a market factor. Short sales will be as easily tracked as any other listing on local MLSs.
4. Both foreclosure and short sale discounts will shrink as overall supplies of distress sales diminish in light of falling default levels. Short sales will speed the process of absorption, reducing inventories of distressed properties for sale in local markets. Although big discounts are still available today with short sales, RealtyTrac found that those discounts may be dwindling in some local markets as rock-bottom home prices draw in buyer demand in markets like Detroit and Washington, D.C., among others.
5. Short sales will hasten the overall housing recovery. The overhang of foreclosures is the primary depressant today and the second greatest threat to the housing recovery, next to unemployment. Because short sales are absorbed into local markets so much faster than foreclosures, they will reduce the depressive effect of massive foreclosure inventories stuck in the processing pipeline.
Photo: Ken Bosma