Up to now, the Obama administration has had a pretty clear goal of doing whatever it could to keep struggling homeowners in their houses. Today, however, the New York Times reports that a new Treasury program will seek to do the opposite: it would encourage underwater borrowers to leave their homes more quickly. Is the Obama administration changing course?
The new proposal relies on short sales. That's where there's a buyer willing to buy a house with an underwater mortgage -- but for less than the borrower's outstanding balance. As you can probably imagine, most of the struggling homeowners can't afford to make up that difference, so the bank generally has to agree to stomach some or all of the loss.
Short sale is often a sensible option for the bank. If the borrower were to foreclose anyway, then additional legal and administrative costs would be incurred. The bank would have to put the home on auction and eventually sell it. If the short sale offer is in the ballpark of what the bank believes it would get at the auction anyway, then it might as well consent. In such cases, the bank is better off short selling than foreclosing.
The Treasury wants to encourage banks to do more of this. Here's how the program would work, according to the Times:
To bring the various parties to the table -- the homeowner, the lender that services the loan, the investor that owns the loan, the bank that owns the second mortgage on the property -- the government intends to spread its cash around.
Under the new program, the servicing bank, as with all modifications, will get $1,000. Another $1,000 can go toward a second loan, if there is one. And for the first time the government would give money to the distressed homeowners themselves. They will get $1,500 in "relocation assistance."
Frankly, $1,000 probably isn't enough in most situations for a bank holding a first mortgage to agree to short sale if it wasn't willing to before. That's sort of like if a potential buyer had offered $140,000 for a home with a $200,000 outstanding mortgage, now she would effectively offer the bank $141,000 instead. Sure, that's more, but if the bank wasn't comfortable selling the home before, I'm pretty unconvinced that another measly $1,000 is going to do much. At best, this could help in the cases where short sale is on the border line.
But the government's real target might not be the first mortgage holder, but whoever owns the second. The incentive for this subordinate party is an interesting idea. In cases where a second loan exists, this party needs to consent to short sale too, since it holds a second lien on the property in question. This could help. Many of those second mortgages will be total losses: if an underwater homeowner can't pay his first mortgage, he certainly can't pay the second. Moreover, foreclosure will generally wipe out the second mortgage altogether. Many of those second mortgage holders may jump at the chance to get even just $1,000 -- it's better than nothing.
From the borrowers' perspective, I'm completely unclear why they need any carrot at all. Usually, short sale is a pretty great deal for them: they don't have to go through foreclosure. If they're going to lose the home anyway, short sale is usually the most attractive option at their disposal. Honestly, this $1,500 feels like more of a transfer payment from the sympathetic federal government. It may make homeowners more willing to consider short sale more quickly, but most of them probably would have ultimately done so anyway.
In fact, I worry a little about this encouraging short sale for those who don't need to foreclose. Some friends of a friend living in Florida recently completed a short sale on their home because they were annoyed their home was so underwater; they could have continued paying their mortgage if they had chosen to. They decided to short sell and rent a nicer place for less than their mortgage payment. Should people like this really get an additional $1,500 incentive?
Right now, short sale isn't incredibly uncommon, but it happens much less often than foreclosure. If this program works as anticipated, it would shift that proportion. The only major consequence that I see on the real estate market here is that housing inventory might turn over a little more quickly. All of these homes that would have eventually gone through foreclosure and auction will be purchased a little bit sooner. That would be a good outcome, as it would help the housing market to hit the bottom more quickly. But I'm a little surprised that the Treasury is now putting speed to the bottom ahead of keeping people in their homes. That's definitely a change in direction from what I understood to be its philosophy.
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