Short sales viable after new rules?

Does it make any sense for a bank to take a $300,000 loss just to stand strong on a short sale? That's exactly what a Philadelphia mortgage banker told me happened with his house in the Old City of Philadelphia when he filed for bankruptcy in 2009. With the downturn his income went from $500K to under $125K and he could no longer afford the mortgage on the home he'd paid $715K for in 2004.

The banker first told Chase, the bank that held the first lien, of his difficulties in November 2008. His tenant offered to buy the home for $525K In January 2009 and he started working with Chase on the short sale. The appraisal came in at $575K, but Chase bank, which held the first lien told him it would not lower the price below the $690K he had in mortgages on the home.

With a short sale the bank agrees to allow the sale of the home for less than the mortgage amount. He told me the home finally sold at auction to the second lien holder Citizens Bank for $225K in November 2009, after the banker filed for bankruptcy.

While that's a dramatic shortfall on a piece of property, this outrageous tale of loss in probably not the only one you'll hear. Hopefully the new rules on short sales that start Friday will make short sales a more viable option. But will they actually make a difference? Even a spokeswoman for the Treasury Department told me it's too early to tell. She said we'll know in a couple of months when the banks start reporting their numbers after the new rules take affect on April 5.

Bill Loblin, the chairman of the Short Sales Working Group for the National Association of Realtors and CEO of Century 21 Advantage Gold, told me the problem with short sales is the "lack of uniformity" with how banks use short sales. Realtors can wait months for an answer on a short sale offer and few buyers are willing to wait, especially if they hope to make use of the tax credit for home buyers.

Loblin said that right now, "it takes way too long to negotiate a short sale." He added that "all around the country, some agents are hesitant to show a short sale." He's not sure if the new law will help because he "doesn't know what the enforcement process will be" if a bank decides not to follow the rules.

So what are the rules? The rules are set by the new Home Affordable Foreclosure Alternatives (HAFA) Program, which seeks to find alternatives when a borrower cannot qualify for a modification under HAMP rules, because they don't have enough income. Both short sales and deed-in-lieu of foreclosure will be options. In a deed-in-lieu of foreclosure the homeowner turns the keys over to the bank without the need for a foreclosure and the bank agrees to accept them without seeking any funds for a short fall when the home finally sells.

If a borrower is not eligible for a HAMP modification, then the bank will use the information gathered during the HAMP process so they don't need to do additional eligibility analysis. The borrower will get a pre-approved set of terms for the short sale before the property is listed, which means the potential buyers won't have to wait weeks or months for an answer from the bank. The bank is also required to fully release the borrower from any future liability for the debt.

For short sale offers where there isn't a pre-approved set of terms, banks must respond to an offer in 10 days. But, Loblin isn't sure when that 10-day count begins. Is it when the contract is offered or when all paperwork required by the bank has been submitted? He suspects banks will find ways to stall their answers. "It's a cumbersome process," Loblin says. He expects it will "take a couple of months to get the bugs worked out."

To be eligible for help under HAFA rules:
  • The property must be the borrower's principal residence;
  • The mortgage loan must be a first lien mortgage originated on or before January 1, 2009;
  • The mortgage is delinquent or default is reasonably foreseeable;
  • The current unpaid principal balance is equal to or less than $729,7501; and
  • The borrower's total monthly mortgage payment exceeds 31 percent of the borrower's gross income.
If you are in the middle of the HAMP process or have been told you don't qualify, be sure to ask about HAFA alternatives for help in getting out of your loan obligations.

Lita Epstein has written more than 25 books including The 250 Questions You Should Ask About Avoiding Foreclosures and The Complete Idiot's Guide to Personal Bankruptcy.

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