Second mortgages held short sellers hostage
Short sales come in two basic varieties; properties with second mortgages and properties without. If a property does not have a second mortgage, short sales are generally quicker and easier to approve. The first mortgage is often covered by mortgage insurance, and as a percentage of the total loan amount, any losses are generally small. If a property has a second mortgage — and millions do — then the situation becomes much more complicated.
In lien priority, when a property sells in a short sale, the first mortgage holder gets paid in full before the second mortgage holder gets a penny. There is no sharing of losses by law. Therefore, if the first mortgage is underwater, the second mortgage has no collateral backing, and if the property goes to foreclosure, the mortgage is worth nothing — a 100% loss. During the housing bubble, banks often held second mortgages on HELOCs on their own books and sold off the first mortgage to MBS pools. As a result, the major banks hold billions of dollars in underwater second mortgages worth basically nothing. Of course, thanks to mark-to-fantasy accounting, that’s not how they record them on their books.
When borrowers want to sell their underwater properties, holders of second mortgages have a huge problem. Approving the short sale is tantamount to recognizing a huge, if not total, loss. Obviously, lenders don’t want to do this. On the other side of the transaction is a seller who took out a second mortgage with the assumption some future take-out buyer would pay it off for them when they sold their house for more money than they paid. It never occurred to them they might have to sell for a loss and pay off that second mortgage out of their own pockets. In their world, the debt was associated with the property, and whatever the property sells for is what that mortgage holder gets. Unfortunately, that isn’t how reality works. Second mortgages are real debts owed by the short seller, and the holders of those second mortgages want to get paid.
The main reason short sales take so long to complete is because short sellers don’t want to pay off their second mortgages (and often they can’t), and the only leverage a second mortgage holder has to compel repayment is to say no. The leverage a short seller has is the threat to quit paying and force a foreclosure where the second mortgage holder gets nothing. The two parties enter into this dance where the seller pleads poverty and attempts to shelter assets, and the second mortgage holder scrambles to make a deal where they get some or all of their money either in cash or in future promises to pay on an unsecured basis. Since these two parties are often very far apart in what they believe is a reasonable settlement, the negotiations drag on and on, and nearly half the time, a sale never occurs.
(hat tip to Keith Jurow for emailing me this article)
Tom Axon’s mortgage-collection firm gets about 25 calls a day from delinquent homeowners’ brokers seeking approval to sell their houses for a loss and avoid foreclosure. We’ll help, his staff tells them, as long as we get paid enough.
Axon, working with co-investors, buys distressed U.S. home- equity loans and other junior real estate liens, often for pennies on the dollar. Investors like Axon have to be dealt with whenever a home is sold in a short sale, a transaction in which the lenders agree to accept less than what’s owed on the property.
“The short-sale brokers know us — they know we’re not cupcakes,” Axon, 60, chairman of Jersey City, New Jersey-based mortgage-servicer Franklin Credit Management Corp., said in an interview. “At the end of the day, my friend, you signed a contract. You owe money and we’re willing to reach an accommodation that is commensurate with your ability to pay.”
Vultures buying distressed second mortgage debt is a big business. They make a profit by squeezing a few more pennies out of a second mortgage than a large bank felt they could get. They have little incentive to be accommodating because any such accommodation comes out of their bottom line.
Tough bargaining by second-lien holders is delaying deals and killing some short sales, even as banks embrace the practice to avoid costly foreclosures and help clear the market of homes that are worth less than the loans on them, said Vicki Been, a New York University law professor who has studied mortgages.
“It’s an opportunity for the second-lien holder to charge a price for their cooperation, because it’s needed for a short sale,” Been, a director at NYU’s Furman Center for Real Estate & Urban Policy, said in a telephone interview. “If they’re too greedy, it may squelch the whole deal.”
Is it a matter of the debt vulture being too greedy or the debtor feigning poverty? Very few who are asked to pay on a second mortgage feel they owe anything.
Roadblocks involving second liens are standing in the way of more short sales, which reached the highest number in three years in the first quarter — 133,192 total transactions — said Daren Blomquist, vice president at RealtyTrac Inc., a real estate information service in Irvine, California.
While about 39 percent of homes that have entered the foreclosure process have more than one lien, just 4.2 percent of short sales — 5,658 transactions — completed in the first quarter were on homes with second mortgages, according to an analysis RealtyTrac performed for Bloomberg.
Apparently, borrowers are telling second mortgage holders to pound sand. Very few short sales with second mortgages are getting approved while nearly 10 times as many are going to foreclosure. This barrier is one of the reasons we don’t see more people attempt short sales, with the main reason being they can squat for nothing if they don’t bother.
The average time to sell a property with multiple liens was 448 days, up 27 percent from a year earlier, the company said. It took 352 days to sell homes with a single mortgage, a 6 percent increase from the first quarter of 2011.
A second mortgage lien adds more than three months to the process, and probably accounts for most of the failed transactions.
“It appears that short sales with multiple liens aren’t happening as frequently and are taking longer to complete,” Blomquist said in a telephone interview. Short sales that fail tend to end up as foreclosures instead, he said.
This makes sense because most sellers tell the second mortgage holder they will receive nothing, and the borrower generally doesn’t bother negotiating. After all, if they don’t complete the short sale, they get to live free a little longer, and the debt becomes much more difficult to collect after the foreclosure. Most borrowers believe the second mortgage debt dies at the foreclosure sale, but the mortgage holder does have the right to pursue a deficiency judgment if they wish.
… Second-lien holders are protecting their interests, “which, unfortunately, don’t dovetail with everybody else’s interest,” said Mark Zandi, chief economist at Moody’s Analytics Inc. in West Chester, Pennsylvania.
“Subordinate liens have become the biggest hurdle to resolving the foreclosure crisis more quickly,” he said.
Second mortgage liens are what will derail the bank’s plan to move more borrowers through the short sale process rather than forcing a foreclosure. It will take a year for banks to give up and finally foreclose on the remaining squatters.
Homes with second mortgages were twice as likely to be underwater, according to a July 12 report by real estate information provider CoreLogic Inc. That makes them candidates for short sales, even if they don’t have delinquent loans, because their mortgage debt is greater than their resale value. The average negative equity for homes with second liens was $82,000, compared with $47,000 for single-mortgage homes, Santa Ana, California-based CoreLogic said.
“It’s very much like hostage situations,” Sam Khater, CoreLogic’s senior economist, said of second-lien holders. “It’s like an all-or-nothing situation in terms of payoff, and they’re very unwilling to bargain.”
The starting point for this negotiation is miles apart. Borrowers feel they owe nothing because the house was supposed to pay the debt. Lenders feel they are owed everything because, well… they are. The sums are so large, most borrowers couldn’t pay the shortfall if they tried, so both parties must move to some middle ground. Unfortunately, often neither party is willing to back off their demands.
Holders of first mortgages are pre-approving short sales, streamlining the closing process, forgoing their right to pursue unpaid debt and giving some borrowers cash incentives of as much as $35,000 for relocation expenses. …
Particularly after the bank settlement, first mortgage holders are ready to deal. Second mortgage holders are not.
For loans guaranteed by Fannie Mae and Freddie Mac, the government-run mortgage companies, servicers now must communicate final decisions on approvals within 60 days of a buyer’s short-sale request. Fannie Mae tries to put a limit on negotiations by capping the amount junior-mortgage owners can receive at $6,000 or 6 percent of the unpaid balance, whichever is less. The company’s guidelines don’t allow any party to the transaction, including the buyer, seller or real estate agent, to kick additional money to the junior-lien holder. …
“PNC pursues deficiency judgments unless otherwise negotiated in the short-sale agreement,” Fred Solomon, a spokesman for the Pittsburgh-based lender, said in an e-mail.
Some lenders make it policy to go after borrowers who don’t negotiate a short sale. It’s the only threat they have to counteract the seller tendency to simply blow out the second mortgage holder in a foreclosure.
The four largest U.S. banks — Bank of America Corp., Wells Fargo & Co., JPMorgan and Citigroup Inc. — held 48 percent of the $849.5 billion in second liens as of March 31, according to the newsletter Inside Mortgage Finance. Home equity lines of credit accounted for $590 billion, or 69 percent of the value of second liens, as of that date, according to Amherst Securities Group LP.
Nonperforming junior liens sell for between a quarter of a penny and 60 cents per one dollar of the outstanding balance, he said. ….
Not all second mortgages are completely underwater, and many of the borrowers who are underwater are still paying, so these mortgages often still have value. However, with no collateral value backing them, they are very risky.
While Axon of Franklin Credit Management declined to say how much his company collects on average, he said it’s higher than the industry standard of 6 percent of the unpaid balance. …
The key to success is knowing something about the borrower, according to Axon. … A BMW parked in the driveway may be a clue to a homeowner’s finances, Axon said.
The company also compiles a profile of the borrower using public databases, credit scores, original loan applications and, sometimes, Facebook and Twitter pages, and ranks borrowers based on their ability to pay, Axon said.
“We are making our decisions based on characteristics of the borrower,” he said. Homeowners are “the ones being stubborn. They’re the ones who got their money and bought their boat, and now they want their boat for free.
I have made that same point about a million times now. Borrowers looked at this debt as free money. They still do. Very few, if any, of the borrowers who took on this debt thought they would pay it back from their wages or other assets. It was free money generated by the house and paid for by the house. This belief is one of the central pathologies of the housing bubble.
The fact is we’re willing to discount the obligation, get this behind them, and have them fulfill their obligations. If everybody gave everybody what they got for free, we wouldn’t have a banking system.”
No, we wouldn’t. We would have the United States of Bailouts, which is what we have now.