As in any time of instability, there is the potential for risk on both sides. The first step in managing risk is knowing the terms; the second step is to have some knowledge of the process; the third step is to have some knowledge of potential pitfalls.
Short sale and foreclosure are terms we hear a lot recently in discussions of the Bellingham County real estate market and Whatcom, and are used incorrectly by many people, confusing everyone. Let’s try to make some sense of all this… but to do so we need to add some additional terms. We will discuss equity, default, distressed properties, bank owned, REO and foreclosed. Don’t worry, it really isn’t that hard once you know the vocabulary.
Let’s start by defining the basic terms:
o Equity – The amount remaining after you sell your home and pay all liens (think mortgage, taxes, etc.) and costs of sale (think real estate commission, repairs to sell, state excise taxes of Washington and Whatcom County, title insurance). for the buyer, escrow or attorney fees, etc.). Many sellers forget selling costs when calculating their potential equity, which is why you should always get a “net sheet” from your real estate agent. Note: An appraisal, a listing price, an estimate of value allow you to calculate only “potential” capital: you don’t know how much you actually have until the check is in the bank.
o Short Sale – A sale in which there is negative equity. In other words, the sales price doesn’t cover all of the liens and selling costs, so the seller must bring money to the table to close. If the seller can’t or won’t add money to close the transaction, they can ask the lender to take less than is owed. The seller cannot sell under this circumstance unless the lender agrees, because the seller cannot provide clear title to the buyer. Note: Whether or not the seller is current on the loan payments has nothing to do with whether a sale is “short.”
o Default – A borrower (homeowner) is in default when they have violated the terms under which they agreed to repay their loan. Usually, this means they are at least 30 days late on a payment. At this point, they will most likely receive a call from their lender or a written Notice of Default. It is very foolish to ignore this. Note: A seller in default may have enormous potential capital or none at all.
o Distressed Property – The primary residence of a homeowner who is in foreclosure or in danger of foreclosure because the homeowner 1) has defaulted on the mortgage; 2) is at least 30 days past due on the mortgage; 3) they believe they are not likely to pay the mortgage within 4 months or 4) they are at risk of losing due to non-payment of taxes. This is fully defined in RCW 61.34 and introduces additional pitfalls and liabilities for buyers who offer to help a seller avoid foreclosure. This is a Washington state consumer protection law and the penalties are steep.
o Foreclosure – The process between the Notice of Default and the auction on the courthouse steps. After default, fees and penalties are assessed and the interest rate jumps to the “default rate” as specified in the promissory note the seller signed when he borrowed the money. During the first part of this process, the seller may “refresh the loan” by making all late payments plus additional interest, penalties, etc. However, there comes a time when the seller’s only option is to pay the amount due (which by that time has grown substantially due to additional fees). This can be done by refinancing the loan (but they probably won’t qualify right now) or by selling the house. The seller does not need the lender’s permission to sell, as long as there is enough capital to pay all liens and fees. Remember, a seller may be in foreclosure but still have equity in the home.
o Foreclosure Sale – The final step in the foreclosure process, when the home is put up for auction on the courthouse steps and purchased, usually by the lender, but potentially by anyone. The details of foreclosure sales are an article in themselves (there are several books available on the subject), so we won’t go into them here. Suffice it to say that when it ends, the borrower no longer owns the home and has a period of time to vacate.
o Bank Owned, REO (real estate owned), Foreclosed: These 3 terms mean the same thing: the foreclosure process is over and the bank (or whoever bought it at auction) owns the home.
As you probably already know, the main confusion arises because people often refer to a house at any point in this process as “a foreclosure.” What we have just seen is that the conditions that govern what can happen to that house at various points in the process are very different, which means that the impacts on an owner and a buyer are very different.
Let’s look at the homeowner first
The steps and timelines of the foreclosure process are defined by Washington state law, with a typical time frame between default and foreclosure being around 6 months. It is to the owner’s advantage to renegotiate his loan or sell the house rather than have the bank foreclose, and he has a considerable amount of time to explore his options. For the purposes of this article, suffice it to say that entering any of the positions described above has a negative impact on a homeowner’s credit score, but the sooner the above list is acted upon, the less impact both the credit score as in the general financial situation. The worst thing a landlord can do is pretend that he doesn’t have a problem. It is best to act when they think they see a problem coming.
Homeowners sometimes have the attitude that they are going to lose the house and can never buy another one anyway, so what difference does it make if your credit score is bad? Tragically, they don’t realize how many aspects of their lives are affected by their credit score, from renting an apartment to the amount of utility deposit required to the amount they pay for insurance, not to mention what happens when they need to buy . a new car.
Losing the house or being forced to sell it is a tragedy, but the owner has some control over the amount of damages. Particularly in recent weeks, the possibility of a bank working with a borrower who is in trouble has increased. The key is to contact them early.
How does all this affect a buyer?
The impact on a buyer depends on where in the process it enters the picture. Please note that the scenarios described below assume that the terms of an agreement include those in the forms provided by the Northwest Multiple Listing Service.
In a short sale situation, either before the seller defaults or after, the buyer will negotiate with the owner. However, the homeowner will be able to comply only if the lender agrees to the terms of the sale, meaning any agreement will be conditional on the lender’s approval. This means that there could be a wait of up to 4 months between the agreement between the buyer and the seller and the lender’s confirmation. This means that often a buyer must spend money on inspections and loan fees without knowing that he will be able to buy the house or what the final interest rate on his loan will be.
If a home is in default and therefore in foreclosure, but the seller has equity at the purchase price, there is no impact to the buyer. All bonds will be paid for from the seller’s proceeds at closing and clear title will pass to the buyer. The only exception to this is if the closing date falls within 20 days of a scheduled foreclosure sale. In that case, in the State of Washington, the buyer has a legal responsibility to consider the interests of the seller above their own. It is essential that you speak with an attorney before entering into such an agreement.
If a home has been foreclosed on, the lender (or someone else who bought it at the foreclosure sale) is the owner. There are a couple of oddities in buying a foreclosed home:
o Generally, a foreclosed home that is sold by someone other than the lender is not eligible for a conventional loan within 90 days of the foreclosure sale.
o Lenders’ owners often have special addenda that they require to be included in any purchase and sale agreement.
o Owners of foreclosed properties must provide the Washington state required disclosure form.
o The deed granted by a lender will generally not be a Security Deed, but title insurance will be provided for the buyer.
For the most part, there is little impact on the buyer.
Summary
We hope we have given you a better understanding of the terms, process, and potential pitfalls involved in buying and selling property in Bellingham and Whatcom counties affected by the current troubles in the credit markets. If you have more specific questions or need additional resources, please feel free to contact us at JohnsonTeamRealEstate.com for assistance.
Thanks to Gary Tice of Fairhaven Mortgage for reviewing this information for accuracy. Any errors, of course, are ours. If you would like to discuss financing or refinancing options, you may contact Gary at 360-224-1492 or [email protected]