mortgage

Twist in short sale rule

Monday, March 15
>Written 7:40 a.m. EDT

SHORT SALE TRAP: New rules governing short sales are going to force borrowers to do something that they might be lousy at: playing hardball with home equity lenders.

A short sale happens when the bank lets you sell the house for less than you owe. Lenders consent to short sales when the only alternative, foreclosure, would be more costly. Lenders are reluctant to approve short sales and they typically take forever to decide whether to accept offers from potential buyers.

The feds are trying to ease and accelerate short sales with an initiative called HAFA -- Home Affordable Foreclosure Alternatives. It goes into effect by April 5.

The HAFA guidelines, published by the Treasury Department, contain a potential problem that hasn't received much attention, so far as I can tell. Maybe that means it's not really much of a problem, or maybe I'm unusually perceptive. Probably the former, but I'll tell you about it anyway.

The troublesome issue has to do with subordinate liens -- in other words, home equity loans and lines of credit. The HAFA rules tell borrowers to negotiate with these lenders and clear up the liens. Troubled, underwater borrowers aren't always equipped for hard-nosed talks with home equity lenders. That's something that the lender of the first-lien mortgage should do.

Under HAFA, the federal government indirectly bribes subordinate lien holders to allow short sales to go through. A home equity lender can throw up roadblocks to impede a short sale, and HAFA seeks to buy off home equity lenders by giving them 3 cents for each dollar that the borrower owes. Of those 3 cents, 1 penny is taxpayer money.

You might think that, from the home equity lender's perspective, 3 cents on the dollar is a pittance. But in many short sales, the home equity lender gets nothing. Three cents on the dollar is better than zero cents. Under HAFA, when the home equity lender accepts its 3 percent payoff, it's supposed to release the lien and promise not to sue the borrower for any of the other 97 percent.

This is where things get puzzling. Treasury is telling home equity lenders (I'm paraphrasing): "Play by our rules and you'll get 3 percent instead of nothing. And one of our rules is that you can't sue the borrower for the difference." On the other hand, Treasury tells borrowers (and this is a quote): "We require each subordinate lien holder to release you from personal liability for the loans in order for the sale to qualify for this program, but we do not take any responsibility for ensuring that the lien holders do not seek to enforce personal liability against you. Therefore, we recommend that you take steps to satisfy yourself that the subordinate lien holders release you from personal liability."

Translation: If home equity lenders want their 3 cents instead of getting nothing, they have to promise not to sue the borrower. But the Treasury Department won't enforce this rule; borrowers have to enforce it. Borrowers who are broke and beleaguered and intimidated by bankers.

Bribing home equity lenders to speed up short sales is a good thing for the housing economy, because it could get us through this foreclosure crisis faster and move people more quickly into homes that are appropriate for their incomes and their stages in life. But requiring the borrower to make sure the home equity lender extinguishes the lien and waives the right to sue for deficiency? That seems a bit much.

FED MEETS THIS WEEK: The Federal Reserve's rate-setting Federal Open Market Committee meets Tuesday. They won't raise interest rates, and they can't cut them further. If there's any drama coming from this meeting, it's regarding what the Fed will say about its liquidity programs, especially the $1.25 trillion mortgage-buying plan. I don't expect any surprises, and the meeting will be a snooze. The Fed prizes predictability right now.

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