January 18, 2008

Today’s Real Estate

Housing market woes find soft landing

By Donna Nardi
Special to the Times

Melinda Flores was feeling depressed when penciling in numbers figuring what it would take to sell her home. Flores, like many homeowners who purchased their home with little or no money down in the past two years, had no home equity. The cost of selling her home would be a steep $82,000 above the value of her home, which she just didn’t have.

After consulting with friends and family, Melinda contacted Brett Jennings, who informed her she was an ideal candidate for a short sale. What is a short sale? It’s a transaction in which the lender consents to sell a home for less than what is owed on the note. Short sales, once a rarity, are making a comeback and helping banks and homeowners alike ease the pain and soften the blow in this shifting real estate market.

I recently caught up with Jennings of Keller-Williams Realty in Campbell to learn more about the short sale phenomenon. He has studied foreclosures and short sales extensively, and has become a certified Short Sale Specialist. He has a wealth of information on the subject and experience as an investor and lender, enabling him to help sellers navigate this stressful time and avoid many of the tax and legal pitfalls facing homeowners in distress. Jennings’ experience helps him understand firsthand why a lender would be loathe to foreclose on a property – it’s a headache and hugely expensive.

To avoid future pitfalls, it’s important to understand how we got here. The majority of short sales are a result of newer homeowners who too frequently borrowed 100 percent and more of the home’s value upon purchase, using sub-prime Option (ARM) Adjustable Rate loans.

When the full interest payment wasn’t paid monthly, the balance of the owed interest was tacked onto the principle. Then the loan adjusted on schedule, which of course, was always a higher payment amount.

There was no room for a hiccup. After two or three adjustments, the homeowner could no longer tread water and soon began to sink. At that point, a choice must be made--keep the home until the lender begins foreclosure, or sell it now, owing more than the home’s value. To make such a decision, one must look at the impact of the foreclosure versus the short sale process.

Lesser of two evils
Why would a bank opt to take a loss, rather than foreclose on a home? Don’t they want to “make all that money” on a valuable home? When we understand the problems lenders face by foreclosure, a short sale becomes rather attractive.

Lenders are buried with the rising wave of foreclosures. Federal lending laws require that for any loan that goes into default, lenders hold two to five times the loan amount in cash reserves. In addition, defaulted loans negatively affect the bank’s credit rating and ability to borrow money at the best rates on the wholesale markets.

Finally, the cost of foreclosure is high. In a 2005 foreclosure study by the Mortgage Bankers Association the estimated average cost of a bank foreclosure was more than $60,000. All these factors give lenders an incentive to take the loss of a short sale, rather than the higher cost of foreclosure.

Solution for homeowners
When a homeowner can no longer afford to make their mortgage payments, foreclosure is the imminent threat. But, a short sale is a way for the homeowner to avoid foreclosure, and minimize damage to their credit score.

A bankruptcy will impact your credit score by an average of 300 points, and a foreclosure’s average is 250 points. But a short sale will impact the score only by an average 120-150 points and the credit recovery time can be shorter.

Previously, one of the downsides to a short sale was that the homeowner could be subject to income tax on the amount of debt forgiven by the lender. This problem arose when a lender would forgive some of the loan by negotiating a reduction of the loan amount, or when the lender forecloses on a property, and sells it for less than the outstanding mortgage.

But now, President Bush has signed a new law effective this month that will eliminate the negative taxation implications on homeowners that owe more than they can sell it for. This new law will allow those homeowners affected by this law off the taxation hook, which is great news. But this group should be sure they understand all implications when opting for a short sale.

It’s not all bad news in the real estate market. Short sales can also be a great opportunity for people planning to buy a home. Because lenders and homeowners are motivated to sell these properties, they are typically priced at or slightly below market value. Add to that the lender’s incentive to avoid foreclosure, and most will agree to a short sale at 5-10 percent below market value. Your realtor can help you locate specifically short sale properties, using an advanced MLS search.

In our current real estate market, short sales are providing a win-win for banks and homeowners alike to avoid foreclosure and further deterioration of the housing market. So, for now, short sales are here to stay.

Donna Nardi is a Realtor, Accredited Staging Professional, and Senior Real Estate Specialist with Prudential California Realty in Willow Glen. You may reach her at (408) 918-4410, or donna.nardi@prurealty.com, or www.HappyWayHome.com.