Out of the ash of the mortgage meltdown-bubble bursting-long lasting recession has come a new type of seller. One that has learned how to manipulate the many programs offered by banks to help those that simply cannot afford their house. Unfortunately, in the end, we all pay the price.
Where did this come from?
For the most part, San Carlos has been immune from a flood of short sales and foreclosures. Because we have been almost entirely immune from these types of transactions, many in San Carlos are unaware of just how corrupt the system has become. Word has gotten out on how to manipulate the short sale system and sellers are taking advantage of it. We are starting to see this manipulation locally and on a more frequent basis.
What is a short sale?
A short sale occurs when a bank or banks (depending on the existence of a second mortgage), agree to accept less than what is owed to them as a full a final payoff on their mortgage balances. Banks have been agreeable to short sales because it saves them the time, effort and expense of going through the foreclosure process. The short sale works well for sellers because it allows them to get out from under the mortgage and the short sale will not have the same devastating effect as a foreclosure on the seller’s credit rating.
Those who manipulate the system vs. those who are truly in trouble
The sad part about short sales is that there are families who have truly hit a streak of bad luck and have no choice but to short sale their house. Unfortunately, there are others who are using the short sale process as a way to work the system every which way possible in order to net a substantial financial gain. The issue I have with this second group is that they are getting away with a financial gain, while everyone else who has worked through a very difficult recession to keep their home, ends up paying the cost of their financial gain through higher bank fees, lower property values and higher taxes.
Here is an example of how some of these folks have worked the system:
Sara Seller buys a home in 2003 in San Carlos for $900,000. Sara Seller’s home appreciates in value to $1,250,000 by 2007. Sara Seller applies for a second mortgage and chooses a cash out refinance. Sara Seller takes the $350,000 and pays $100,000 cash for a two new cars, and puts the other $250,000 into a variety of account such as retirement, vacation, and a college account for her kids. By 2009, Sara Seller’s home has dropped in value from a high of $1,250,000, to $1,075,000. Sara Seller has decided that she no longer wishes to make payments on the home because her business has hit tough times and she is stretched too thin. Additionally, she realizes that the house is now $175,000 under water and does not want to wait around for the home to appreciate back up to its 2007 value.
Sara Seller decides to attempt a short sale. The first thing her realtor tells her is that the bank will not take a short sale seriously until they stop receiving payments. Sara Seller stops making her monthly mortgage payments and puts the home on the market as a short sale, subject to bank(s) approval. Sara Seller’s realtor has correctly informed her that since her house is a short sale, she will need to put the home on the market at a slightly discounted price. If she does not do this, buyers will not be willing to stick with the long, drawn out process of a short sale. Sara Seller puts her home on the market for $975,000. Sara Seller obtains an offer for the full list price of $975,000 and starts the short sale process with her banks. If the short sale goes through and the second mortgage holder agrees to waive their deficiency rights (as is what happens in most successful short sales), here is the net effect:
(1) Sara Seller is no longer liable for the mortgages on the property.
(2) Sara Seller keeps the two cars that she bought for $100,000 which she owns outright as well as the $250,000 that she dropped in other retirement, college and vacation accounts.
(3) Sara Seller gets to keep the money she pocketed for the six to seven months of not paying her mortgages.
(4) The banks lose a combined $275,000, plus another $45,000 in real estate fees.
(5) All other homes on that particular street and surrounding area just had their property values lowered because of the new low comp via the recent short sale.
Are there any corrective measures being put into place to stop this?
Banks have gotten wise, but are still playing catch-up to some of these seller tactics. Some of the data released recently for California suggests that banks have scrutinized the applications of short sale sellers more carefully and have only been approving the sellers that are truly destitute. There is also talk that the Franchise Tax Board may go after some short sale sellers for the tax due on the deficiency amount, in the above example this would be the tax due on $350,000. Finally, many banks are feeling as though some areas of the country have recovered to the point where they do not need to necessarily accept short sales. In other words, they are willing to go through foreclosure and get more of a financial benefit on the sale after foreclosure. In any event, it is still a deeply flawed system that has been fully exposed.
8 Comments
And then there’s the hardworking young family, forced out of their home and into a rental while their former home sits empty month after month. Over here on the wrong side of the tracks I personally know two families who have lost their homes. That’s a pretty substantial number in a neighborhood of only six blocks.
Hi Pat,
Thanks for your comment. I have helped three families, all with young children, in San Carlos over the last 12 months with short sales. All were incredibly difficult on the family. It becomes even more frustrating when you know that other folks are exploiting these options for personal gain.
Bob
It kills me to drive by that empty house, knowing that someone is losing money on it each month but wouldn’t modify the loan for the family. The foreclosure sat empty while the bank tried to sell it then rented, undoubtedly at a loss. That one was owned by a city employee, which is even more sad.
I see the point here but on the other hand what had once been the unthinkable for many people (cheating the system and failing to honor financial obligations) is hardly worse than the behavior of banks, rating agencies, etc. that got the economy into this mess in the first place. I think many people see little difference morally between this situation and the tax-payer financed bailout of Wall Street. I can’t agree more with the point that cheating short sellers do a lot of harm to the property values of their neighbors, but sadly I think in these times many more people than ever before are making choices from self-interest and little else.
@PR… the banks may have helped caused the problem, but the reality is in a lot of cases people were living outside of their means or didn’t understand (or care to understand) what they were getting into when they purchased their home.
Granted, there are situation, like a job loss, which put people into this mess. Those are the people I’m truly sorry for.
I hate to think about the amount of foreclosures out there (albeit only a small number in San Carlos).
Don’t get me wrong, I’ve seen my own house go back to the value where I paid for it not that long ago, but I’ve also been fortunate enough to refinanced to lower my payments. But to begin with, I didn’t purchase a house I knew I couldn’t afford in the first place, which is the case in some instances.
There is enough blame for this problem to go around.
Bob, I would like to commend you for having the guts to write this blog. Being in the lending industry for the last 10 years, my job has gotten insanely challenging and ridiculous at times. I am exhausted as everyone is emotionally tired so they take it out on me, and I just have to take it all. I know you go through this everyday. All my great clients who have been honest has to pay the price for all those that have cheated and lied in the past.
We all have to sacrifice now and make changes to ride out this market. It burns me that people are trying to work the system to gain some cash. That is so wrong. What’s sad is that you and I are paying for all the people that have lied, cheated and created this situation. There are so many people in true need. They don’t even have money to pay rent. When someone decides to work the system, they are stealing resources from someone who truly needs it. Stealing!!!! What everyone needs to know is the more people try to work the system, the banks will eventually shut it all down, as Bob has indicated. Then everyone looses.
It is my hope that everyone takes a minute, evaluates their financial situation, make smarter decisions, sacrifice a little and ethically do the right thing. That is the only way we all can recover and for the market to improve.
@Izzy…. My husband and I have 2 college and 2 Masters degrees between us, including one from a very prestigious business school. We are both very comfortable reading financial statements and legals statements, and we found our mortgage documentation to be, how shall we say, confusing. Sometimes deliberately so.
For example, we were told that there would be NO penalty or fees for paying off and closing our HELOC. Then when we read the 100s of pages of documentation (yep, we read EVERY word and our real estate agent and mortgage broker acted like we were crazy…!!) and found that there was a $300 fee to close the HELOC before 3 years. So we asked if we could keep it open for 3 years but carry no balance and pay any fees and were once again told NO (this time with more eye rolling). Well whaddya know, apparently there is a $75 annual fee to keep the HELOC open even if there is a zero balance. Thanks Wells Fargo!
Now, in the greater scheme of a million dollar plus property, $75 is nothing. But it’s a perfect example of all the CR*P that the banks pulled, and continue to pull, with consumers all the time.
Yeah people game the system, and frankly I’m mad because I’m fundamentally honest. I played by the rules, saved my 20% down payment even as local real estate went up for no particular reason and all the banks (oh, and real estate agents too! let’s not forget that they told us to just throw in another 50K so we’d outbid the next person and get the house of our dreams) talked and talked and talked. Yeah, I’m mad. But frankly I’m also a teeny bit mad that I didn’t do what Sarah Seller did — at least then I’d have 2 cars and a retirement fund.
k – you hit it right on the head. After years of the run-up in the bubble from which many derived benefit – property owners, mortgage brokers, real estate agents, banks, mortgage securities investors – it’s somewhat astonishing that some are now shocked – shocked! that the self-dealing hasn’t stopped there. I’m not saying it’s right but let’s not get on our high-horse with folks that are doing hardly worse than what’s been done before.