Monday, March 8, 2010

Short Sales and 2nd Liens

Original posted on Calculated Risk:

A couple of articles tonight that fit together with my earlier post: Housing: A Tale of Boom and Bust and a Puzzle The puzzle is when the banks will start moving ahead with distressed sales (foreclosures and short sales).

First David Streitfeld at the NY Times writes about the Treasury's HAFA program: Short-Sale Program to Pay Homeowners to Sell at a Loss

Taking effect on April 5, the program could encourage hundreds of thousands of delinquent borrowers who have not been rescued by the loan modification program to shed their houses through a process known as a short sale, in which property is sold for less than the balance of the mortgage. Lenders will be compelled to accept that arrangement, forgiving the difference between the market price of the property and what they are owed.
...
Under the new program, the servicing bank, as with all modifications, will get $1,000. Another $1,000 can go toward a second loan, if there is one. And for the first time the government would give money to the distressed homeowners themselves. They will get $1,500 in “relocation assistance.”

Should the incentives prove successful, the short sales program could have multiple benefits. For the investment pools that own many home loans, there is the prospect of getting more money with a sale than with a foreclosure.

For the borrowers, there is the likelihood of suffering less damage to credit ratings. And as part of the transaction, they will get the lender’s assurance that they will not later be sued for an unpaid mortgage balance.
emphasis added
Short sales under HAFA are much better than foreclosures for many borrowers because HAFA requires lenders to agree not to pursue a deficiency judgment (one of the key stumbling blocks for eliminating 2nds). And this is also better for the 2nd lien holders too since they get something (note: the program also includes a deed-in-lieu of foreclosure option with similar payments and requirements).

Of course short sale fraud is also a huge concern. Streitfeld quotes economist Tom Lawler:
Short sales are “tailor-made for fraud,” said Mr. Lawler, a former executive at the mortgage finance company Fannie Mae.
And from James Hagerty at the WSJ: Home-Saving Loans Afoot
Rep. Frank said banks' reluctance to write down second mortgages is blocking efforts to reduce the first-lien mortgage balances of many borrowers who owe far more on their loans than the current values of their homes. ...

Many second liens have little value because of the plunge in home prices, Rep. Frank wrote, adding: "Yet because accounting rules allow holders of these seconds to carry the loans at artificially high values, many refuse to acknowledge the losses and write down the loans."
As Hagerty notes, the banks are reluctant to write down the 2nd liens because they might still have value even after foreclosure. That is because 2nd liens are recourse, and the lenders could pursue the borrower for a deficiency judgment (or sell the loans to a collector). Frequently the most cost effective course of action for 2nd lien holders is to wait and do nothing. And that is frustrating for the 1st lien holder (commonly Fannie or Freddie).

Is $1,000 enough to get 2nd lien holders to sign off and give up the right to a deficiency judgment? I expect that the lenders will pick and choose ... but this should help.

Update: the WSJ has a copy of Barney Frank's letter to the four large banks.

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