In January, housing analysts predicted that 2010 would be the Year of the Short Sale. Never have industry observers been more on target.
Short sales have more than doubled in the past year, according to data collected by the Office of Thrift Supervision. A recent Campbell/Inside Mortgage Finance Survey showed that short sales are the largest segment of the distressed housing market, representing 17.9% of such transactions.
Distressed borrowers now have a viable, industry-accepted option to get out from under unsustainable housing debt besides foreclosure. A short sale occurs when the mortgage servicer agrees to the sale of a home for less than the amount owned, with the lender or investor forgiving the difference or deficiency.
Servicers and investors are learning that with nearly 2 million homes and borrowers facing foreclosure, the loss incurred by a short sale is always less than the loss from a foreclosure in any market, anywhere.
But until this year, servicers operated under the maxim, "Pay me now or we'll foreclose." Years ago, any kind of a loan workout or attempt to stall a foreclosure was thought to be an obstacle. Subsequently loss-mitigation departments were established, but they seemed to be in a race with their foreclosure department colleagues to see who could dispose of the loan first.
Mortgage servicers' outlook has now shifted 180 degrees, as they talk about everything but foreclosure. Today, servicers consider short sales a graceful alternative to foreclosure.
What brought this about, in a servicing environment once focused solely on foreclosure after attempts at loan modifications failed?
Eighteen months ago it seemed nobody in servicing had heard of a short-sale certification, a professional education designation. Now everybody wants to be short-sale-certified.
When the housing crisis rapidly spread in 2008, servicers that had agreed to follow the Home Affordable Modification Program most likely began to address the issue of loan deficiency and subsequent writedown of loans. Hamp helped to provide standardization, timetables and consistency to the loan modification process that laid the groundwork for short-sale guidelines.
Then the administration and the industry began to discuss, when everyone was focused on loan retention, what to do about fallout, the sizable number of loans that won't survive attempts at modification. This resulted in the administration's Home Affordable Foreclosure Alternatives program, which encouraged Hamp servicers to embrace short sales. Actually they had no choice but to join Hafa, which was a requirement for those in Hamp.
Last year servicers already had the wind in their sails on the expanding sea of short sales. Hafa, which standardized the process and provided deal timetables, has strengthened the wind.
A very important aspect of Hafa that doesn't fit within any guidelines is that it initiated a willingness within the industry to talk about short sales, while heightening awareness among distressed borrowers that foreclosure isn't the only option after workout attempts fail.
I believe the Treasury Department's role of collecting and reporting data under Hafa as well as Hamp provides a moral suasion that boosts short-sale opportunities.
The Treasury has no power of force over servicers to mandate short sales, but it does have the ability to embarrass servicers who generate low numbers. Nobody wants to be last when the scores are tallied.
A key to short-sale success is keeping the distressed borrower engaged in the process beyond the stage of working out a loan modification through enhanced communication between the servicer and borrower, as well as the investor.
Explaining the process clearly absolutely increases short sales. Investors will find short sales a safe haven compared to the hassles of foreclosures and subsequent big losses.
Though Hafa as a federal program in and of itself has not seen the majority of short sales under its imprimatur, it has established the framework for the burgeoning short-sales market. I predict Hafa and other short sales will increase steadily in early summer through the fall. In the next 18 to 24 months short sales will be at their peak and then begin to decline.
States suffering the deepest price depreciation, such as California, Nevada, Florida and Arizona, will see the largest spike in short sales, while the opposite will hold true for states affected by milder home-value depreciation.
As short sales gather momentum, it's time to fit the last piece of the puzzle, increasing borrower awareness of the credit consequence of foreclosure versus short sales. A step in the right direction would be more public communication and education.
The credit side of the industry and credit regulators should take the lead and clearly state to the borrower the credit ramifications for defaulting on a loan, choosing a short sale or even opting for foreclosure. And, of course, these ramifications should be consistent.
Better cooperation on the credit side will help distressed borrowers make better decisions. There should be a clear enunciation, for example, that foreclosure will cost borrowers a 200-point hit on their credit scores, versus 50 points for a short sale.
Fannie Mae and Freddie Mac have rethought their policies for underwriting new mortgages for borrowers experiencing past foreclosures and short sales.
For instance, if such former borrowers keep their credit clean, Fannie Mae says that they are eligible for a new mortgage in two years after a short sale and in five years after foreclosure. I believe it should be more like seven years or longer on the foreclosure side to better balance the choice. This would also, hopefully, reduce the number of borrowers who are saying, "foreclose on me," thinking they can live for free while some new program comes down the path to address their situation.
A clear sign that short sales are taking hold is the development of technology to shorten the timetable of short sales. We've gone from no technology in this arena to competing technology in the past year to 18 months.
Though the trend in short sales will be on the downswing in three to five years, the technology won't go away and it will benefit servicers with greater efficiency in handling borrower contingencies.