Hidden costs in short sales

Q: I'm about $150,000 upside down on my house, and I have been trying to do a short sale. I had a contract to sell it to a buyer who is well-qualified and has been waiting patiently for several months while we awaited approval from my mortgage lender. (I have two mortgages, with two different lenders.)

Anyway, we got an approval on the first mortgage, but on the second mortgage they refused to allow the short sale with anything less than 30 percent of what I owe them. The first mortgage lender refused to sign off on the short sale, though, if the second lender got more than a flat $5,000. This left about $15,000 between the two, and my agent couldn't break the impasse.

I don't understand this -- I'm on the verge of foreclosure, and my second won't get anything if I lose the house, because my negative equity in the place is more than I owe them. What am I missing here? Was there anything we could have done differently?

A: If I had a dollar for every time a thwarted short-sale seller, baffled by the banks' collective refusal to play ball, asked me what they were missing, I'd be a rich woman, not a real estate columnist. Recently, though, a valid (yet unhelpful) answer has emerged.

What we've all been missing is the impact of private mortgage insurance coverage (PMI), which is to offer banks -- especially second mortgage lenders -- an opportunity to recover their total loss if they refuse to allow a short sale and you lose your home.

PMI works to cover a lender in the event their borrower defaults on their loan. However, most of us understood PMI to be a policy that is obtained by first mortgage lenders on loans greater than 80 percent of the borrower's loan-to-value ratio. That just means that we always thought of PMI as something that a lender required only when there was a low- or no-downpayment loan involved.

And we all believed that using two loans to purchase your home, where the second loan stood in for your downpayment (e.g., an 80/20 or 80/10/10 loan scenario) avoided PMI altogether.

In fact, these scenarios govern only whether a borrower is required to pay for his or her own policy of PMI on top of the normal mortgage loan interest and fees. In reality, most (if not all) lenders obtained PMI on their entire portfolios of loans, including even "regular" 80 percent mortgages and on the second mortgages they originated and serviced as home equity lines of credit (HELOC) or downpayment substitute loans.

They didn't charge borrowers for these PMI policies as a separate fee, although I'm certain that the cost of the PMI was factored into the other fees and costs of the loans.

Accordingly, what you're missing is that the second lender is really unmotivated to take a lowball recovery like the $5,000 it would get if it agreed to the short sale on the terms set forth by the first lender, because the second lender might very well be able to recover 100 percent of the loan amount if you lose the home to foreclosure and it files a claim with its private mortgage insurance company. ...CONTINUED

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