Trends in Real Estate: Why Short Sales Eventually became a Viable Option for Military Families
by Karina Gafford
MilitaryByOwner staff writer
To better understand short sales, meaning the sale of a home for an amount less than what is owed on the property, we will look at the fictional example of a typical military family, Servicemember Sally and her husband, Tim. Sally and Tim may or may not have children, dogs, cats, and birds, too, but those details are entirely irrelevant to the rest of our story. For more specific information on short sales, please refer to MilitaryByOwner’s Resources.
Sally and Tim purchased a home at their new duty station for $250,000 at the height of the real estate market in 2007. To complete the transaction, the couple used a VA zero down payment loan to finance the property, earning an interest rate of approximately 6-percent, which was a typical rate for those with decent credit at the time. Since Sally and Tim used the VA loan, they had to roll in a 3-percent VA funding fee of $7,500. They also choose to roll in their closing costs, which amounted to approximately $5,000, bringing their total mortgage amount to $262,500. At the time, the property was worth the purchase price of $250,000, and they anticipated that the property value would continue to rise, which would help both cover the closing costs, funding fee, and eventual broker fees upon resale of the property when they eventually would have to change duty station again.
When interest rates dropped in 2009, the couple chose to refinance at a rate of 4.5-percent, saving them hundreds of dollars on their mortgage each month. Again, the couple chose a zero down payment closing, rolling almost $8,000 in closing costs into their lowered principle of $259,000 (they had been paying down for two years at 6-percent), which brought their new loan total to $267,000. Though the new loan amount was higher than the original balance, the monthly principle and interest payment was lower.
Unfortunately, when Sally received orders in 2011, her property appraiser determined that the value of her home now only amounted to $170,000. The couple would stand to lose approximately $100,000 by selling their home; the lender would expect the $100,000 at closing. Almost one-quarter of all homes on the market in America at the time Sally and Tim planned to sell were underwater, which meant that they owed more on the principle than the entire value of their home, according to research company Core Logic.
Facing this substantial and unaffordable loss, Sally and Tim researched their options, and found the following:
1) Remain in the home and continue to pay the mortgage: This was not an option as Sally had received orders to report to a duty station several states away. She could choose to continue to pay the mortgage, but the couple would not be able to afford to pay for both a mortgage on this property as well as rent at their new assignment. They also did not have sufficient savings to continue to pay for the home for an extended period.
2) Stop paying the mortgage and eventually go into a foreclosure situation: Sally needed to maintain a top secret security clearance, which she could not do if she needed to report a foreclosure on her upcoming background renewal check. Only recently has the military become somewhat more lenient with regard to foreclosures, assuming that servicemembers keep their chain-of-command abreast of the situation and that the foreclosure represents a one-time failure to fulfill a financial obligation as opposed to a trend.
3) Stop paying the mortgage and return the keys to the lender in a deed-in-lieu of foreclosure situation: Just as with the foreclosure situation, Sally would have to report a deed-in-lieu on her security clearance background check. There was simply no way to know what ramifications this may have for her clearance. If she failed her background check, then she would stand to lose her renewal of contract with the military, which was also up in a year and a half. If Sally lost her employment, the couple determined that they definitely could not sustain payments on the property.
4) Try to rent the property to help cover the mortgage: When Sally met with a property manager, the manager informed her that many others had experienced her situation. Since so many foreclosures were available to purchase at prices far cheaper than Sally and Tim’s home, investors had snapped them up and rented them out for significantly less than Sally would be able to afford. The couple’s home would not be competitive in the rental market, and if they chose to rent at a lower rate, they would be responsible for a hefty monthly portion of the principle, causing a strain on their already tight budget. Many military families did choose this option. Since these families lived far away from their properties, having a property manager nearby helped greatly in terms of marketing, leasing, and caring for the property.
5) Appeal to the lender for debt forgiveness in the form of a short sale: Sally and Tim inquired about the possibility of a short sale when they received orders in the summer of 2011; however, the lender would not discuss this option as the couple did not pose a credit risk. They had decent credit, had always made timely payments, and they had a moderate amount of savings sufficient to cover several months of payments if necessary. Further, in order to even qualify for a short sale, the couple would have to show late or missed payments. As Sally did not wish to put her security clearance in jeopardy by risking her good credit score, she determined that they could not take this option.
None of the options worked for Sally and Tim. They moved to their new duty station with their family, now carrying the mortgage of their previous property in addition to the rent payments for their new home. After months of trying to sell the property for closer to the amount they owed, they received no offers. The couple finally chose to rent the property, taking a huge loss each month. When a large repair bill came in, the couple’s savings balance drained. One more repair bill and they faced imminent deep debt and the prospect of requesting personal loans and payday loans at high interest rates.
In 2012, however, the Making Home Affordable program determined that a PCS represented a hardship for military families such as Sally’s who owned homes in their previous duty stations that were worth less than they owed. By this point, military family advocacy organizations and Holly Petraeus, working through the Consumer Financial Protection Bureau, helped gain recognition of the striking discrepancy between civilian and military families in the treatment of short sales. For one, servicemembers must maintain good credit to keep their jobs while civilian families did not. For another, servicemembers could not choose to remain in their homes while civilian families could.
To remedy this discrepancy, servicemembers who owned homes that were underwater could appeal to their lenders for a hardship short sale as a result of a PCS. Further, the military families would not be responsible for the tax on the deficiency on the home. This all meant that if Sally and Tim sold their home as a short sale for $170,000, they would neither owe a penny at closing nor the possibility of tax on the $100,000 deficiency. Assuming the couple fell into the 15-percent tax bracket, they otherwise would have owed $15,000 to the IRS had the Mortgage Forgiveness Debt Relief Act not been in place when they finally sold in 2012. This act, however, is up for renewal in January 2014, as it has been each year since its initiation in 2007.
If your family is facing a situation similar to that of Servicemember Sally and Tim, look for a real estate agent with experience dealing in the sale distressed properties under MilitaryByOwner Business Directory. MBO’s partners have experience working with military families, and will best help you prepare the requisite documents and PCS hardship letter for the lender.