Shadow Inventory and the Foreclosure Process in Virginia vs Maryland

The Washington Post had a few good articles this weekend about battling foreclosure. One article, in particular, highlighted the differences in approach by Virginia and Maryland. Starting in 2008, Maryland lawmakers passed laws to give homeowners more time to try to work out solutions with lenders; these measures included waiting periods, counseling, and required mediation. These laws, combined with the fact that Maryland is a judicial foreclosure state, slows down the process.  While this is great news for the people being foreclosed on, it often just delays the inevitable, and has affected Maryland’s real estate recovery. According to the article, Maryland ranks as #4 for longest duration of a foreclosure, with average days of 634. Virginia, on the other hand, is a non-judicial foreclosure state, which results in very fast foreclosures, averaging 132 days, the 4th fastest in the nation. (The U.S. average is 348 days.) Virginia can foreclose so quickly because at settlement, home buyers sign a deed of trust that allows the lender to foreclose outside of the court system.

I’m often asked by potential home buyers whether we can expect a wave of foreclosures and how to take shadow inventory into account. The foreclosure process in Virginia provides high visibility into the shadow inventory; one need only look at the publicly filed notices of default, and if the home owner doesn’t work out a deal with the lender, it will become real estate owned by the bank. At that time the tax record will reflect the change in ownership and you can be sure the bank will be trying to sell that home at some point. The timing remains an issue; banks don’t want to flood the market with foreclosures, thereby depressing all prices.

In Maryland, homeowners could stay in their homes for many months, or even years, before that home becomes real estate owned. They could well resume making payment or complete a successful short sale within that time. Notices of default are still used but the foreclosure process itself will likely take more than a year, providing a number of options (not to mention rent- and mortgage-free living) for home owners.

The bottom line for home buyers? Virginia pulls off the band aid quickly, resulting in short term pain to the market, but the end will arrive more quickly. Maryland slows down the process hoping that home owners will find a solution or otherwise resume making payments. We can expect a much slower rebound there. So when someone asks me: “Are we at the bottom?” I must reply with the question: “In which state?”

More Resources: Mortgage Bankers Association “Judicial Versus Non-Judicial Foreclosure”

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Washington, DC, Delinquencies and Shadow Inventory

The Mortgage Banker’s Association reported that the seasonally adjusted delinquency rate for mortgage loans on one-to-four-unit residential properties fell to 7.99% in the third quarter of 2011, the lowest level recorded since the fourth quarter of 2008. While any decrease is good news, don’t get too excited just yet– it’s a decrease of just 45 basis points.

The delinquency rate is an important one to follow because it’s one of the best leading indicators we have for predicting ‘shadow inventory.’  Shadow inventory is the elusive backlog of future foreclosures–that is, homeowners who are inevitably headed towards foreclosure but the paperwork is still going through so the bank has yet to take possession of the house and/or list it for sale.  Foreclosure processes vary widely state to state, and it’s notoriously difficult to predict when a property will actually hit the market.  Buyers and market bears are always shouting about the huge backlog of inventory coming down the road, dooming recovery progress in the shaky housing markets.  Yet here in the DC area we have been waiting years for this alleged ‘tidal wave.’

I wouldn’t hold your breath.  First, these delinquency stats have been relatively stable for years, and we haven’t seen the big bump in foreclosures yet in our area–the fact is that our local market (particularly close in Northern Virginia and DC) has remained strong enough to absorb foreclosures and short sales as they come to market.  Second, remember that banks control the inventory they take possession of, and they are well aware of the laws of supply and demand.  If a bank is trying to recoup as much value as possible, why would they flood the market with inventory, thereby depressing prices?  The carrying cost of a property for a bank is minimal–after all, they don’t pay themselves a mortgage–so the only real incentive for them to get properties off the books is regulatory requirements that affect the amount they have to hold in reserves.  So it’s a big of a juggling act for banks.

Delinquencies, of course, are tied to unemployment rates: no job = can’t pay the mortgage = delinquency.  DC’s strong job market is another reason we don’t see the avalanche here that other parts of the country might experience.  But stay tuned…the lack of a budget deal from the super committee could mean serious cuts in government spending in our local market.

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This Month in Real Estate: Foreclosures Down as Short Sales Become Viable Options

April stats for foreclosures are out, and they show a 2% decrease form April of 2009, possibly due to more sellers being aware of short sales as a viable option, and more buyers recognizing that short sales may pose a good buying opportunity.

Short sales are still long, frustrating processes for all parties involved, but if you are part of a program with a proven track record and professional negotiators, sellers can find themselves out from an incredible financial burden, and buyers can find themselves in a great home with a great interest rate mortgage.

If you’re a seller thinking a short sale may be a good option for you, contact us. We are Certified Home Rescue Institute agents, and able to counsel buyers with confidence–this program has a 95% success rate for closing short sales. There are important factors to consider, such as credit score, deficiency judgments, and tax implications. Work with an agent and a program who can counsel you on these topics. We only work with sellers who have been counseled on all of their options, including loan modifications, foreclosures, and bankruptcy, in addition to having been educated on the short sale process.

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Why Don’t Short Sales Close?

Most buyers know by now that a very low percentage of short sales close. And I don’t mean that buyers need to wait a long time (though they do) — I mean they NEVER close.  What are some of the reasons why?   And what happens to them?

First, let’s recap:  What is a short sale? As I’ve discussed before, a short sale is a “pre-foreclosure” sale by the seller wherein he is “short” on his payoff to the bank on the loan.  Therefore the bank needs to sign off on any contract before it goes to settlement.   The seller walks away with nothing, while the bank takes a loss.

Sellers often list homes for a very low price because they simply don’t care—the bank is the one taking the loss, and the seller just needs an offer. Once an offer is in, the seller sends it to the bank for approval, a process which could take many months.

Short sales are often frustrating for buyers because they have such a low closing ratio.  Just because a home is listed as a short sale does not mean the bank has approved the price.  The bank may not even be aware the homeowner is trying to sell!

So why do short sales not close?  Let me count the ways…

We can bucket the issues into two categories: Buyer “Problems” and Seller/Bank “Problems.” I combine Seller and Bank into the same bucket because really it’s not up to the seller by the time it reaches short sale status—the bank is the one taking the loss, and so the bank is the one that has to sign off.

There are several reasons a bank may not approve an offer on a short sale:
•    Offer Too Low: The most obvious is that the offer price is too low.  The bank had no input into setting the price, nor any input on price reductions.  The seller is indifferent as to the offer price –after all, they are lucky to be getting out of the house at all, and they certainly are not going to be walking away with a dime.  This is why you often see homes listed ridiculously low versus similar homes nearby.  The seller just needs an offer to get the process started.
•    Second (or Third) Trusts: Closely related to the “Offer is too low” category is that the second trust may not sign off on the amount they are receiving (if any).  It’s quite common for sellers to have more than one mortgage or HELOC on the property, and 2nd and 3rd trust holders receive very little, if anything, in short sales.  Sometimes they refuse to sign off because they simply have no incentive to do so.
•    Seller Doesn’t Qualify: Sometimes a seller simply has too many other assets for a bank to approve a short sale.  If the seller has money in their accounts, the bank is going to want that money.  Similarly, a seller has to show a hardship—they can’t simply say it’s a short sale because they’re underwater and don’t want to pay anymore.  And don’t be naive on this…sellers don’t volunteer this information to the bank at the beginning of the process–they typically wait until they have an offer and hope that the bank will somehow not ask to see evidence of their other assets.
•   Why Sell When You Can Live for Free?: Commonly a homeowner will stop making mortgage payments once they realize they are in a short sale situation.  Though the homeowner gets the usual form letters and phone calls threatening them with eviction, the fact is that they are living for free during that period of time.  Some accept the foreclosure as inevitable and simply live there for free as long as they can…completely unmotivated to accept an offer because once an offer is approved, they have to move and start paying somewhere else.  They only have to show the bank that they are ‘trying’ to sell the home.
•    Foreclosure Trumps Short Sale: If the bank is pursuing foreclosure, then it’s a race against the clock.  The two departments often don’t coordinate.  Even if they do, often times a bank will decide that it’s more economical to foreclose than accept too low a payoff.
•    Unexpected Consequences: These next two fall into the “I didn’t realize if I did a short sale that would happen” category.

◦    Deficiency Judgments: Most sellers don’t realize that even though the bank accepts a loss, the seller is still technically liable for that amount, and the bank reserves the right to pursue that amount later.  (This is also true of foreclosures.)   It does not get wiped out as in a bankruptcy. While it’s uncertain whether banks actually will pursue these individual homeowners, the risk remains, and sellers may get cold feet at the last minute, scuttling the sale.
◦    Tax Effects: Sellers also may not realize that they will receive a 1099 for the amount of their debt forgiveness, creating potentially taxable income.  There are several ways a seller can be exempt from this, but it’s critical to consult a tax adviser.  If during the course of the transaction they realize this and have doubts, they could refuse to go forward.

As if those reasons didn’t provide enough hurdles, even if the seller and bank stars align, the buyer might be the one to torpedo the transaction:
•    Home Inspection: Frequently the home inspection is not conducted until after the bank gives its approval of the transaction (and why not…smart buyers don’t want to risk their money on a transaction that has a small chance of closing.)  But what if there are problems in the inspection?  Short selling sellers rarely have enough money for any significant repairs, and the bank is not going to agree to a lower amount after it took months to get a sign off on the original.
•    Appraisal Problems: This cuts both ways—a low appraisal will trigger a buyer to want to renegotiate, but a high appraisal will trigger a bank rejection of the offer as a ‘below market’ price.
•    Bank Takes too Long: As noted above, the process can often take many months (count on at least 3, and up to a year or even more).  Buyers often get frustrated and back out while waiting for a response. There are also buyers who will put in offers on many different properties hoping that something will hit, and whichever one answers first is the one they pursue.  Often you’ll see in the remarks field “already approved at this price” which means the bank finally did get around to approving a contract, but the buyer had walked away by that time, leaving the seller with an approval letter, but no buyer.

So what’s the good news on short sales? Banks are getting better/faster at them, and some government programs are in process to help incentivize both first trust holders and second trust holders (also referred to as first lienholders and second lienholders.)  But that only addresses a few of the potential issues above.

There are also programs and professional negotiators who are making tremendous strides in mitigating some of the challenges listed above, significantly increasing the chance of a settlement. They’ve found ways to protect the buyer’s interests while still optimizing the chance of a bank sign off.  I’ll discuss some of these in another post, so stay tuned.

So what happens to the short sales that never close? Sometimes they continue to sit for months and months as “Active” or even “Contingent” status in the multiple listing service.  Sometimes the foreclosure department wins the race and forecloses on the home.  Sometimes the homeowner makes just enough of a payment to keep the bank from moving forward from foreclosing, and sometimes the seller may start again making payments stopping the entire process.  Most of these homes, however, will eventually end up as foreclosures if the short sale process is not successful.

More Resources:

Short Sale Statistics in Arlington

Contact Us to Talk More About Buying or Selling Short Sales

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Short Sale Statistics for Arlington

House Under WaterOur local MLS has added a field to specify short sales (though “Undisclosed” is still an option), which makes it a little easier to get a handle on the current state of the market.

So where are the short sales in Arlington?

As of the date of this post, there are 46 active short sales in Arlington. Here is how they break out by zip code:

North Arlington:
22201 = 4 properties (2 in Westview, 1 Colonial Village, 1  Clarendon 1021)
22203 = 1 property (in Lexington Square)
22205 = 3 properties (Broyhill Heights, Garden Commons, Fostoria)
22207 = 2 properties (Highview Park, Berkshire Oakwood)
22209 = 1 property (Belvedere)

South Arlington
22202 = 1 property (Arl Ridge)
22204 = 32 properties (scattered, but mostly 1-2 br condos)
22206 = 2 properties (Courtbridge & Nauck Valley)

It’s easy to see where the concentration of short sales is for Arlington–the area just south of Rt 50, bordered on the west (roughly) by Carlin Springs Rd, which includes neighborhoods such as Alcova Heights, Douglas Park, Columbia Forest, Barcroft, Glencarlyn, Arlington Heights, Penrose, and Columbia Heights.

What are your chances of a short sale closing?

This has long been the challenge for buyers, who are often facing a lease deadline or trying to capitalize on the $8000 first time buyer tax credit or historically low interest rates. In November 2009, 17 short sales closed–pretty good! That means that there is currently 2.7 months of short sale inventory — almost consistent with Arlington’s inventory as a whole, which is hovering around 4 months–about 6% of which is short sales, and another 10 (<1%) are foreclosures. Half of the 10 foreclosures are in 22204, as well.

Compare this to the 14.7% of Fairfax County’s current inventory that are ist1_4273718_foreclosure_home_for_saleshort sales and an additional 6.3% that are foreclosures.   So 21% of Fairfax County’s inventory is ‘distressed’ vs just 7% of Arlington’s.  Alexandria City currently has 11% of their 455 listings as short sales, and another 4% as foreclosures, for a total of 15% distressed.   DC has 7% short sales and 10% foreclosures.  So to recap:

% Distressed Sales

  • Arlington: 7%
  • Fairfax 21%
  • Alexandria 15%
  • District 17%

How long does it take to close a short sale, and how much do they go for?

Arlington’s 17 short sales that closed had an average Days on Market of 90, and an average sold-to-list price ratio of 97.4%.  Our actives, on the other hand, have Days on Market ranging from 1 to 524, with an average of 114.

Should buyers be looking at short sales?

Short sales are certainly not without their challenges, but they can be a good deal, depending on what you’re looking for, where you’re looking, and how flexible you are with timing as well as condition of the property.  If you’d like to discuss more about buying short sales, please contact us. And if you need to sell in a short sale position, we can help with that, too.

Learn More: Sign up for our free first-time home buyer class at Arlington Central Library on  Jan 26 at 7:00 pm (registration required)

Read More: Risks of Foreclosures

Read More: What’s the Difference Between a Short Sale and a Foreclosure?

Source: MRIS as of 12/13/09 All data deemed accurate but not guaranteed.

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