Chapter 6 – Foreclosure And Short Sales: Buy And Sell Distressed Properties
Homeownership is the cornerstone of the American dream. Yet, the United States is experiencing one of the most troubling housing markets in its history. With 65 percent of Americans owning a home, the mortgage crisis has had not only a severe financial impact but a psychological blow for many Americans whose homes are now worth less than they were when they bought them. In 2009, according to the Mortgage Bankers Association, there were 6.7 million distressed properties, which is a property that has to be sold to pay off a mortgage because of defaulted payments. Included in that percentage for 2009 were the 10 percent of prime mortgages were in default, the 41 percent of subprime mortgages are in default, the slightly more than 17 percent of Federal Housing Administration (FHA) mortgages that were in trouble, and the nearly 10 percent of Veterans Administration (VA) mortgages that were in default.
While most indicators show these numbers improved by 2103, Hawaii has not escaped the pain of the down market. In 2009, Hawaii had the 10th highest foreclosure rate in the nation. In November 2010, it had the 12th highest foreclosure rate, with one in every 404 housing units in foreclosure. In 2011, the troubling housing market continued to be devastating for the Hawaiian market, though the rate of foreclosures improved after several years of rising. According to RealtyTrac, in January 2011, one in every 512 homes received a foreclosure filing.
The number of Hawaii foreclosures has decreased after hitting record highs. From April of 2012 through April 2013, only 466 new homes filed for foreclosure in the entire state of Hawaii, an enormous decrease from previous years. The 2011 foreclosures were found mostly on Oahu, with a significant number on Hawaii Island and Maui and a handful on Kauai.
In addition, investment markets and second homes, with their traditionally strong sales, have been hurt by the housing slump. So, what options are there for homeowners who are in danger of losing their home? And are there opportunities for others lurking behind the foreboding numbers?
Let’s examine two options that homeowners might consider in an effort to save their homes: short sales and foreclosures. Both of these options present opportunities for sellers to get out of homes they can no longer afford – and for buyers to find good deals on their next home. However, each process is complicated and fraught with pitfalls. To navigate this difficult process, the advice a reputable realtor with extensive experience in distressed properties is invaluable, whether you’re buying or selling.
Short sales –- Seller’s Perspective
When the owner owes the lender more than the house is worth and the homeowner needs to sell the property, a short sale can be the solution for the distressed homeowner. A short sale occurs when the home is sold for less than the value of the loan. Short sales can be a solution for sellers who are upside down on their property – that is, they owe more on their property than it is worth — and can no longer make their mortgage payments. In 2009, short sales accounted for 10 percent of all properties for sale in the Maui MLS. This wasn’t the case a year earlier, when short sales were creating anxiety among home buyers, sellers and real estate agents who sometimes harbored unrealistic expectations of the short sale process. The number of sales improved as people became accustomed to the length of time involved in a short sale, the difficulties involved in completing a successful short sale, the qualifications needed to get a short sale approved, the required documents, and so on. In order for a short sale to work, the lender must approve and accept less than the full payoff of the loan. It’s important to note that not all lenders will accept this lower payment, especially if it makes more sense to foreclose on the property.
With the rules in Hawaii tightening for the lenders, we have seen banks encourage delinquent homeowners to participate in the short sales through seller moving incentives. We have seen them range from $2500 – $35,000 depending on the investor behind the loan.
In light of today’s housing crises, short sales have become very popular. But who qualifies for a short sale? If you’re interested in seeking a short sale as a solution to your property woes, you must be able to answer yes to all of the following questions:
- Has your home’s market value dropped?
- Is your mortgage in or near default?
- Are you experiencing financial hardship?
- Do you have no assets?
Let’s explore each section a little more closely. First, you must be able to prove that your home is worth less now than the unpaid balance that you owe to the lender. A comparative market analysis (CMA) can determine the value of your property and the price point of comparable homes. The CMA will contain information such as sold listings, pending listings, active listings and comparable home information, such as square footage, amenities, location and construction.
If your mortgage is in or near default, you might qualify for a short sale. Even if you are not currently in default, you may be eligible. Once upon a time, a lender wouldn’t consider a short sale if the homeowner was current on his mortgage. That’s no longer the case. So even if you’re current on your mortgage payment but you know that in the future you won’t be able to pay for the mortgage, you may still qualify for a short sale. This situation is known as “imminent default.”
You must meet the financial requirements to qualify for a hardship in order to be considered for a short sale. A financial hardship can mean any of the following: divorce, unemployment, death, medical emergency and bankruptcy. To get started, you will need to prepare a hardship financial package to the bank. While each bank has its own short sale guidelines, most banks will require the following documentation:
- Completed financial statement
- Two years of tax returns
- Two years of W2s
- Recent payroll stubs
- Last two months of bank statements
- Seller’s hardship letter
- Letter of authorization
- HUD-1 or preliminary net sheet
- Comparable market analysis
Lastly, you must show that you have no assets. If your financial documentation shows that you have any assets, the lender might not agree to a short sale, believing that you are capable of paying the difference in price. However, having assets might not completely preclude you from being approved for a short sale. Some lenders might grant the short fall
and require the seller to pay back the difference. Or, in some cases, the lender might reduce the amount the seller has to pay back.
Consequences of Short Sales
While short sales might meet the needs of some homeowners, they are not without consequences. Short sales affect credit ratings. Appearing as a ‘foreclosure in redemption status’ or a ‘pre-foreclosure that’s been redeemed,’ a homeowner can expect, according to some, a drop of 200 to 300 points on one’s credit rating, depending on one’s credit score prior to the short sale. If you do not actually become delinquent on your mortgage, the drop will not be as severe, and will vary depending on your circumstances.
Homeowners should also consider the tax implications of a short sale. Even if you sell your home as a short sale, you still might be on the hook for the taxes. The homeowner who sells his home, whether voluntarily or involuntarily, may still owe Uncle Sam, who will send the homeowner a 1099 with the outstanding balance. A realtor experienced in short sales should be able to guide you through the tax implications of the move – or point you to another professional who can.
Short sales –- buyer’s Perspective
Before buying a home that’s being sold as a short sale, you need to do your homework. Homes that are sold as a short sale can seem like a bargain, and sometimes they are. However, on occasion these home prices can be too good to be true. For example, just because the seller has lowered the price doesn’t mean that the lender will accept it. It’s also important to understand that a short sale doesn’t always mean that the home has lost any value. There can also be the case when the homeowner overpaid for the home and a short sale would bring the home in alignment with neighboring homes. Additionally, short sales can take a notoriously long time to be approved. So, if you’re anxious to get into a new home relatively quickly, a short sale may not be your solution.
Before bidding on a short sale home, the following areas should be researched:
- Amount of mortgage owed. You’ll want to find out how much is owed on the home. Since the primary lender will get the bulk of the proceeds from any sale, the secondary lender, who’ll need to agree to the sale, might get a very small amount from the sale proceeds and therefore may reject the offer. So, find out how many loans make up the mortgage and how much is owed on each loan.
- Qualifications of the short seller. Since all short sales require a package to be submitted to the bank, you’ll want to find out if the seller has submitted a short sale package to the listing agent, who will submit the short sale documentation to the lender. At a minimum, the short sale package should contain the following documents:
- Tax returns
- Financial statement
- Bank statements
- Seller’s hardship letter
- Payroll stubs
These documents are required, so be sure that the seller has submitted them to the listing agent.
- Short sales offers. Because short sale homes will receive many offers, you’ll want to find out about your competition, i.e. how many offers have been submitted. Your goal is to make an offer below, but near, the market value that will still beat your competitors.
- Comparable sales. Because of the length of time it can take for your bid to be accepted, what is initially a pending sale can eventually become comparable to other sales. In other words, because these bids can take so long to be accepted they can turn out to be comparable to bids of other homes in the neighborhood, possibly eclipsing your lower bid. Since short sales can be priced at a very low, almost ‘too-good-to-be-true’ price, you’ll need to understand that banks won’t accept offers that are too low since they’re in the business of making money, not losing it, and they want to recoup as much money from the sale of the home as possible. As a result, your bid should be priced near market value.
- Realtor experience. How many successful short sales has the listing agent completed? This is huge, if it’s their first one there are sure to be lots of surprises.
If you’re thinking about buying a home through a short sale, it’s important to understand that just because a house is listed as a short sale doesn’t mean that it will necessarily sell that way. It simply means that the home seller and listing agent are hopeful that it will be a short sale. The bank has the ultimate decision if the planned short sale will come to fruition. It’s also important to remember that if the home has two mortgages, both lenders have to accept the offer.
While there’s no magic formula that will help you know what decision a bank will make on a short sale, here are some reasons why banks will reject a short sale offer:
- Short sale documentation is incomplete. Because some documents might get lost or misplaced, you would be advised to have a list of and multiple copies of your documents in the event that the package is incomplete.
- Seller doesn’t qualify for a short sale. The seller must be able to demonstrate financial hardship. If the seller has any assets, the bank may reject the offer.
- Short sale is priced too low. If the bank believes that it can make more money by selling the home at market value, then the short sale will be rejected. Banks want to see proof as to why the home is a short sale and will require a comparative market analysis (CMA) to justify the short sale price.
- The bank doesn’t own the mortgage. Beware! As you know, just because a bank services a mortgage doesn’t mean that it owns it. If the bank realizes that it doesn’t own the mortgage, it will be unable to accept a short sale offer as it no longer owns the property. This can sometimes take a while for the involved parties to realize, resulting in frustration for the potential buyer.
- The buyer doesn’t qualify for a short sale. In this case, the buyer who wants a short sale home has to qualify for it just as any other mortgage. Credit history, employment and debt ratios will be factors to determine if the buyer qualifies for the short sale.
Since the banks have the ultimate decision in determining the approval or disapproval of a short sale, negotiation is the key. Your strategy should be to understand the value of the property and make offers at or below that value regardless of the current list price. Then, you need to get lucky by making the offer at the right time, when the bank has just reduced the list price or is about to. Since you do not know when that will be, just keep making offers with the guidance of your realtor.
Growth in Foreclosures
While the number of foreclosures in Hawaii fell in 2013, there are still many distressed homeowners in the state. In fact, experts say the recent decline in foreclosures has more to do with foreclosure prevention programs and other processing procedures that tend to slow down the foreclosure process than with an actual decline in the number of distressed homeowners.
There were 466 foreclosure filings in Hawaii in 2013, according to RealtyTrac. Maui’s foreclosure problem spots were Kihei, the state’s second most distressed neighborhood, along with Lahaina, Kahului and Wailuku.
Foreclosure –- Seller’s Perspective
A foreclosure occurs when the property owner can no longer make principle or interest payments on the loan, leading to the property being seized and sold by the institution that holds the loan, usually a bank. There are many reasons why a property goes into foreclosure, including but not limited to:
- medical/health problems
- excessive debt
Just because a homeowner is in default doesn’t mean that the situation will lead to foreclosure. Some lenders are willing to work with homeowners if they deem the homeowner’s financial problems are temporary. Also, courts of equity may intervene if the lender tries to repossess the property when the borrower defaults. This action will grant the borrower an equitable right of redemption if the debt is repaid. However, it’s important to note that in Hawaii there is no statutory right of redemption. This means that the borrower may not be able to reclaim the property post-foreclosure even if they pay the defaulted amounts three days before the foreclosure sale. In Hawaii, there’s also judicial foreclosure proceedings whereby the lender can go to court but the court will determine the final judgment of foreclosure. As part of a publicly noticed sale, the property is then sold by a sheriff. The complaint, known as the lis pendens, is filed in court and provides public notice about the foreclosure.
If you are facing foreclosure, your first step should be to consult a realtor with experience in distressed properties, particularly one with Certified Distressed Property Expert (CPDE) certification. An experienced realtor can guide you through your options – perhaps helping you to save your home from foreclosure.
There are several different types of foreclosures in the United States:
- Foreclosure by Sale occurs when a judge decides the day that the property will be sold. At this point, the homeowner still has a chance to save the home if the entire mortgage payment can be made. If not, the homeowner will lose the property with the proceeds going to the auction, the lender and the homeowner (respectively).
- Foreclosure by Power of Sale, available in some states, including Hawaii, occurs if a power of sale clause is included in the mortgage. This process doesn’t require court supervision and tends to be quicker than the Foreclosure by Sale proceedings. This is the leading method of foreclosure in Hawaii.
- Strict Foreclosure (Deed in Lieu of foreclosure), takes place when there is very little equity in the property. In this case, the judge will issue law days, thereby allowing the homeowner time to get caught up with the delinquent payments. The length of the law days vary from each state and each homeowner’s situation.
Borrowers need to know about the possible consequences of a Deed in Lieu of foreclosure. In this case, the borrower may give the deed to the lender thinking that this forgives him of the mortgage. Not so! Giving the deed to the lender will stop the foreclosure, but doesn’t mean that the lender will forgive you of your debt. Borrowers need to understand that the lender can still sell your house for whatever price they can hope to get and come after you for the remaining balance. Returning the deed also doesn’t prevent any of this from showing up on your credit report. So before you consider turning in your deed, turn to a reputable realtor with experience in foreclosures. His representation could save you from owing money on a home you don’t own.
It’s also important to note that a borrower has a right to contest a foreclosure. By asking the court of equity for an injunction, or a temporary restraining order if the repossession is immediate, the borrower may effectively stop the foreclosure. Borrowers can also challenge the validity of the debt. In this case, the lender must prove that the debt is valid. This action can stop the foreclosure and allow the borrower to sue for damages.
You might think that once a foreclosure occurs that the homeowner won’t owe any more monies on the property. However, some homeowners will receive a tax bill from the lender for the amount that wasn’t recouped. This can occur because in the eyes of the IRS, you are not paying back money that you borrowed, thus it’s viewed as income. Exceptions are a cash-out refinance, as well as if the borrower’s debts exceed his assets and he files a Form 982 with the tax return. This action can clear this financial obligation.
Foreclosure –- Buyer’s Perspective
During this troubling housing market, many people are interested in purchasing foreclosed properties. While this can be a good opportunity to buy a home at an excellent price, the potential homebuyer should carefully research the process of buying foreclosed homes in consultation with a realtor with experience in distressed properties. In Hawaii, it’s important to note that most foreclosures can take from 60 to 90 days. This might be delayed even further if the borrower goes to court to contest the foreclosure, files for bankruptcy or seeks to delay the foreclosure proceedings.
There are three ways that a buyer can purchase a foreclosed property – buy from the seller before the property is foreclosed, buy the property at an auction, or purchase the home after the foreclosure, directly from the lender. In Hawaii, there is also the possibility of deficiency judgment, whereby a property may be obtained when it sells for less than the full amount of the debt. Buyers can look up foreclosed properties in the classified newspaper ads under Foreclosure Notices, Auction Sales or Sheriff Sales. Buyers can also research properties held by Federal Housing Administration (FHA), Veterans Administration (VA) or Housing of Urban Development (HUD).
Even though many foreclosed properties are not available for inspection before purchase, buyers should make every effort to inspect the property. Buyers should also research the property’s market value. Before receiving the title, the buyer should research the title to determine if there are any liens or other potential problems.
If you purchase the property from the bank, you should realize that some homeowners may be angry due to the loss of the home and damage the property. If there’s damage with these ‘as-is’ properties, the former homeowners will likely not pay for any damages. You, the new homeowner, will have to pay for any damages. It’s not uncommon, for instance, for angry homeowners to smash out windows, flood the home and remove copper and wiring. Also, in Hawaii, some borrowers are choosing not to pay their mortgage due to anger over the government financial bailouts and the lost value of their properties.
In addition, the new homeowner may need to evict the homeowners once the title is received. This can be a tricky proposition since the homeowners may be long gone and the property is taken over by people other than the previous homeowners, such as relatives, friends and even squatters. You’ll need to get legal assistance to help with eviction if you’re not familiar with the process.
Buyers of foreclosed properties should consider the following:
- Foreclosure proceedings vary from state to state. For example, in states with non-judicial foreclosures, including Hawaii, lenders don’t have to go to court to before starting the foreclosure process. In these states, the foreclosure process can proceed much more quickly. In states with judicial foreclosures, the lender has to go to court to start foreclosure proceedings. This slows down the foreclosure process.
- Buyers are typically allowed a period of redemption to catch up on the late mortgage payments, including interest and principal payments.
- Missing required documentation, such as information about equity and offers placed, can result in the sale being revoked.
- The new homeowner must be willing to evict people from the property.
Distressed properties can be a bargain for some buyers. However, research should be done to understand the pros and cons, as well as the consequences for buying short sale and foreclosed properties. Buyers and sellers should stick to the adage – if it seems too good to be true, it just might be.
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