the role of equity in foreclosure and short sales.

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the role of equity in foreclosure and short sales.

William MacBride
Handyman · NY · Member since 2008 · 47 posts · 2 votes

Hi
I'm just getting into this and trying to clarify the basic cash flow patterns of the foreclosure and short sale market. Bear with me because I'm a real newbie. Let me start with a hypothetical situation.

Somebody takes a mortgage for 300, 000 dollars out to buy a nice house. They make their payments ok until they've achieved 100 thousand dollars of equity. They still owe 200 grand, and suddenly they lsoe their job and can't make any more payments. They start getting notices from their lender that their property is going to go into foreclosure.

The way I understand the short sale deal is that their lender agrees to take 150, 000 for the house instead, to save them time and hassle and fees for auctioning the house off. But the individual in foreclosure can't pay them this amount of money. That's where an investor comes in with the money and either buys the house himself, or flips it quickly making say 10 grand.

Now- what I don't understand is why the owner of the house can't just skip these middle men and sell the house himself. I mean if the house was worth 300 grand when he bought it, it should AT LEAST be worth the 150 or even the 200 that he owes right? Hell it might even be worth more than the mortgage he took out.

It's referred to as an "upside down' situation when the owner can't expect to make as much from sale of the house as he owes the lender, but I just don't really see why this is the case. Wouldn't prices have to fall very sharply to create this situation, and even if he'd only paid off a little of the mortgage wouldn't he still be in a fairly good position?

If anyone can clarify this I'd appreciate it.

Thanks a lot,
Will

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  • Jon Holdman
    Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
    18y

    If the house is truly worth $300K, and they owe $200K, no bank is going to accept a short sale.

    If someone paid $300K for a house, got 100% financing (common a few years ago), they would need to make payments for 17.5 YEARS before the balance was down to $200K. If they found themselves in a foreclosure situation, they should be able to sell their house, and pay off the note. Even without the crazy appreciation from 2001 to 2006, the house would be worth significantly more after 17.5 years.

    The reality, though, is that many people bought in 2005 or so. They paid $300K for a house and got 100% financing. They got an ARM. They had to lie (i.e., do a stated income loan) to qualify for the teaser rate. They assumed by the time the loan reset in 2007 the house would be worth $350K and they could refi into another loan.

    Instead, the house is now worth $250K. Their loan balance was $294,000 when they stopped paying after two years. Now its up over $310K with the missed payments, late charges, and legal fees. A short sale would come into play because they owe much more than its worth. If they sold it themselves, they might net $230K on the sale. That means they need to bring $80K to the closing table.

    In both the examples, when someone goes into foreclosure, its unlikely the house is going to be in move in condition. If you can't make you're payments, you're probably not going to be taking care of the place. I'm sure there are exceptions, but in many cases, when a property is in foreclosure, it needs work to get it into a salable condition. Plus, commissions and closing costs can take 8% (or more these days with seller concessions.) If the area has many houses for sale, only the very best ones, either best condition or best bargains, will sell. So, even a house that would be worth $300K in top-notch condition will likely net the seller only $250-260K if it needs some minor work. It takes 11 years to pay a 30 year, 100% note from $300K down to $250K.

    If you watch the MLS, you will see a lot of listings that say "short sale" or "short sale approved." These are ones where the owner is trying to sell themselves.

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  • William MacBride
    OP
    Handyman · NY · Member since 2008 · 47 posts · 2 votes
    18y

    Thanks a lot for the reply. I see the situation - it's probably pretty common to have that happen. somebody only has paid off a little of the mortgage.
    While we're on the subject, I can think of a few alternate outcomes that might occur, might as well explore them, basic as they might seem
    1. lets say we've got that same situation, somebody owes close to the full amount on a mortgage on a 300k house. let's say they owe 275k still. Investor comes in and pays the lender 25k and assumes the rest of the mortgage. Now he's got plenty of time. He makes 10 grand in repairs in a month. So now he's put only 35k into the house. He finds a buyer who'll pay FMV - 300k. He sells it, pays the mortgage off, and walks away with 15 grand.
    I just want to know if that situation is fairly common, or if you have any comments on it. Probably it would be hard to find a buyer (rather than an investor looking for a "wholesale" property) who would be able to come up with the full 300k up front.

    I'll posit some more hypothetical situations in subsequent posts.

    Thanks again,

    Will

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  • Frank Adams
    Loveland, CO · Member since 2008 · 1k+ posts · 123 votes
    18y

    I didn't realize we had two threads going on this, nice to see that john agreed with me.

    In the alternate situation you described no investor in his right mind is going to give $25K. The loan balance is $275 and FMV is $300. $10 in repairs puts him over $300K. You've ignored holding costs, which on a $300K ppty could easily be $800-$1K/month. On a FSBO you'll still have marketing costs, just not a realtor commission and the selling costs (title, legals, etc) probably average 2%.

    This is why we recommend you pay no more than FMV X .70 - repairs. Even with no repairs the most you'd pay for the ppty you describe is about $210K.

    all cash

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