Lenders avoid foreclosure with short sales or restructuring

There is an article in today’s UK edition of the Financial Times. It focused on the bankruptcy filing by New Century, a US based sub-prime mortgage originator. Near the tail end of the article is the following which I will quote here.

The fallout from payment problems on sub-prime mortgages has prompted a flurry of activity across Wall Street to stem the tide of losses.

Bear Stearns, the biggest US underwriter of bonds backed by home loans, yesterday said its EMC Mortgage unit had created a specialist team to travel the country helping restructure loans for distressed borrowers. The scheme is intended to stave off foreclosures, in which lenders on average lose 40 per cent of the money they lent.

Tom Marano, global head of mortgages at Bear Stearns, said investors should ultimately benefit from the scheme. “Proactively avoiding foreclosure can reduce the severity of losses, benefiting both homeowners and bondholders,” he said.

The link to the full article on the FT.com site (UK) is New Century Files for Chapter 11

People talk about short sales. With a short sale a lender is accepting a pay-off for a loan in default where the amount paid is less than the total amount owned to the lender. A net payment to the lender after all closing costs is agreed. If the lender receives the specific amount by the agreed date they will release the borrower from the loan and release the lien on the property. Be very clear that the seller who is also the borrower in default can not make money from the sale of the real estate. The lender or lenders who are agreeing to take less than they are owed will review the closing statement as they want to know the borrower is not putting money in their own pocket when the lender is getting less than they are legally entitled to at closing. If the borrower is able to walk away from the closing with a check then the lender will not agree to the short sale.

The above quote from the FT is talking about an alternative that can be better for the borrower and the lender. EMC Mortgage is working with borrowers to see if they can restructure a loan that is in default assuming the borrower really could keep up with the new payments after a change in the loan terms. EMC Mortgage is willing to take less now and maybe less in the future so that the loan stays out of foreclosure.

In both the short sale and in a restructuring the lender is being pragmatic. They know that there is a cost to a full blown foreclosure. They are in the business to make money. Money later vs. a loss now is certainly something they will consider.

There are limits to what a lender can do to restructure a loan or when agreeing a short sale. If the loan was resold into a Mortgage Backed Security (MBS) bond offering the possible options might be very limited given the MBS contract terms and conditions. As a borrower or an investor you need to ask to find out. Also expect that loss mitigation departments are not always a shining example for prompt customer service and speedy responses. Polite persistence helps.

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3 Responses to “Lenders avoid foreclosure with short sales or restructuring”

  1. Beach_babe9711 Says:

    I had a question, on what you think is the best choice, for someone out of highschool. And thanks for the short sales information.

    If you had 100,000$ what would you do to make the most money with it?

    buy tax liens and make 16-24% each year?

    money down on a rental (single family) and keep the cash-flow, then refinance later?

    buy a pre foreclosure or bank REO with a lot of equity and sell it real fast, using the 100,000 for monthly payments and to make repairs?

    money down on a 4 unit multi family, and have the first 2 or 3 units pay the mortgage, and the other 1 or 2 units make your cashflow?

    put it all in a roth IRA?

    or

    money down on a business, and work for a few years, then just own it, and not work full time?

    There is no perfect answer. There are two variables that really make a difference and indicate the right direction.

    To grow the money assumes some level of risk. If there was zero risk then the return will be no more than what a US Treasury pays as that is the zero risk benchmark investing in the US. UK Gilts in the UK.

    Assuming that some level of risk is reasonable as you want to grow the funds then you need to look at the velocity. If you can invest the $100K, do a project, exit in 30 days and then repeat you can turn over the investment capital 12x maximum in a year. Similar to a retail operation. If the margins are fixed but you can increase the turnover then you can recycle and grow the initial capital.

    Using the suggested examples buying a property, fixing it up and then selling is an option. Not buying (getting a property under contract), selling the contract can be quicker. You might be able to do more flip deals for a small profit and have less risk while producing greater total growth.

    At some level this is also a trade-off between investing time and more passive forms of investing. The more time intensive the more it is like a J.O.B. If you stop working it the money stops. In the high growth phase expect to invest time.

    Rule #1. Velocity matters if the risk is held constant.

    The second area has to do with domain knowledge and managing your risks.

    If you know more about an area or you are more interested you will be reducing the risks compared to someone who is not as knowledgeable. You can reduce the risks in a specific deal through superior knowledge. Having passion about a specific field will keep you motivated and help you stay on top of your game.

    There are may things that one can invest in. There is only so much time in the day to check out all the options. Most investment sectors require specific knowledge if you want above average returns. If you only want average you likely can hire someone else to manage the money.

    Rule #2. Risk and knowledge are closely related. Use knowledge to reduce total risk.

    Conclusion?

    If you are prepared to invest time and energy then investments where you can turn over the capital multiple times in a year is a winning strategy. That could mean buying and selling. Or it could mean buying at a deep discount (cash price) and then shortly afterwards using debt to get your working capital back. Your investment capital is fixed so you need to keep it available to do the next deal. Finding a way to pull out what you invest while keeping the risk down is the key.

    Curve ball: Investments in marketing can have the highest leverage. Marketing can produce high volume deal flow which can produce large results.

  2. Beach_babe9711 Says:

    And another question. when you buy a primary house that you occupy, the interest rate is lower than if you buy a rental property. BUT if you buy a property as your primary residence, after 6 months, you can move out and rent it. so by law you need to live in it at least 6 months before it can legally be a rental. would you recommend just buy a rental property with the higher interest? or buy a property for the intentions of an investment/rental, but live in it for 6 months to take advantage of the lower interest rate and advantage of no money down( if its a primary) then rent it after the 6 months? I’m not sure if the lower interest would be that helpful.

    I was going to live in it 6 months as a primary residence so i can get a lower interest rate and not have to put money down, then after 6 months, rent it.

    Two things.

    1. There is no law for how long you have to live in a property you purchased with an owner-occupant loan. The loan application is more about intent and purpose. That said, do not lie. The reduced interest rate for OO is not worth the legal complications. Mortgage fraud is a criminal act and can include jail time if someone is found guilty of the crime.

    2. The difference in the interest rate should not materially matter to the deal. If the deal is not a good deal a slightly better interest rate will not help enough. Better to find a good deal in the first place.

    Finally, I noticed you reference to minimizing the down payment. Using a loan where you can maximize the leverage (little to no down payment) is not always wise. You have to look at the cash flow. If the property will not support itself then a larger down payment might be a better idea. Even a 5% down payment will generally improve the loan terms by a large amount compared to a zero down loan.

    Alternatively you can set aside the cash you were going to use as a down payment and use that cash to feel the alligator (negative cash flow property) each month. If you wanted to put $10K down and instead you put $10K into a savings account you can afford to pay a $100/m negative for 100 months (ignoring the interest earned on the savings). You are speculating that in the future the rents will rise and/or that the value of the property will go up.

    When considering a deal with a negative cash flow you have to ask yourself if you are just being lazy or are there really no better deals out there? The problem with an alligator is they can eat you alive. You will get a negative reminder each month that your investment is costing you money that you have to go to work to earn. If things get tight you might be forced to sell when the market timing is not right. When a property supports itself then you feel little pressure to sell.

  3. Clark Jester Says:

    J Corey is on point again.

    “In both the short sale and in a restructuring the lender is being pragmatic.” Great Quote.

    Cheers,

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