I get a lot of questions posed to me about short sale and foreclosures. An interesting one was posed to me recently.  “How much will a foreclosure cost me?”

I had to really think about this question.  Sure the standard answer about the difference in being able to obtain a loan in the future with Fannie Mae being 2 years vs. 5 years and the FICO score dropping by up to 250 points came to mind.  However, I was thinking that question was asking for a quantifiable number.  How could I quantify the cost of a foreclosure?

I spoke with my loan broker and decided to see what the actual cost would be by comparing someone obtaining a loan pre-foreclosure and then post-foreclosure.

Let us assume an individual has a FICO score of 750 and wants to buy a home for $500,000 with 20% down; so he would be borrowing $400,000.  By running the FICO score through the Fannie Mae guidelines, this individual can obtain a 30 year fixed loan at 4.735 % and have a monthly mortgage payment of $1,997 as of 7/15/2010.

Let’s assume that same individual had gone trough a foreclosure and had taken a 250 point hit on his FICO score.  What would the “cost difference” be for him if he wanted to obtain a loan to buy a house today?

First, any individual with less than a FICO score of 620 cannot qualify to borrow from traditional lenders; the only option available to such a person would be the hard money arena or private lenders.

Private lenders require down payments of 20% , but more like 30-40% .  They are also short term loans, so you would only be able to borrow for 5 years or less, you would have to make other arrangements after that point or build up your FICO to the point where you would be able to qualify for a traditional loan.  But for easy comparison’s sake, we will ignore those two important facts, since there is no other alternative funding method. Let’s assume an individual is able to qualify for a loan of $400,000 after a foreclosure.

After checking with one of her private money lenders, my loan broker came back and told me a private money lender would charge 10% to lend $400,000.   The monthly payment on that loan would be $3,510!

How much will a foreclosure cost?  About $1,510 per month, by my calculations.

Please don’t write to me, pointing out all the errors in my unscientific reasoning.  This was a simplistic exercise trying to somehow quantify the damage to visualize the loss a person may suffer.

The general perception is that the people who are not paying their mortgages are either unemployed or are the common man who is going through a rough time.   This headline, however, paints a bit of a different picture: it is the borrower of  loans that are over a Million Dollar who are defaulting at a higher rate than the borrowers below a Million Dollars.  One in Seven for the Million Dollar borrower versus one in twelve for the other borrower.

The talk of the moment right now is that of strategic default.  And the interesting thing is that this article raises the question as to whether the rich are making strategic financial decisions to stop paying their mortgage as bad investments.   That certainly would explain why the segment with the higher net worth and other resources are defaulting at a higher rate that the less fortunate segment of society.

It would be interesting to see how this pans out.

Today, Fannie Mae announced how it would deal with strategic defaulters: they will be punished by being unable to qualify for a loan for up to 7 years through Fannie Mae and the latter will reserve the right to take legal action to recoup the losses in states that permit deficiency judgments (not the case in California).  The line has been drawn in the sand.

Strategic defaulters, or those borrowers who have the financial ability to pay their mortgages but who choose not to and walk away because the value of their homes are underwater, are becoming a big problem for banks as the stigma is becoming less and less meaningful and the distressed properties market is ever increasing.   One study puts strategic default at 1/3 of all defaults which eventually lead to foreclosures.

Fannie Mae is addressing a big problem for itself and trying to force strategic defaulters to think twice before walking away from their mortgage obligations.  It’s a perfectly understandable move on its part as it is trying to do potential future damage control.   This reason is also why it has agreed to participate in the HAFA program guideline to encourage negotiated and approved short sales rather than have homeowners simply walk away. Fannie Mae and Freddie Mac have figured out it is better to work with the distressed borrowers and, for those who qualify, work out an agreed short sale resolution rather than have the property foreclose, as the loss to them will be significantly greater in the end. They are simply engaging in good business practices by mitigating their loss.

As discussed briefly in the previous post , HAFA is the new Federal Government’s Program designed to complement the loan modification Program (HAMP), to help those borrowers who cannot qualify for said loan modification efforts.   Below is a bit more detail in a FAQ format.

What does HAFA stand for?
Also known as the “April Program”, HAFA stands or Home Affordable Foreclosure Alternatives. It’s a brand-new government program starting on April 5, 2010 that will streamline and incentivize alternatives to foreclosure. Under HAFA, participating banks must work with you to help you avoid foreclosure.

What are the “Alternatives” in HAFA?
HAFA provides two alternatives that will allow you to avoid foreclosure:

• Short Sale – If you owe more on your home than it is now worth, a short sale will help you sell your home and save yourself from financial ruin. According to HAFA, a real estate agent must be involved in this process. Agents with the CDPE designation are specially trained to help you with a short sale.
• Deed-In-Lieu – This is where the bank accepts the deed of your home instead of (“in-lieu of”) foreclosure. You do not get to keep your home, but your mortgage debt is forgiven.

HAFA also provides up to $3,000 in Borrower Relocation Assistance to help you transition beyond a short sale or deed-in-lieu of foreclosure.

Why should I consider a HAFA short sale?
HAFA sets distinct guidelines and incentives for banks and lending companies so that you will know whether or not you can complete a short sale. One of the common myths about short sales is that they take forever to complete. HAFA makes sure that short sales happen more quickly by streamlining the short sale process.

How is HAFA different from a short sale?
The main issue with traditional short sales was that they took too long, and it was difficult to keep buyers interested in the process. HAFA is a program designed to speed up the short sale process and even gives banks incentives for each short sale they do. Also, after completing a HAFA short sale, you may be given up to $3,000 in Borrower Relocation Assistance to help you transition. During a non-HAFA short sale, there is no government incentive for banks to help you.

Do I have to hire a real estate professional for a HAFA short sale?
Yes, but it doesn’t cost you anything. HAFA pays the real estate professional’s fees. It is a requirement of a HAFA short sale that you work with a real estate professional to help you through the process. CDPE-designated agents understand this process, and are located throughout the country. Find a CDPE in your area today to help you get started.

How do I get started?
Your first step should be to contact an educated real estate professional in your area. An agent can walk you through the HAFA process, determine your eligibility, and provide you with the best solutions available for your particular circumstances.

How do I qualify?
Most homeowners facing financial hardship can qualify for HAFA. If you applied for a HAMP Trial Period Plan but did not qualify, or were unable to complete the Trial Period Plan, you are definitely eligible for HAFA. If you are unsure about your situation, contact a CDPE in your area immediately.

What’s in it for me?
HAFA is the only program that gives you cash for avoiding foreclosure through a short sale or deed-in-lieu of foreclosure. If you complete a short sale or deed-in-lieu, then up to $3,000 in Borrower Relocation Assistance may be available to aid in your transition. This program seeks to ensure that no one will be left high-and-dry if they cannot afford their home. The biggest gain of HAFA, however, is that it helps you get your life back if you feel like there are no other solutions when faced with foreclosure.

How long does the process take?
HAFA speeds up the short sale process by putting in place distinct timelines that the banks—and you—must follow. Each step of the process has a defined amount of days in which it must happen. This keeps everyone on track. The longest possible time allowed in the HAFA short sale process is four months.

What is the April Program?
HAFA is commonly referred to as the April Program.

HAFA Scams
There are many people out there trying to scam homeowners by requesting up-front fees for HAFA short sales. This is fraud. A CDPE-designated agent will never ask you for money. MakingHomeAffordable.gov(MHA) provides the following guidelines:

• Beware of anyone who asks you to pay a fee in exchange for counseling service or modification of a delinquent loan.
• Scam artists often target homeowners who are struggling to meet their mortgage commitment or anxious to sell their homes.
• Beware of people who pressure you to sign papers immediately, or who try to convince you that they can “save” your home if you sign paperwork or transfer over the deed to your house.
• Never make a mortgage payment to anyone other than your mortgage company without their approval.
• Do not sign over the deed to your property to any organization or individual unless you are working directly with your mortgage company to forgive your debt.

Who is Eligible for HAFA?

Most homeowners in facing financial hardship are eligible. As a rule, if a homeowner is eligible for HAMP but cannot pay the mortgage, then he or she is eligible for an assisted short sale through HAFA. However, loans owned or guaranteed through Fannie Mae or Freddie Mac do not qualify. Servicers must consider possible HAMP eligible borrowers for HAFA within 30 calendar days if the borrower has one or more of the following criteria :

• Does not qualify for a HAMP Trial Period Plan
• Does not successfully complete a HAMP Trial Period Plan
• Is delinquent on a HAMP modification by missing at least two consecutive payments
• Requests a short sale or deed-in-lieu

For a loan to qualify, it must meet the following criteria:

• The property is the borrower’s principal residence
• The mortgage loan is a first lien mortgage originated on or before January 1, 2009
• The mortgage is delinquent or default is reasonably foreseeable
• The current unpaid principal balance is equal to or less than $729,750
• The borrower’s total monthly mortgage payment (as defined in Supplemental Directive 09-01) exceeds 31 percent of the borrower’s gross income
• The mortgage is not owned or guaranteed by Fannie Mae or Freddie Mac

Part 3 of 3  Which Banks are supporting HAFA?

Read Article here.

Hip Hip Hooray!

Bank of America today announced its decision to agree to permit principal forgiveness for certain Countrywide loans which are severely underwater.  This decision will affect some 45,000 borrowers who have “sub-prime and pay-option” loans.

This is fantastic news for those who are affected, as negative equity or being under-water, is one of the biggest reasons why some borrowers face foreclosure.  Of course, the fact that some of these borrowers are voluntarily choosing foreclosure and walking away probably has something to do with BofA’s announcement today as well.

Countrywide issued a lot of sub-prime and  option ARM products to consumers in California, could it be that they are acknowledging they were questionable products?

Whatever the reason, this is good news for all distressed property owners as this may be the first step and other lenders may follow Bank of America’s steps.

This is an excellent article about the general overview of how short sales are reaching into the mainstream of the real estate industry.

The article, however, leaves a false impression that the REO listings are receiving more money because they close at 99% compared to 91% for short sales. However, there are plausible explanations for the differences in those two closing ratios.

1.  Short Sales generally have to start off at market price and require systematic price reductions which must be justified to the lenders for them to agree to the sale. Because buyers want deals but the lenders want to start with market price, price reductions are inevitably built in to the process.  Whereas in a REO, the bank and its accountants have pre-determined their bottom-line net price, which is typically below market rate.  Because they are dealing with bottom-line net prices, the banks will rarely agree to accept prices that are far off their list price, if at all.  By contrast, there is a bit more latitude in negotiating price in a short sale.

2.  In addition to having to start off at market price, comparable short sales generally list at a higher price point because owners typically live there and take better care of their homes where their family still resides; compare that to an REO where the owners often destroy many components of the house during the eviction process.  Short sales show better so are also more popular because they are closer to move-in condition that REOs.

So despite the impression that short sale properties receive less money, the reality is that short sale properties, sell at higher price points for comparable properties, yet close at a lower ratio relative to list/sold price because of the lenders demands to list at or near market price.

I suppose these were often the emotional responses of perfectly rational homeowners having irrational responses upon learning that their lenders would force their family out of their homes and try to sell their homes at auctions.   I imagine I would not react in such drastic ways; but who knows how one would react unless one were in the other person’s shoes?

Well, here is a homeowner’s reaction to a foreclosure notice………