In Depth Analysis: CalculatedRisk Newsletter on Real Estate (Ad Free) Read it here.

Friday, August 24, 2007

Short Sales and Short Arms

by Tanta on 8/24/2007 09:21:00 AM

The Boston Globe has a story out on short sales. There is the requisite anecdote about some borrowers in trouble. The soylent details:

Jeffrey Finch spelled out the problem in a hand-written letter: He'd lost his job as a minister, and his wife's take-home pay as a teacher, $3,100 a month, did not cover their $3,300 mortgage payments. . . .

Lenders "are not in the business of owning real estate," said Fran Yerardi, president of Bay State HomeVestors in Newton, who negotiated the short sale on the Finch's behalf. HomEq and investors who held their mortgages forgave $168,500 of the couple's $440,000 total debt, allowing HomeVestors to buy their house for $271,500, renovate it, and resell it for a profit. . . .

In the case of the Finches in Jamaica Plain, it took Bay State HomeVestors three months to negotiate the discount purchase. Bay State is a franchise of a Dallas company, HomeVestors, whose stock-in-trade is buying houses in poor shape, fixing them up, and reselling them. Its yellow billboards that state, "We Buy Ugly Houses," dot the Boston area. Profits on individual deals can be anywhere from $10,000 up to, in rare cases, $100,000.

In anticipation of a declining market, Yerardi opened HomeVestors' first New England franchise last year and has about 30 short sales in progress. Franchises are now in Braintree, Worcester, Connecticut, and Rhode Island, he said. The entire company has submitted more than 200 short-sale plans to lenders this year, he said. "Two years ago, you never heard of short sales."

The Finches' undoing was a subprime refinancing with WMC Mortgage, which they used last August to take $10,000 out of their home equity for renovations. Two WMC subprime mortgages were used to refinance a 30-year fixed mortgage obtained in 2005 to buy the house from Denise Finch's mother. Their payments immediately jumped $900.

While Denise Finch lost the house in which she grew up, the couple bought a newer one -- from HomeVestors -- for $152,000 in Charlotte, N.C., where both have family.

That’s all the information about the Finches that you get in this article.

The current total loan amount is $440,000, but apparently $10,000 was cash taken out in August of 2006. So we’ll assume they borrowed $430,000 in 2005 for an in-family (non-arm’s-length) transaction, buying Denise’s mother’s home for at least $430,000. If this was the home Denise grew up in, it wasn’t built in ’05. It’s possibly not surprising you’d need a $10,000 renovation loan. We aren’t told how much, if any, Denise’s mother owed on it.

If the payment on the total $440,000 is $3,300, they were paying an effective blended rate of about 8.25% on the total refinanced loan balance, assuming amortization, or 9.0% on an IO. We are told that the $3,300 payment is $900 more than the old payment on $430,000. That would imply that the old loan carried a payment of $2,400, which implies an interest rate of 5.50% on the old loan, if it was an amortizing fixed, or 6.625% if it was IO. (I’m ignoring T&I for the moment.) Damned good deal on that $10,000, huh?

If they got a 100% subprime loan to buy the new house in NC, we’ll guess they might be paying 10% on it. That would be a new house payment of $1,333.91, or 43% of their last verified income of $3,100. You can add taxes and insurance if you want to. You can assume that the new loan isn’t “subprime,” even though the borrowers now have prior mortgage delinquencies/short sale on their credit report, and you can assume they had some money for a down payment, if you want to. Hey! Maybe mom gave them some money out of the “capital gains” cookie jar! Maybe a down payment came from a builder or this HomeVestor outfit. Beats me. The problem with non-arm’s-length transactions is not just finding the “skin,” it’s figuring out what the game is.

You can assume that in the current environment such a loan would be offered at a much lower rate than 10%, if you feel like it. I think you can guarantee that the new loan involved “stated income” of the sort that involves how they need not just schoolteachers but more ministers in NC than in MA and so they pay them at least as much and so “replacement income” is virtually guaranteed you see. Or, possibly, those family members in NC are supplying “stable monthly income.” Whatever.

So one non-arm’s-length deal got replaced with a new non-arm’s-length deal. Denise’s mom and HomeVestors appear to have made profits. WMC took a nasty write-off. The Finches are on their way to being subprime borrowers for the rest of their days. I’m pretty sure they’ll get a 1099 for the taxes on $168,500, and given their track record I wouldn’t be shocked to find them going to a payday lender to borrow it. Quite the work-out, I’d say.

Please note, you workout-haters, that I am not suggesting that WMC should have modified this loan somehow, at least not based on the facts we are presented with. I merely want to suggest that I have my reasons, at times, for thinking that short sales are not these pristine rational free-market “rapid clearing” devices some folks would like to think they are. I am also, of course, hinting to a reporter (again) that it sometimes helps to try to “work out” the numbers you are given before you report on them. They might suggest a slightly different story.

In any case, I will leave you all to ponder the due diligence you would require of a servicer if you were the noteholder and you were being asked to accept a short sale. What would you want to know about the bid or bids submitted?