In previous American Banker op-eds, I have stressed that there are several tools available to policy makers and lenders to help pull us out of the housing/mortgage crisis. And generally these tools have been utilized with increasingly positive results. The Obama Administration deserves credit for working to improve the Housing Affordable Modification Program, which has helped over 1 million borrowers receive modified loans. While this is short of the original goal for the program, it is clearly having an increasingly beneficial impact in helping underwater borrowers take advantage of today's record low interest rates.
I have also spoken of the absolute folly of the continuing discussion of "principal forgiveness" as a strategy for relief for troubled borrowers. There is simply no fair or equitable to selectively reduce the principal amount of a mortgage debt. Such relief to one borrower will inevitably lead to a similar demand by other borrowers, and, of course, the proportional reduction of all mortgage debt in totally unfeasible. Furthermore, the selective reduction of mortgage debt will lead to bad behavior, raising the issue of moral hazard.
There is one circumstance, however, where one can say that principal forgiveness is in fact feasible, and that is in the instance where the borrower is giving up ownership of the property through what is known as a short sale.
This is the sale of a property for less than the loan amount and relieving the homeowner of the debt by payment of less than the full loan amount. It is estimated that since the onset of the housing crisis, some 7 million homeowners have lost their home through foreclosures or short sales, with the vast majority being foreclosures. And with another 11 to 12 million homeowners underwater on their mortgage obligation, there are many more candidates for foreclosure.
But it would serve an enormous public purpose if the vast majority of new foreclosures could be moved into the category of short sales, thereby avoiding the financial and societal cost of foreclosure and eviction as well as the community impact of another abandoned property. Such a shift could give a significant boost to the housing recovery.
To assess why short sales are not yet playing a more meaningful role in the recovery process, we enlisted the help of the real estate community in tracking, in a very detailed way, a typical short sale negotiation. Here are the facts in one case:
1) The borrowers moved away in mid-2009 and listed the property with a prominent local real estate agent. The property was left largely furnished and carefully maintained, inside and out.
2) After two years, in mid-2011, another agent was retained and, after further price reductions, a contract was signed in early 2012 at a price which was 25% less than the loan amount. The contract specified a 60-day short sale approval contingency and 90 day settlement.
3) Upon advice of the real estate agent, the borrowers stopped payments on the loan and applied to the servicer (a top 10 player) for short sale approval.
4) Voluminous personal and business financial information was requested and promptly provided by the borrowers after being reviewed by their agent. The financial information clearly established that the borrowers were in no position to fund the mortgage deficiency.
5) As the contractual deadline approached, the borrowers repeatedly called their contact at the servicer to ask for the status of their application, with no response. After the 90-day time frame specified in the contract had elapsed, the borrowers filed a formal complaint with the Consumer Financial Protection Bureau.
6) Three to four weeks after filing the CFPB complaint, the servicer contacted the borrower asking for more detailed information, in effect beginning the process all over again. The new information was supplied in four days.
7) Shortly thereafter, the borrower received notice of a foreclosure sale in 30 days. Since the borrowers feared the potential damage to their credit from a foreclosure would ruin their small business, they sought and were able to make contact with a senior official of the loan servicer.
8) As a result of this contact, the foreclosure date was postponed for 30 days. The servicer revealed to the agent that it was experiencing difficulty in securing the approval of the mortgage insurer. With the additional time, the agent was able to determine that the purchaser was willing to extend the contract and arrange the necessary financing approvals, property inspections, etc.
9) After numerous last minute emergencies, a short sale application, which should have been a slam dunk, finally went to settlement eight and a half months after the process began.
What is clear from this case is that the short sale would never have taken place without the incredible patience of the prospective purchaser (one should note that during the intervening months, interest rates were trending down, to the benefit of the purchaser), the aggressive steps taken by the borrowers in filing a regulatory complaint and the intervention of senior management at the servicer.
As a result, certain lessons are clear:
1) Loan servicers must have uniform guidelines in establishing that a proposed price in a short sale is fair through adequate exposure to the market and confirming appraisals.
2) Servicers must have standardized documents to enable a prompt review of the ability of the borrower to fund any deficiency resulting from the short sale.
3) Servicers must have experienced, trained personnel reviewing short sale applications who are able to make a prompt determination and recommendation for approval or disapproval.
4) Regulatory authorities must establish specific time frames by which decisions must be made by the servicer, including the concurrence of other parties involved in the transaction such as mortgage insurance companies.
Short sales present a major opportunity to help potentially millions of underwater borrowers obtain relief from desperate situations without the unnecessary economic and societal consequences of foreclosure and eviction. To help move the country through the continuing overhang of the housing crisis, we must streamline and simplify this process.
Alexander R. M. Boyle is the retired vice chairman of Chevy Chase Bank. He has worked in mortgage lending and consumer banking for 30 years.