Editor’s note: With the collapse of the subprime lending market leading to tightened credit, many are wondering what happens to the millions of loans that are expected to default or more importantly, what happens to the homes and the people who bought them. In this four-part series, Inman News looks at what the lending industry is doing to help people get out of loans or get back on their feet and how some real estate agents are making this their specialty. We’ll go in-depth on short sales, REOs and forbearance programs.

Editor’s note: With the collapse of the subprime lending market leading to tightened credit, many are wondering what happens to the millions of loans that are expected to default or more importantly, what happens to the homes and the people who bought them. In this four-part series, Inman News looks at what the lending industry is doing to help people get out of loans or get back on their feet and how some real estate agents are making this their specialty. We’ll go in-depth on short sales, REOs and forbearance programs. (Read Part 1, Part 3 and Part 4.)

If 2006 was a slow year because fence sitters were waiting for sellers to lower their asking prices, the fallout from the subprime lending crisis could make this year equally problematic.

Even as prices in overheated markets come down from the stratosphere, bargain-hunting buyers may not be able to take advantage of them because lenders are tightening their underwriting standards

Analysts at Banc of America Securities LLC predict a credit crunch could push demand for homes down 15 percent this year. While the National Association of Realtors is less pessimistic — credit issues may dent home sales by about 3 percent for two years, the group forecasts — there’s little talk of an immediate turnaround.

But the problems in subprime lending are providing new opportunities for some real estate professionals.

Millions of homeowners who purchased property using adjustable-rate loans are facing higher monthly payments as their interest rates reset. If they’re able, some will bite the bullet and make the higher payments. Others who want to stay in their homes will try to refinance or work out new loan terms (see Part 1).

But thanks to the slowdown or reversal in home-price appreciation, many who put little or no money down on their purchases may owe more than their homes are worth. For many in such situations, the only way to avoid foreclosure is a short sale.

In a short sale, a lender agrees to let a borrower pay off their mortgage by selling their home for less than the loan balance. Sellers are typically barred from receiving any of the sale proceeds (in some cases they receive a small sum to cover their moving expenses).

In a sense, everybody loses in a short sale. Lenders get less than they are owed, and borrowers often walk away from such deals with blemished credit (a short sale stays on a credit report for seven years, unless a lender agrees not to submit it).

But short sales are often the best solution for all involved. Lenders can avoid the considerable costs involved with foreclosure, and borrowers are relieved of the obligation to pay off the balance of a loan on a home they no longer own.

Whatever their drawbacks or benefits, short sales are expected to keep many agents busy in the current down cycle.

A recent analysis by First American CoreLogic Inc. projects that 13 percent of the 8.37 million adjustable-rate mortgages originated between 2004 and 2006 will default in the next six to seven years — a total of 1.1 million homes. If even a percentage of those homes end up as short sales, they could prove to be a significant source of business for those with the knowledge and desire to cash in.

For many agents who have only experienced the boom half of the boom-and-bust business cycle, short sales are uncharted territory. While some may be able to learn on the fly, entering the world of short sales requires a thorough understanding of a complex process, and connections with lenders. It also helps to have patience with borrowers and an eye for shady operators, say those with experience in the field.

The basic steps involved in conducting a short sale include:

  • Proving that a borrower is experiencing hardship and won’t be able to continue making loan payments

  • Demonstrating that a home is worth less than the loan it secures

  • Finding a qualified buyer

  • Convincing the lender’s loss-mitigation department that it’s in their best interest to approve a short sale

Since borrowers are often in trouble before taking steps to initiate the short-sale process, all of the above steps may have to be executed on a demanding timetable.

Jaclyn Erwin, a Charlotte, N.C.-based Realtor, got started in the real estate business four years ago. In the last year, the former biology and anatomy teacher has developed a specialty in short sales.

When she started getting calls from homeowners facing foreclosure, Erwin did her own research and took a course on short sales. Now that she’s established, she finds her connections with lenders’ loss-mitigation departments opens doors for her.

“A lot of agents just don’t know what to do or how to do it,” Erwin said. “It takes a very special personality. I talk to people in loss mitigation — I get all the way up to the vice president with some companies.”

While some of her short-sale clients got into trouble because they lost their jobs, others are victims of mortgage fraud or did not understand their loan.

“Most of them have ARMs, and … a lot of them tell me they didn’t know (that the rate would go up so much),” Erwin said. It’s common for homeowners facing foreclosure to have worked directly with a listing agent or builder when they bought the property, she said.

Erwin said she also prospects FSBO listings to find clients. In some cases, homeowners may be too embarrassed to reveal that a property is facing foreclosure — even to their agent.

“To them that’s a very emotional thing,” Erwin said. “They’re so scared; they feel like they’re trapped.”

Erwin first talks to distressed borrowers over the phone, obtaining permission to call lenders on their behalf. She also checks to see whether the home’s loan is in a special program such as FHA, which provides for a 90-day extension in getting short-sale approval.

Although foreclosures are on the rise in the Charlotte area — the default rate among homes built and financed by Beazer Homes USA is the subject of a federal investigation — Erwin said she’s able to pull off the average short sale in about 30 days.

“The last one I got an offer on day 12,” she said. “Foreclosures are on the rise, but the market is still very good in Charlotte,” because of an influx of buyers from areas like Florida and Atlanta.

Another way to get into short sales is by working with lenders on sales of real estate-owned, or REO, properties (see Part 4).

In Columbus, Ohio, Rich Kruse works with property owners, lenders and attorneys to sell homes, businesses and goods that have foreclosed on by lenders or placed in receivership by courts.

Kruse said that as of late his firm, Gryphon USA Ltd., has also been doing more short sales. Because of the glut of REO properties in the Columbus market, lenders have begun referring troubled borrowers to him to negotiate a short sale instead of foreclosing on them.

“They (lenders) are saying if we take this property back through REO, we’re going to have Rich sell it anyway, so why don’t we recommend they call Rich as an alternative to foreclosure?” Kruse said.

According to a 2003 Federal Reserve study, lenders stand to lose 30 percent to 60 percent of an outstanding loan balance going through the foreclosure and REO process.

Not only is the foreclosure process itself expensive, but lenders are often reluctant to take possession of a property because they will have to maintain it and may end up paying utility bills and homeowner association fees. The glut of REO properties in some markets means houses may stay on the market for months, and there’s always the risk that a property will be vandalized before it’s sold.

“It’s a huge foreclosure market right now” in North Carolina, Erwin agreed. “There are a lot of foreclosures. I can show you (the lender) why it’s more beneficial for you to take (the short sale).”

Kruse said he’s been working mainly with small community banks, which have an added motivation to avoid foreclosure: their reputations depend on their close ties to their customers.

“They not only have this financial issue, they also have a political issue,” Kruse said. With a community bank, “you run into the bank officer while you’re at the grocery store.”

Kruse said he hopes mid-size and large banks will see the success community banks in the Columbus area are having with short sales, and become more open-minded to that option.

“Right now, some of these big lenders have so many problem loans, and they’re not staffed up to deal with customized solutions for all the borrowers,” Kruse said. “With the big organizations, you have to choose A, B or C — you don’t have the luxury of negotiating some of these other custom solutions.”

Read more about potential roadblocks and common mistakes in short sales in Part 3.

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