Big loans, short sales

Font Size

Print

Feedback

Email

Discuss

Related Articles

Crisis deals under severe pressureIMF unsure if worst financial crisis is over

: Many Americans are discovering an unfortunate twist to the housing crisis: Even after selling a home and moving away, they might have to keep paying on it for years, even decades.

With home prices tumbling, millions of people owe more on their mortgages than the houses are worth. If a new job or other life change compels them to sell, their choices include bringing a pile of cash to the closing to make the bank whole, going into foreclosure or cutting a deal with the lender to pay off the balance of the loan over time.

How sellers will react when confronted with these unappealing options is one of the biggest questions hanging over Wall Street as it tries to move beyond the carnage overwhelming such venerable firms as Lehman Brothers, American International Group and Merrill Lynch.

A sale for less than the value of the mortgage on a property is known as a “short sale”, because the transaction leaves a homeowner short of the funds needed to settle the debt. Agents and lenders say the number of short sales is rising markedly.

Reluctantly, banks are agreeing to let some short sales go through. But instead of writing off the unpaid portion of the debt, they want homeowners to sign a note promising to pay some or all of the balance due.

Moody's Economy.com estimates that about 10 million homeowners have negative equity, a condition known colloquially as being upside down or underwater. By next June, the forecasting company expects the total to rise to 12.7 million—a quarter of all homeowners who have mortgages.

Owners in this predicament who must sell, like the Kellys, have few alternatives if they are not flush.

“The first wave of foreclosures involved a lot of investors who just disappeared,” said Lance Churchill of Frontline Seminars, which teaches real estate agents how to negotiate with lenders on short sales. “Now, homeowners with jobs and assets are underwater and want to sell. The banks want as much as they can get, today or in the future, and the owners want to get away clean.”

This clash is a central aspect of the financial crisis engulfing Wall Street. During the boom, millions of mortgages were bundled into bonds that were sold to investors and banking houses. But with real estate prices falling and mortgage defaults rising, it has become nearly impossible to calculate the worth of those bonds, and investors are fleeing them.

Lenders like Citi, which has already lost more than $50 billion in ill-advised real estate-related ventures, are walking a tightrope.

If they do short sales without trying to extract anything from the sellers, everyone in the country who is upside down could try to wriggle out. The banks and bondholders will take a fresh wave of hits; some might not survive. But if a lender drives too hard a bargain, the owner can default, leaving the bank worse off than if it had taken the short sale.

“It’s a game of chicken, with huge consequences for the banks, the borrowers and the economy,” Churchill said.

Lenders’ demands take many forms. Mary Gonzalez, an agent in San Jose, Calif., had to stave off a request from a mortgage company that her client take cash advances on her credit cards to settle a mortgage debt. That lender eventually agreed to settle for a few thousand dollars.

At the other extreme, JPMorgan Chase says it wants short sellers to sign a note for the full balance due, with interest, over 30 years if necessary.

While there are no authoritative national numbers on short sales, a related statistic, the number of people selling their homes for less than they paid, is rising rapidly, at least in California.

In August, 54.2% of Californians who sold their homes suffered a loss, a sharp rise from 16.8% in August 2007. Today’s number exceeds the peak of 53.2 % reached at the end of the last downturn in January 1996, according to the research firm DataQuick. (In some of those cases, the sellers may have lost their down payment without necessarily incurring a cash shortfall at closing.)

The foreclosure option is bad for everyone. Short sales offer all parties the ability to cut their losses earlier. But they also bring homeowner and lender into direct conflict on the contentious issue of who was responsible for those losses in the first place.

Borrowers went wild during the boom, buying multiple properties at high prices, signing outlandish loans, taking out large sums to live in high style. But none of that would have been possible, of course, if banks chasing quick profits had not abandoned their lending standards.

The Kellys, both 64, did not join the free-for-all. He works in financial services; she is a doting grandmother and a volunteer at the local blood bank. “We’re not loaded,” Linda Kelly said.

They bought their home in December 2001 for $225,000. They refinanced once, four years later, taking out $75,000 to do improvements. At the time, the house was appraised at $450,000, seeming to offer a sufficient cushion.

But then the market tanked. Last winter, when the Kellys first began looking into selling, they knew any offer would be far below what they owed, and they could not afford to make up the deficit. So they began talking to Citi about their options. They did not want to surrender the house to foreclosure, ruining their credit, hurting their neighbours and betraying their image.

“We’ve never defaulted on any obligation through our whole lives,” said Mike Kelly, a former Marine who had served in Vietnam.

Citi sent the Kellys a letter saying, “We look at mortgages as partnerships.”The lender said it would be willing to let the home be sold for its fair market value, “even if the proceeds are less than the total amount owed.” Additional payments over the decades were not mentioned.

The Kellys had to jump through many hoops, surrendering their financial documents and explaining why they merited approval for a short sale. Only when a buyer was in hand and a price had been negotiated did Citi demand the $40,000 promissory note from the Kellys.

A spokesman for Citi, while declining to comment on the Kelly case, said the amount each seller is asked to provide is determined by “affordability criteria,” and the sum is negotiable. But the e-mail exchanged between the Kellys and their Citi case worker do not show much evidence of negotiation.