Here is a little history as to why people were forced to do short sales and the reasons behind it all. About 18 years ago, most subprime mortgages began their slide to an “underwater” position, meaning their value was greater than the market value of the financed home! That is what is meant by “underwater.” The percentage of new lower-quality subprime mortgages rose from the historical 8% or lower range to approximately 20% from 2004 to 2006, with much higher ratios in some parts of the U.S.
A high percentage of these subprime mortgages, over 90% in 2006 for example, were adjustable-rate mortgages. These two changes were part of a broader trend of lowered lending standards and higher-risk mortgage products. Further, U.S. households had become increasingly indebted, with the ratio of debt to disposable personal income rising from 77% in 1990 to 127% at the end of 2007, much of this increase mortgage-related.
My professional and expert opinion is that Alan Greenspan, who was the Fed chairman from Aug. 11, 1987 through Jan. 31, 2006, had caused much disruption, due to allowing so many to enter the mortgage market, with variable rate mortgages, providing those, who I believe, couldn’t really afford to purchase a home. This type of loan had never existed in the past.
Greenspan, along with President George Bush and Wall Street, benefited greatly by packaging these loans into multimillion-dollar to billion-dollar CDO’s (Collateralized Debt Obligations) or mortgage-backed securities and sold them off to whoever wanted to purchase, whether investors or even entire countries. The thought was that the U.S. economy, at the time, was doing well and bulletproof. Janet Yellen, one of the newly elected Fed governors, played a crucial and critical role in convincing Alan Greenspan that some inflation was good for the economy. As she put it, “a bit of lubrication was good for increasing economic growth and that was a decision that would haunt Greenspan’s tenure as Fed chair until he was replaced by Ben S. Benanke on Feb 1, 2006. He served until Jan 31, 2014.
Greenspan realized too late, however, the unfortunate error of his decision, and when in December 1996, he came out with the term “irrational exuberance” in the financial markets, no one was even listening or even cared. Things were flying along and everything appeared in excellent shape, with low unemployment and great interest rates. But the bubble was growing unchecked, allowing those who could least afford a mortgage to enter the market, just so they could taste and enjoy the “American Dream” even though they didn’t realize that it would only be for a short term until the bubble popped.
It was one of the greatest financial errors ever made. Greenspan pushed interest rates much higher at the beginning of his tenure when inflation exceeded 5% due to strong growth and low-interest rates after the great recession of 1988, which then caused another recession. Afterward, the economy expanded into the longest peacetime expansion in our nation’s history.
The methods to approve a short sale for a homeowner whose mortgage is under water and is unable to pay on time are as follows: the owner has to provide all the necessary and required documentation to show the need to allow the short sale. They will also do a credit check and also ask for all their assets and liabilities to prove the tenuous position they are in, to approve their “short sale.” If approved by the lender, then the owner will be allowed to place their home on the market with a knowledgeable experienced brokerage. When offers come in, and even though they may be less than the mortgage amount that is owed, the bank will generally forgive the difference between the agreed price and the existing mortgage.
Then the contract with the method of payment is sent off to the bank holding the mortgage for the short sale approval, whereby the bank will either approve or deny acceptance of the offer. Once approved the closing will be set up. The time could be a few weeks to as many as a few months to complete the short sale. It is more complicated than a regular real estate sale and a broker should have expertise and knowledge in how to start and complete the sale.
Generally speaking, a short sale is more to the homeowner’s advantage than a foreclosure. In a few instances, if mortgage payments continue to be on time during a short sale, the seller could essentially apply for a new mortgage for their next home. More importantly, the IRS also has extended the forgiveness of that money saved between the sale price and the mortgage, and for now, is not reportable income, as it used to be a few years ago when you had to report the savings on your short sale as income. However, nobody could afford to pay the income taxes on the savings, so Congress passed a law that the savings were no longer subject to income taxes, because if you couldn’t afford your mortgage payments, you could not afford to pay the income taxes either.
Foreclosure is more serious and has a very huge impact on one’s credit for at least a two-year period. However, today it could take longer to secure a new mortgage if foreclosure had taken place. Credit is more severely impacted not only by foreclosure but by the last resort of action, bankruptcy, which would be the last avenue to pursue.
Philip A. Raices is the owner/Broker of Turn Key Real Estate at 3 Grace Ave Suite 180 in Great Neck. He can be reached by cell: (516) 647-4289 or by email: [email protected] or via https://WWW.Li-RealEstate.Com Just email or snail mail (regular mail) him with your ideas or suggestions on future columns with your name, email and cell number and he will call or email you back.
