13 September 2011

Do We Need A Right To Short Sell?

In the majority of states where there are recourse mortgages, if you sell a house for fewer net proceeds than are necessary to pay the mortgage, you are liable for the unpaid balance of the mortgage and immediately in default, with the full amount owed due and payable at the moment that the transaction closes. A bank can agree to waive the unpaid balance or reach another agreement with the borrower, but particularly in markets experiencing mass housing depreciation, where resources are strained, the transaction costs can be immense.

Just as pre-payment penalties are disallowed in many consumer oriented agency mortgage programs, perhaps there should be a right to short sell and pay the remaining balance according to the terms reduced by the proportion of the loan balance that has been paid.

For example, suppose that you have a 30 year mortgage with 25 years of payments remaining remaining and a current balance of $200,000 upon which you must pay $800 a month of interest and principal and $200 a month of escrow payments for property taxes and insurance, but are only able to sell the house for $180,000 net of costs of sale. This would leave a balance due on the mortgage of $20,000, which would be due and payable immediately under a standard residential mortgage in the absence of an agreement, and even if a short sale could be negotiated, you might have discharge of indebtedness income unless you could prove to the I.R.S. that you were insolvent and would hurt your credit record.

But, if there were a right to short sell, that $1,000 a month combined payment could be reduced to a payment of $80 a month for the next 25 years at the same interest rate on the remaining balance and as long as you made those payments, you would not be in default.

Many mortgage debtors would jump at the chance to make those reduced payments for a prolonged period rather than default and harm their credit records, but are unable to refinance the balance of the amount owed to the bank, for example, due to the loss of a job or deteriorated credit rating, and are certainly unable to do so at a mortgage loan interest rate. And, more payments mean more money for the bank without having to hire collection agencts and lawyers to collect those payments.

What complaint would the bank have in that situation?

You would have the same dollar amount of personal liability that you would under current law, following closing, so you wouldn't have much of an incentive an incentive to engage in a below market value sale. Indeed, such a sale would, on average, likely produce more net proceeds than a foreclosure with fewer transaction costs in the long run. Unlike cram downs in a bankruptcy (were they permittted for residential mortgages), the price would be determined by the market rather than an appraiser and would leave the selling debtor with no room for a winfall if the price turned out to be too low.

You would be paying the same interest rate you bargained for on the outstanding balance, and the bank had already agreed to accept prepayments and hence have the potential to lose the benefit of an existing above market rate interest rate on its loan. The bank would not be exposed to any credit risks that it hadn't already bargained for in the original transaction and also bargained for the possibility the housing values would fall, reducing the value of the collateral.

The would receive payment in full no later than the date that it had originally bargained for, and indeed, it would receive a large share of the funds it was entitled to under the note sooner than it was entitled to demand. It would incur fewer transaction costs that it would in a negotiated short sale or a foreclosure. The bank would be permitted to treat the loan as one that is not in default, helping the quality of its mortgage portfolio and clarifying how the debt should be valued without the complication of collateral.

From the customer's perspective, it would make it possible for a homeowner who is upside down in a declining market to swiftly cut their losses without negotiations that take time and expertise and cooperation from a bank that has the right to be unreasonable, it would make it possible for a homeowner to extricate himself or herself from a property to relocate to another job without the complication and expense of leasing the property to someone else (possibly at a loss) in the meantime, and it would allow the homeowner to have greater certainty upon which a plan for dealing for a burdensome debt could be formulated.

In big dollar transactions, with prepayment penalties, one sets aside treasury bonds sufficient to cover the remaining payments and negotiates a substitution of collateral, but why not dispense with the elaborate artifice to get the same effect in a consumer transaction.

The reduced number of foreclosures, of course, would also help the real estate market in general by creating a sense of normalacy instead of a pent up demand to sell property at prices that can't be offered without bank cooperation, thereby reducing foreclosure and REO expenses and helping the bank's overall portfolio in a market.

No comments: