Question: Should You Choose a Short Sale Over a Foreclosure?

Answer: Whether you should do a short sale or let the home go to foreclosure depends on several factors. While for some homeowners, it is easier to throw up your hands and let the bank take your home, that might not be the wisest thing to do.

Short Sale Benefits

Here are a few benefits for doing a short sale that may not have occurred to you:

• You are in control of the sale, not the bank.
• You may sleep better at night knowing who is buying your home.
• You will spare yourself the social stigma of the “F” word, foreclosure.
• Contrary to popular belief, you can be current on your payments and still effect a short sale.
• Your home sale will be handled like any other home sale.

Buying Again After a Short Sale

If your payments have never fallen behind 30 days late and the lender does not require that you pay back the loan, Fannie Mae guidelines may allow you to buy another home immediately.  If you have been current on your mortgage and other installment debts in the last 12 months prior to the short sale completion and the proceeds from the short sale serve as payment in full, you would be considered eligible for a new FHA insured mortgage immediately.

If your payments are in arrears yet a short sale is granted by your lender, you may qualify to buy another home with a Fannie-Mae backed mortgage within 2 years, regardless of whether the home is your primary residence.  The wait for an FHA loan is 3 years from the date of the short sale being completed.

Buying Again After a Foreclosure

With certain restrictions, you may be eligible to buy another home in 5 years if the home was your primary residence. Without restrictions, the wait is 7 years.

If you are an investor and do not occupy the home, the wait to buy with a Fannie Mae insured loan is 7 years.

Affects on Credit After a Short Sale

A short sale is not a derogatory mark on your credit because credit bureaus do not show the word “short sale” on your credit report. It may say “pay as agreed” or “paid as less than agreed,” among other categories. Some clients have reported negative FICO score drops from 50 points to 130 points.

The point drop is typically due to being in default (behind on your payments).

Affects on Credit After a Foreclosure

A number of sources have reported FICO score drops from 200 to 400 points after a foreclosure. Generally this credit score will remain on your credit report as a public record for 10 years.

Credit Reports After a Short Sale

All lenders report short sales differently and some do not report them to the credit bureaus at all.

Credit Reports After a Foreclosure

If a prospective employer runs a credit check on you, your job application may be denied if you have a foreclosure on your record.

Deficiency Judgments After a Short Sale

Judgments are often negotiated between the seller and the short sale bank. In some cases, such as California, if the home is your personal residence and was financed through purchase money, there is no deficiency judgement.

Deficiency Judgments After a Foreclosure

Banks are unwilling to negotiate deficiency judgments with the homeowner after a foreclosure. In California, for example, according to the California Association of REALTORS, a deficiency judgment may be filed regarding a hard-money loan if the lender forecloses under a judicial foreclosure versus a trustee sale or if the second loan is a hard money loan and the sale takes place as a trustee’s sale.

Loan Application Questions After a Short Sale

Loan applications do not ask questions about a short sale. You may report that you sold your home.

Loan Application Questions After a Foreclosure

You are required to answer the question: “Have you ever had a property foreclosed upon or given a deed-in-lieu thereof in the past 7 years.” If the bank sees you have had a foreclosure, your loan most likely will be denied. If you lie, you may be subject to investigation by the FBI for mortgage fraud.

Length of Time to Move After a Short Sale

If you’ve had a foreclosure notice filed, you may be able to postpone that action while the bank considers your short sale. The wait for short sale approval can be from 1 to 3 months, or longer.

Length of Time to Move After a Foreclosure

Unless prior arrangements have been made, the bank may want you to immediately vacate the property and can commence eviction proceedings.

Taxation After a Short Sale

A personal residence is exempt from mortgage debt relief until the end of 2012 on a federal level. In the state of California, a personal residence is exempt from mortgage debt relief until the end of 2012 at the state level as well.  Some states will still tax you unless you qualify for an exemption. An investor is not exempt from mortgage debt relief, subject to certain conditions.

Taxation After a Foreclosure

Same as with a short sale. Except some lenders immediately send out 1099s, even if the owner is exempt.

Always obtain legal and tax advice before making a decision between a short sale or a foreclosure.  We are not tax experts or attorneys. The information provided is for informational purposes ONLY. It will serve in a starting point to further investigate how a short sale or foreclosure may effect you. We HIGHLY RECOMMEND that you consult a CPA, tax advisor and/or an attorney regarding your questions BEFORE you consider a short sale, deed-in-lieu-of-foreclosure or foreclosure.

An estimated 37,481 new and resale houses and condos were sold statewide last month. That was up 0.5 percent from 37,295 in March, and down 1.3 percent from 37,967 for April 2009. California sales for the month of April have varied from a low of 27,625 in 1995 to a peak of 71,638 in 2004, while the average is 44,758.

The median price paid for a home last month was $255,000, unchanged from March, and up 15.4 percent from $221,000 for April a year ago. The year-ago median was the low of the current cycle. The year-over-year increase was the sixth in a row, following 27 months of year-over-year decline. The median peaked at $484,000 in early 2007.

Of the existing homes sold last month, 38.1 percent were properties that had been foreclosed on during the past year. That was down from a revised 40.3 percent in March and down from 54.6 percent in April a year ago. The all-time high was in February 2009 at 58.8 percent.

The typical mortgage payment that home buyers committed themselves to paying last month was $1,108. That was up from $1,091 in March, and up from $929 for April a year ago, the low of the current cycle. Adjusted for inflation, last month’s mortgage payment was 48.6 percent below the spring 1989 peak of the prior real estate cycle. It was 58.3 percent below the current cycle’s peak in June 2006.

Indicators of market distress continue to move in different directions. Foreclosure activity is off its peaks reached in the past couple of years but remains high in a historical context. Financing with multiple mortgages is low, down payment sizes are stable, cash and non-owner occupied buying is up.

According to the California Association of Realtors (C.A.R.), home sales decreased 8.1 percent in April in California compared with the same period a year ago, while the median price of an existing home rose 21 percent.

Quick Facts:

• Existing, single-family home sales decreased 8.1 percent in April to a seasonally adjusted rate of 483,830 units on an annualized basis compared with April 2009.

• The statewide median price of an existing single-family home increased 21 percent in April to $306,230, compared with April 2009.

• C.A.R.’s Unsold Inventory Index rose to 5.1 months in April compared with five months in April 2009.

“It’s likely that the state tax credit that went into effect May 1 created an incentive for many buyers to postpone closing escrow so they could take advantage of both the state and federal tax credits that were available,” said C.A.R. President Steve Goddard.  “We should see the pace of closed sales edge up in May and June as these tax-incentivized transactions close.

“Sales dipped below the 500,000-unit level for the first time in 19 months also because of supply issues – the demand for attractive foreclosed properties well exceeds the number of properties on the market,” he said.  “At the same time, mortgage interest rates continue to hover near their historic lows, and many buyers are out in force to take advantage of the combination of low interest rates and affordably priced homes. It’s an ideal time for many families to purchase their first home even though they may face stiff competition.”

Closed escrow sales of existing, single-family detached homes in California totaled 483,830 in April at a seasonally adjusted annualized rate, according to information collected by C.A.R. from more than 90 local Realtor associations statewide. Statewide home resale activity decreased 8.1 percent from the revised 526,720 sales pace recorded in April 2009. Sales in April 2010 decreased 6.4 percent compared with the previous month.

The statewide sales figure represents what the total number of homes sold during 2010 would be if sales maintained the April pace throughout the year. It is adjusted to account for seasonal factors that typically influence home sales.

The median price of an existing, single-family detached home in California during April 2010 was $306,230, a 21 percent increase from the revised $253,110 median for April 2009, C.A.R. reported. The April 2010 median price increased 1.5 percent compared with March’s $301,790 median price.

“The strong demand for distressed properties continued unabated last month, and overall, inventory remains constrained in most segments of the market,” said C.A.R. Vice President and Chief Economist Leslie Appleton-Young.  “Listings in April increased compared with a month earlier, typical for this time of year, as more sellers entered the market. At the $300,000 and below price point, the number of homes for sale is at a 3.3-month supply, well below the historical average of seven months.”

Highlights of C.A.R.’s resale housing figures for April 2010:

• C.A.R.’s Unsold Inventory Index for existing, single-family detached homes in April 2010 was 5.1 months, compared with five months (revised) for the same period a year ago. The index indicates the number of months needed to deplete the supply of homes on the market at the current sales rate.

• Thirty-year fixed-mortgage interest rates averaged 5.10 percent during April 2010, compared with 4.81 percent in April 2009, according to Freddie Mac. Adjustable-mortgage interest rates averaged 4.16 percent in April 2010, compared with 4.82 percent in April 2009.

• The median number of days it took to sell a single-family home was 39.4 days in April 2010, compared with 48.1 days (revised) for the same period a year ago.

• Statewide, the 10 cities with the highest median home prices in California during April 2010 were: Manhattan Beach, $1,572,500; Saratoga, $1,440,000; Los Altos, $1,428,750; Mill Valley, $1,200,000; Laguna Beach, $1,162,500; Cupertino, $1,120,000; Newport Beach, $1,037,500; Los Gatos, $1,034,000; Calabasas, $925,000; and Santa Monica, $870,000.

• Statewide, the cities with the greatest median home price increases in April 2010 compared with the same period a year ago were: Richmond, 63.2 percent; Pittsburg, 56.7 percent; Tulare, 37 percent; San Bernardino, 37 percent; Cupertino, 35.7 percent; Monterey Park, 33.9 percent; Tustin, 31.6 percent; Highland, 29.2 percent; Manteca, 28.1 percent; Lancaster, 27.6 percent; and Seaside, 26.9 percent.

Lending institutions started formal foreclosure proceedings on fewer California homes last quarter. It is unclear how much of the drop can be attributed to shifts in market conditions, and how much is because of changing policies, a real estate information service reported.

A total of 81,054 Notices of Default (“NODs”) were recorded at county recorder offices during the January-to-March period. That was down 4.2 percent from 84,568 for the prior quarter, and down 40.2 percent from 135,431 in first-quarter 2009.  The quarterly average is 44,041, while the low of recent years was 12,417 in third-quarter 2004, when housing market annual appreciation rates were around 20 percent.

Several factors are at play here and it’s hard to know how they play into each other right now. A year-and-a-half ago the subprime loan mess was the black hole. Now, playing catch-up, is the financial distress households are experiencing because of the recession. Add to the mix shifting policy decisions, both by lending institutions and in public policy.

We are seeing signs that the worst may be over in the hard-hit entry-level markets, while problems are slowly spreading to more expensive neighborhoods. We’re also seeing some lenders become more accommodating to work-outs or short sales, while others appear to be getting stricter about delinquencies. It’s very noisy out there.

The state’s most affordable sub-markets, which represent 25 percent of the state’s housing stock, accounted for 47.5 percent of all default activity a year ago. In first-quarter 2010 that fell to 40.9 percent.

California’s mid- to high-end housing markets were more likely to have seen a rise in mortgage defaults last quarter, though the concentration of default activity – measured by defaults per 1,000 homes – remained relatively low in those areas.

For example, zip codes statewide with median home sale prices of $500,000-plus saw mortgage defaults buck the overall trend and rise 1.5 percent last quarter compared with the prior quarter, while year-over-year the decline was 19 percent (versus a 40.2 percent marketwide annual decrease). Collectively, these zips saw 4.5 default notices filed for every 1,000 homes in the community, compared with the overall market’s rate of 9.3 NODs for every 1,000 homes statewide.

In zip codes with medians below $500,000, mortgage default filings fell 5.8 percent from the prior quarter and declined nearly 43 percent from a year earlier. However, collectively these zips saw 10.5 NODs filed for every 1,000 homes – more than double the default rate for the zips with $500,000-plus medians.

On primary mortgages, California homeowners were a median five months behind on their payments when the lender filed the NOD. The borrowers owed a median $14,066 in back payments on a median $330,147 mortgage.

On home equity loans and lines of credit in default, borrowers owed a median $3,897 on a median $64,422 credit line. However the amount of the credit line that was actually in use cannot be determined from public records.

While many of the loans that went into default during first-quarter 2010 were originated in early 2007, the median origination month for last quarter’s defaulted loans was July 2006, the same month as during the prior four quarters.

Although 81,054 default notices were filed last quarter, they involved 79,457 homes because some borrowers were in default on multiple loans (e.g. a primary mortgage and a line of credit). Multiple default recordings on the same home are trending down.

Following a historical pattern, mortgages were least likely to go into default in Marin, San Francisco and San Mateo counties. The probability was highest in Merced, Stanislaus and San Joaquin counties.

The number of Trustees Deeds (TDs) recorded, which reflect the number of houses or condo units lost to the foreclosure process, totaled 42,857 during the first quarter. That was down 16.1 percent from 51,060 for the prior quarter, and down 1.7 percent from 43,620 for first-quarter 2009. The all-time peak was 79,511 in third-quarter 2008.

In the last real estate cycle, Trustees Deeds peaked at 15,418 in third-quarter 1996. The state’s all-time low was 637 in the second quarter of 2005.

There are 8.5 million houses and condos in California.

On average, homes foreclosed on last quarter spent 7.5 months winding their way through the formal foreclosure process, beginning with an NOD. A year ago it was 6.8 months. The increase could reflect, among other things, lender backlogs and extra time needed to pursue possible loan modifications and short sales.

Foreclosure resales accounted for 42.6 percent of all California resale activity last quarter. It was up from a revised 40.6 percent the prior quarter, and down from 57.8 percent a year ago, the peak. Foreclosure resales varied significantly by county last quarter, from 13.8 percent in San Francisco to 67.7 percent in Merced.

At formal foreclosure auctions last quarter, an estimated 24.6 percent of foreclosed properties went to investors and others who do not appear to be lender or government entities. That’s up from an estimated 17.6 percent a year ago.

The lenders that originated the most loans that went into default last quarter were Countrywide (7,282), World Savings (6,459), Washington Mutual (6,371), Wells Fargo (5,204) and Bank of America (3,851). These were also the most active lenders in the second half of 2006, and their default rates were well below 10 percent.

Smaller subprime lenders had far higher default rates for that period: ResMAE Mortgage, Ownit Mortgage, Master Financial, First NLC Financial Services and Fieldstone Mortgage all had default rates of more than 65 percent of the loans they originated in the second half of 2006. These and most other subprime lenders are long gone.

Most of the loans made in 2006 are owned or serviced by institutions other than those that made the loans. The servicers pursuing the highest number of defaults last quarter were ReconTrust Co., Cal-Western Reconveyance and NDEx West.

Notices of Default (first step in foreclosure process)
houses and condos

* includes additional counties

Trustees Deeds Recorded (signal homes were lost to foreclosure)
houses and condos

* includes additional counties

California Gov. Arnold Schwarzenegger has signed legislation that re-establishes and extends the state’s $10,000 tax credit for homebuyers, a program that proved so popular last year that it ran out of money by the end of June, eight months before it was set to expire. The measure sets a $10,000 credit, up to 5% of the purchase price, for buyers of newly built homes and a similar credit for first-time buyers who purchase existing homes. The credit will be available on “personal residences” purchased between May 1 and Dec. 31, and “principal residences” acquired between Dec. 31 and Aug. 1, 2011, as long as they were purchased pursuant to a contract executed on or before Dec. 31. The $200 million allocated for the program, which is offered in addition to the revised and extended federal tax credit, will be split evenly between new homebuyers and buyers of existing houses. The credit comes with two caveats, however: It must be claimed in equal installments over a three-year period, and buyers must live in the homes they buy for two years or forfeit the benefit. Despite the restrictions, both builders and Realtors hailed the measure. “The tax credit will help push prospective buyers off the fence, clear out inventory, and jump start the home building industry, which will help create jobs and reinvigorate the state’s economy,” said Liz Snow, president of the California Building Industry Association. Steve Goddard, president of the California Association of Realtors, said he expects the state credit to have the same positive impact on the market as the federal write-off. Nearly 40% of first-timers said they wouldn’t have purchased a home if the federal credit to buyers was not offered, according to CAR research conducted last year for long term care.

So the Fed stopped buying Mortgage Backed Securities, and people are wondering if this will affect mortgage rates. There’s been plenty of whistling past the graveyard, guesswork and denial, where so-called experts have been trying to tell us that there will be minimal – if any – change to rates.

That pipe dream is just nonsense.
Let’s look at what we can expect for mortgage rates and the overall Bond market in the months ahead. During the past fifteen months, the Fed purchased $1.25 Trillion in MBS, which represented 80% of the mortgage market. Prior to this program, mortgage rates were above 6%. Now that the Fed program has ended, it’s reasonable to assume that mortgage rates will rise back towards those levels.

Just How Much Money is $1.25 Trillion?
In today’s financial headlines – the word Trillion is often casually thrown around. So much so, that it’s easy to lose perspective on how much money this really represents. Picture a stack of $100 bills. It might surprise you to know that it only takes a stack four inches high to be worth $100,000. So $1,000,000 would be a stack of $100 bills 40 inches tall. How about a Billion? Well, you would have to stack $100 bills up to the top of the Empire State Building…twice…in order to reach a Billion. So to picture $1.25 Trillion represented by a stack of $100 bills – that stack would be 850 miles high. If you could turn that stack on its side and were able to drive alongside it, it would take you longer than 14 hours to reach the end. If you laid those $100 bills down side by side, they would travel around the world 50 times. We’re talking about a lot of money here.

The Fed’s purchasing influence has been significant. And now in the absence of this safety net, Bond prices and mortgage rates will experience greater volatility and a gradual worsening. Adding to this is the fact that the Fed will, albeit gradually, begin to sell some of their mortgage holdings, as they reverse their quantitative easing measures. It doesn’t take a rocket scientist to see that this will pressure Bond prices…but read on, because there are additional factors at play, which will influence Bond prices lower and mortgage rates higher.

What Moves Mortgage Rates?
Mortgage Rates are not pegged to the 10-year Treasury Note, as some have reported in the media. Those in the know do understand that mortgage rates are based on the pricing of Mortgage Backed Securities (MBS)…and these Mortgage Bonds are influenced by many different factors.

They respond quite well to technical signals as well as Stock market volatility, as money can be drawn from or parked into Mortgage Bonds. Certainly, the news and inflation implications also play a heavy role in influencing Mortgage Backed Securities.

And just like the aforementioned influential factors, Treasuries can also play a role in the price direction of Mortgage Bonds. Last year, the 10-year Treasury Note was at approximately 2.2% and has since moved towards 4%. During this time, mortgage rates have been virtually unchanged. But now, Treasuries are offering yields that are close to the current Mortgage Backed Security rates, which are offered to investors.

Let’s take a moment to understand the difference between the mortgage rate a borrower pays and the coupon yield on a Mortgage Backed Security that an investor receives. If a borrower pays 5.25% on their loan, only 4.5% of that is passed on as a coupon yield to the investor. This is because the mortgage loan servicer (that’s who you make your payment to) takes a piece of the action. Additionally – the aggregators of these loans, like Fannie Mae and Freddie Mac take a piece as well. And let’s not forget the folks on Wall Street, who need to get paid for underwriting, securitizing and selling this paper.

We know that Treasuries are backed by the full faith and credit of the US Government and are free from state income tax. And the 10-Year Treasury Note, while clearly not pegged to Mortgage Backed Securities, does offer investors a competitive alternative with a similar maturity period to Mortgage Backed Securities. But because of greater safety and tax advantages, the 10-Year Note will always trade at a lower yield than Mortgage Backed Securities, and therefore put a floor beneath how low Mortgage Backed Security coupon yields and corresponding home loan rates for borrowers can go.

The US is spending at an unprecedented rate – and its spending money it doesn’t have. This means that more and more Treasuries will continuously need to be auctioned off. And in order to entice buyers to keep absorbing this supply, yields will very likely need to continue higher, just as they have for over the past year.

Additionally – sovereign debt has come into question. Downgrades in the sovereign debt of both Greece and Portugal are a warning to the US that the same can happen here, which would drive the cost of borrowing much higher. Our government currently spends $1.49 for each $1.00 it brings in. Our debt is now 57% of GDP…and rising. Does anyone really believe that Treasury yields are headed lower? As Treasury yields move higher from their current levels, mortgage backed security coupon yields will also need to move higher in order for investors to want to purchase them.

The Ever-Important Carry Trade
While the Fed’s end of the MBS purchase program and eventual selling of MBS – along with an almost certain move higher in Treasury yields – all tell us that mortgage rates are headed higher, there is another important element that could have an even greater influence in moving yields higher and prices lower throughout the Bond market. It’s called an unwinding of the “carry trade.” The low interest rate environment in the US has provided fertile ground for the carry trade, where large investors can borrow at very low rates, and leverage into higher yields, resulting in huge returns.

Let’s take an example: An investor wishes to purchase $1M in Mortgage Bonds yielding 4.5%. This would provide $45,000 as an annual return. In order to make the purchase, the investor puts up only 10% of $1M, or $100,000 in cash – and borrows the other $900,000 at the Fed Funds Rate + 2%, for example – which would be a borrowing cost of 2.25% or $20,250. This investor receives a $45,000 return, but subtracts a $20,250 cost to borrow $900,000 – leaving them with a net return of $24,750. Remember, the investor needed only to invest 10% of the $1M purchase – or $100,000 in cash. This gives the investor a whopping 24.75% return on their investment in a boring little old Mortgage Bond. And of course, this “carry trade” can be used in other securities as well.

While the investor understands that there are always market risks at play – the juicy 24.75% yield cushion gives them much added comfort to stay in the trade. But the biggest risk for the investor is if their borrowing costs – which are based on the Fed Funds Rate – were to rise.

When the Fed starts to hike rates, it will signal the beginning of a tightening cycle. A few Fed hikes can cause the yield cushion to quickly evaporate…and the decline in Bond values from overall higher yields could turn the trade from highly profitable to highly costly in a very short period of time. So why do these carry trade investors have such a care free attitude and confident air? It’s because Ben Bernanke and the Fed have assured them that there is nothing to fear. How did the Fed do that?

Via “Fed Speak,” these carry trade investors hear that “conditions warrant exceptionally low rates for an extended period of time.” Translation: your biggest fear – that a hike in the Fed Funds Rate, which increases your borrowing costs and wipes out your gains – won’t happen anytime soon. It’s this “extended period” verbiage that is keeping the carry trade in place. When the Fed removes the “extended period” language, this will signal that hikes will begin in the near future, and that risk will prompt investors to begin to “unwind” their carry trade holdings. This will include the selling of Mortgage Backed Securities, which will assuredly push yields higher still.

When will the Fed remove the “extended period” language? It may happen sooner than you think. Kansas City Fed President Thomas Hoenig has officially dissented to the “extended period” language at the last two Fed meetings. And recently, St. Louis Fed President James Bullard, while yet to officially dissent, has stated that he feels “extended period” is inappropriate language and should be replaced by “data dependent.” And there have been grumblings from other Fed members, who are growing more concerned that leaving rates too low for too long can spawn asset bubbles or inflation down the road.

What It All Comes Down To
When all the factors are considered – the chances of higher interest rates are a virtual lock. And anyone in the market to borrow should consider acting sooner rather than later. With such low rates still in our hands…and all these various factors pointing at the inevitable fact of rates moving higher…you have to wonder what people sitting on the sidelines are waiting for?