The concept of short-sales is all the rage now. Guru after guru is offering learning materials and boot camps and all manner of expensive fluff because this is the latest buzz.
Real investors have been doing short-sales with lenders for as long as there have been lenders and borrowers. It isn’t new and the lender is more than willing to help with the details of the process.
When they can.
The loss mitigation departments don’t employ stupid people. They know how to use math and figure out which option loses the least for their employer but that isn’t the only variable in play.
Many people may not know it but the lender you close with isn’t always the lender who actually owns the note. Most lenders package their loans and sell them as a form of security. All is well until things start to go wrong and the borrower starts to fall behind.
I had a lengthy conversation with a loss mitigation specialist at a large lender earlier this week. Much of what he talked about I knew or suspected but there were a few surprises.
For example, I knew that loans the lender didn’t own but just serviced would not affect their reserve requirements when the borrower defaulted even if the mortgage is foreclosed. I also knew that once the loan is bundled with others and sold as a package there are lot more parties to the negotiation. I also suspected the holders of these mortgage backed securities were taking a short-term view and he confirmed that.
The net-net is the lenders often have little ability to maneuver to work out any kind of solution. There are too many players involved and approvals needed.
Over lunch, Jacob lamented, “We aren’t stupid but often it looks like we choose the stupid option. Just last month the foreclosure process was completed on a home in Winder. I had been working with an investor who put together a good short-sale package. It really was the way to lose the least amount of pretax money on the total transaction.”
But, he couldn’t get it approved because the ultimate holders of the securities backed by the pool this mortgage was in wouldn’t go for it.
“There were eleven representatives of fund managers involved,” he said. I asked if by representative he meant lawyers and he said yes, and that makes it even harder.
“Every young stud of a lawyer is out to prove themselves. They all boast about being able to recover money even from the unrecoverable. Well, some of the people in trouble on these loans today really are unrecoverable from that standpoint. If we as a lender foreclose we will get the property and that is about it.
Jacobs voice grew more frustrated, “And if Private Mortgage Insurance is involved you are just about guaranteed to be wasting your time in even collecting the data for a short-sale package and forwarding it up the line.”
Yes, PMI does complicate it significantly. When PMI is involved the funds holding the securities have no motivation to deal. They will be made whole after the foreclosure by the insurer.
I asked him what the single biggest obstacle he thought prevented the fund managers from accepting more short-sales. He didn’t hesitate, “It’s the whole 1099 thing. These fund managers won’t even consider waiving sending the 1099.”
The “1099 thing” is where the lender writes off the losses and sends the borrower a 1099 for the loss amount as forgiven debt. This makes their write off very clean and forces the borrower to pay income taxes on the amount “forgiven” and that is often an inflated number.
“The thing is many times a failed short-sale puts the borrower in a worse position when everything is said and done because every representative will bill time against the defaulted loan and drive the costs higher. I’ve seen it drive the paper losses up by $20K just in the additional fees alone. If it is added as a condition to the short-sale package they just about wet their pants with excitement because they know they won’t accept it but will drag out all of the other negotiation points often just to drive up the costs!” he said.
He also talked about how the fund managers look at the losses differently than the lenders typically do. They are looking at the funds’ short-term yield as a whole, not the yield on any single loan. And often a bigger write-off can be their best choice. “The deck is kind of stacked against the borrower,” he added.
Now, you have to keep in mind Jacob has only one view into this. I’m sure those representing the various funds would have a much different perspective.
So, where are you most likely to succeed in short-sales? In deals where the lender still owns the note secured by the mortgage.
You have to ask, “Who owns the note?”
If the answer is it was packaged and sold then you are most likely wasting your time and driving up the amount on the 1099 the borrower will ultimately receive.
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