The current Bellingham/Whatcom County housing climate has created crisis for some homeowners and opportunity for some home buyers. As in any time of instability, there is the potential for risk on both sides. The first step to managing risk is to know the terms; the second step is to have some knowledge of the process; the third step is to have some knowledge of the potential pitfalls.
Short sale and foreclosure are terms we are hearing a lot recently in discussions of the Bellingham and Whatcom County real estate market, and many people use them incorrectly, which gets everybody mixed up. Let’s try to make some sense of all this…but to do that we need to add a few additional terms. We’ll talk about equity, default, distressed properties, bank-owned, REO and foreclosed. Don’t worry, it really isn’t all that hard once you know the vocabulary.
Let’s start by defining the basic terms:
- Equity – The amount left over after you sell your house and pay off all the liens (think mortgage, taxes, etc) and costs of sale (think real estate commission, repairs to sell, Washington State and Whatcom County excise taxes, title insurance for the buyer, escrow or attorney fees, etc). Many sellers forget about the costs of sale 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” equity – you don’t know how much you really have until the check is in the bank.
- Short Sale – A sale in which there is negative equity. In other words, the sale price does not cover all the liens and costs of sale, 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, (s)he may 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 the seller is or is not current on the loan payments has nothing to do with whether a sale is “short”.
- Default – A borrower (property owner) is in default when they have violated the terms under which they agreed to pay back their loan. Typically, this means they are at least 30 days past due on a payment. At this point they will most likely get a call from their lender or a written Notice of Default. It is very foolish to ignore these. Note: a seller in default can have a huge potential equity or none at all.
- Distressed Property – An owner’s primary residence which is in the foreclosure process or in danger of foreclosure because the owner 1) has defaulted on the mortgage; 2) is at least 30 days delinquent on the mortgage; 3) believes that they are likely to default on the mortgage within 4 months or 4) at risk of loss due to nonpayment of taxes. This is fully defined under RCW 61.34 and holds pitfalls and additional responsibilities for buyers who offer to help a seller avoid foreclosure. This is a Washington State consumer protection law and penalties are steep.
- Foreclosure – The process between the Notice of Default and the auction on the steps of the courthouse. After default, fees & penalties are assessed and the interest rate jumps to the “default rate” as specified in the promissory note that the seller signed when they borrowed the money. During the early part of this process the seller can “bring the loan current” by making all past due payments plus extra interest, penalties, etc. The time comes, however, when a seller’s only option is to pay off the amount owed (which at that point has grown substantially due to the extra fees). This can be done by refinancing the loan (but by this time they probably can’t qualify) or selling the house. The seller does not need permission from the lender to sell, so long as there is sufficient equity to pay all liens and costs. Remember, a seller can be in the foreclosure process but still have equity in the house.
- Foreclosure Sale – The final step in the foreclosure process, when the house is put up for auction on the steps of the courthouse and is purchased, usually by the lender, but potentially by anyone. The details of foreclosure sales are an article in themselves (there a number of books available on the subject), so we won’t go into them here. Suffice it to say that when it is over, the borrower no longer owns the house and has a period of time to vacate.
- Bank Owned, REO (real-estate owned), Foreclosed – These 3 terms all mean the same thing: the foreclosure process is over and the bank (or whoever bought it at the auction) owns the house.
As you can probably tell by now, the primary confusion arises because people often refer to a home at any point in this process as “a foreclosure”. What we have just seen is that the conditions which govern what can happen to that home at various times in the process are very different, which means that the impacts on a homeowner and a buyer are very different.
Let’s Look First at the Homeowner
The steps and time frames through the foreclosure process are defined by Washington State law, with a typical time frame between default and foreclosure sale of around 6 months. It is to a homeowner’s advantage to renegotiate their loan or sell the house rather than have the bank foreclose, and they have a considerable amount of time to explore their options. For the purposes of this article, suffice it to say that getting into any of the positions described above has a negative impact on a homeowner’s credit score, but the earlier in the above list that one acts, the less the impact on both credit score and overall financial situation. The absolute worst thing a homeowner can do is to pretend that they don’t have a problem. The absolute best is to take action when they think they see a problem coming.
Homeowners sometimes have the attitude that they are going to lose the house and will never be able to buy another one anyway, so what difference does it make if their credit score is bad? Tragically, they are failing to think about how many aspects of their lives are influenced 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 one’s home, or being forced to sell it is a tragedy, but a homeowner does have some control over the amount of the damage. Particularly in recent weeks, the possibility has increased that a bank will work with a borrower who is in trouble. The key is to contact them early.
How Does All this Affect a Buyer?
The impact on a buyer depends on what point in the process (s)he enters the picture. Note that the scenarios described below make the assumption that the terms of an agreement include those in forms provided by the Northwest Multiple Listing Service.
In a short sale situation, whether prior to the seller going into default or after, the buyer will be negotiating with the homeowner. However, the homeowner will be able to perform only if the lender agrees to the terms of the sale, meaning any agreement will be conditioned upon the lender’s approval. This means there could be as much as a 4 month wait between agreement between buyer and seller and confirmation from the lender. This means that often a buyer must spend money on inspections and loan fees without knowing that they will be able to buy the house or what the ultimate interest rate will be on their loan.
If a house is in default and is therefore in the foreclosure process, but the seller has equity at the purchase price, there is no impact on the buyer. All liens will be paid from the seller’s proceeds at closing and clear title will transfer to the buyer. The one 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 seller’s interests above their own. It is critical that they talk with an attorney prior to entering into such an agreement.
If a house has been foreclosed upon, the lender (or other person who bought it at the foreclosure sale) is the owner. There are a couple of oddities in buying a foreclosed home:
- Typically, a foreclosed home being sold by someone other than the lender is not eligible for a conventional loan within 90 days of the foreclosure sale.
- Lender owners often have special addenda which they require to be included in any purchase and sale agreement.
- Owners of foreclosed properties are required to provide the Washington State mandated disclosure form.
- The deed given by a lender will not usually be a Warranty Deed, but title insurance will be provided for a buyer.
For the most part there is little impact on the buyer.
Hopefully we have given you a better understanding of the terms, the process and the potential pitfalls involved in buying and selling Bellingham & Whatcom County properties impacted by current problems in the credit markets. If you have more specific questions or need additional resources, don’t hesitate to contact us at www.JohnsonTeamRealEstate.com for help.
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 can reach Gary at 360-224-1492 or email@example.com.