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Coming Up Short, More And More
Troubled Borrowers Increasingly Allowed to Sell for Less Than Loan

By Renae Merle
Washington Post Staff Writer
Saturday, July 11, 2009

More than two years into the housing crisis, lenders are beginning to allow more troubled homeowners to unload their homes for less than they owe. The practice, known as a short sale, is gaining popularity as an alternative to foreclosure, but it remains a difficult and lengthy task to pull off because the lender bears the brunt of the loss.

The number of short sales completed jumped 208 percent during the first quarter of this year compared with the same period in 2008, according to a report issued last month by the Office of Thrift Supervision and the Office of the Comptroller of the Currency, which regulate banks.

Short sales could increase further as home prices continue to fall, leaving a growing number of borrowers owing more than their home is worth. Also, the Obama administration is implementing a program to pay lenders to accept less than the balance owed by the borrower in such deals.

Already, Bank of America, the country's largest mortgage lender, has seen completed short sales jump 50 percent so far this year, said Dave Sunlin, a senior vice president who manages the foreclosure and real estate division. "We understand this is an opportunity to mitigate our losses, while helping turn around the housing market and help homeowners," he said.

Bank of America opened a short-sale call center last year. And the bank hopes to launch a pilot program within 30 days that would shrink to one week the time it takes to have a specific short-sale offer approved, Sunlin said. Under the program, prospective sellers apply to Bank of America to get preapproved to pursue a short sale in general, then go back to the bank for approval of specific offers as they come in. The program will initially focus on borrowers who fail to qualify for a government foreclosure-prevention program, he said.

"If they have come to the conclusion that there is no possible workout, they should contact us as quickly as possible," Sunlin said.

The types of homes that end up in short sales vary widely. At the beginning of the financial crisis, most of the homes were on the lower-priced end of the market, said Marc Cormier, an agent for Re/Max Allegiance in McLean. But now, more higher-end homes are ending up in such deals, including a 10-bedroom home in Potomac, which was originally put on the market last year for $10 million, he said. The seller reduced the asking price to $5.5 million last month, and it's listed as a short sale. "You're going to be seeing more of that from now until 2010," Cormier said.

Last year, about 5 percent of home sales in Loudoun County, one of the hardest-hit parts of the region, were short sales. Now they account for about 23 percent of the market, said Tony Arko, an agent for Market Advantage Real Estate. "A year ago, there was almost nothing. Everyone thought short sales were going to be a blip on the screen," Arko said.

Still, the short-sale process is notoriously slow and cumbersome. Unlike normal sales, the seller's lender must approve the deal and is often suspicious of lowball offers, potentially dragging out the process for months. About 60 percent of approved short sales do not ultimately close, largely because buyers walk away from the deals, according to Bank of America.

Wells Fargo began streamlining its short-sale process last year, said David Knight, its senior vice president of specialty servicing for default and retention operations. It used to take more than 90 days for a short-sale offer to be approved; now it can be done in 30 days in some cases, Knight said. "We said there were a lot of things we can do ahead of time so we can give a decision faster," he said.

For example, bank officials used to wait until they received a short-sale offer before starting the process. Now, Knight said, they encourage borrowers to contact them early so they can begin assessing whether the home would qualify for the program and help them set a proper price.

Before attempting a short sale, borrowers should weigh the potential tax liability and prepare for the usual hassles of a sale -- cleaning for open houses and negotiating with bidders -- even though they won't reap the usual cash payoff, real estate agents and lenders said. A real estate agent experienced with short sales can be helpful, they said, but borrowers should also prepare to provide documentation of a hardship that would persuade their lender to accept less than owed.

"You can't have $25,000 sitting in your checking and expect the lender to take a bath on the house," said Frank Borges Llosa, owner of FranklyRealty.com, an Arlington-based brokerage.

For bargain hunters, a short sale can provide a chance to get a home at a below-market price. But don't expect a lender to accept every lowball offer, Arko said. A bank may be willing to write down the value of the property 10 percent from the current value, but it probably will balk at taking a larger hit, he said. "They are not just taking any offer. . . . You are not going to be able to get 20 or 30 percent off market value," Arko said.

But the process can also test a buyer's endurance. Despite efforts to streamline the process, lenders apply a hodgepodge of rules and vary in how long they take to approve a deal.

"You have to be patient" said Mary Ellen Nicol, a certified housing counselor for Consumer Credit Counseling Service of Atlanta. "Be prepared to give the lender time to review the process. Be prepared to call the lender frequently."

That is what James Sejd, an industrial contractor, has learned. Sejd researched short sales and the market before making an offer on an 8,500-square-foot Gainesville home in April. The home was listed for $900,000, and with his $850,000 bid, Sejd felt confident of a quick approval.

But for three months, Sejd said, he has been waiting for an answer from the bank. In the meantime, home values have continued to fall. Sejd said he is worried that the home's value has fallen even further, to about $800,000, and interest rates have risen from historic lows since he placed his offer. The higher interest rates could raise the mortgage payments by $300 to $400 a month and cost at least $100,000 over the life of the loan, Sejd said.

"I am like a racehorse in the gate, and the gate won't open," Sejd said. "I offered money to be moved up in line; they said that wasn't possible."

This house is in a good location for his family, including access to a preferred school district, Sejd said. But if a comparable home is put on the market in the same neighborhood, he would consider it. "If I find another property, I have nothing to lose by moving on," he said.

Despite the cumbersome process, more homeowners are expected to opt for a short sale over losing their home in a foreclosure in the next year. It is a way to retain some minimal amount of control over the experience, despite the fact they are still losing their homes, Nicol said. "You have some say-so in the closing process, in the whole process of moving out of the house," she said. "Especially for families, this gives them a timeline so they can look for other housing and worry about the right schools with less disruption."

But before pursuing a short sale, homeowners should research the long-term financial implications. A short sale can prevent a homeowner from securing a new mortgage backed by the Federal Housing Administration for years. And while some borrowers choose a short sale hoping that it will have a less severe impact than foreclosure on their credit rating, that is not always the case, said Craig Watts, a spokesman for FICO.

Much depends on how the lender reports the short sale to credit rating agencies such as Experian and on how many payments the borrower missed beforehand, he said. "There is a fairly widely held myth that a short sale is gentler on the FICO score than a foreclosure, and it's not," Watts said.

Also, homeowners should consider whether they could be taxed for the difference between the outstanding mortgage and the sale price. The Internal Revenue traditionally considered the forgiven mortgage debt to be income, on which the borrower owes tax. Congress passed legislation in 2007 temporarily exempting short sales involving primary residences from that rule, but not on those involving second homes and investment properties. The exemption lasts until 2012. Home-equity lines of credit, and other second liens against a property, are still some of the biggest obstacles preventing short sales, real estate agents and industry officials said. Even if the primary lender agrees to a lower price, a second lien holder can block the short sale. In some cases, that second lender may agree to accept a small portion of the debt, 5 percent to 10 percent, as a payoff. But the lender may turn around and demand that the borrower cover some of the unpaid debt.

The Obama administration is attempting to address this type of stalemate by agreeing to share the cost of extinguishing second liens on the property. "This is something you may want to talk to an attorney about to make sure that they don't come after you later," Cormier said. "It's very complicated. I strongly encourage the seller to review the final documents for what they say and don't say with an attorney."

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