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Realities of Real Estate: Foreclosure and Short Sale Update

In many parts of Maryland, the housing market is beginning to heal.

Especially for the perimeter of Washington, D.C., popular benchmarks like the Case-Shiller Home Price Index have shown consistent improvement for some time now. The D.C. area continues to defy the nation as a whole, recording steady price increases since March 2009.

Nevertheless, a robust recovery still remains elusive. The persistently anemic state of the economy, a sour attitude with respect to consumer confidence, and limited visibility down the road has us driving around in first gear, worried about slipping back into the ditch.

Part of what weighs on the housing sector is the concern over foreclosures and short sales. There’s a lot of debate over how many are out there, how many are yet to come and how they will affect overall housing prices as these distressed sales are absorbed.

Before we get into that analysis, let’s first review the differences between a short sale and a foreclosure. With a short sale, the homeowner has been given permission by their mortgage holder(s) to sell the property for less than the outstanding balance on the loan. The difference between the proceeds of the sale, and what’s still owed might be forgiven by the lender, or the homeowner may be required to sign a promissory note for the balance.

On a foreclosure, the homeowner has defaulted on their mortgage obligation, allowing the lender to seize their collateral (the house). There are a number of steps in the foreclosure process, but in the end, ownership passes to the lender and the property becomes what’s known as a REO, or Real Estate Owned.

From the perspective of the bank, a short sale might be preferred, as it eliminates the tremendous expense associated with foreclosure, along with the associated deterioration in property condition that usually accompanies going down the path of foreclosure.

As for the homeowner, a short sale might, or might not be a preferred option. If you go for a short sale, plan on taking a hit of 100 to 160 points on your credit score, and it’ll probably be about two years before you can qualify for another home loan. With a foreclosure, your credit score will sink by 200 points or more, and it’ll be five to seven years before you’ll find yourself buying another house. But some people are willing to suffer the greater degree of damage a foreclosure entails, just to eliminate any further financial obligation connected with the property.

So, how prevalent are foreclosures and short sales, and how are they affecting our local housing market? To a large extent, it all depends on where you live.

In some parts of Maryland, these distressed sales are sporadic enough so as to limit their influence. In other parts of the state, foreclosures and short sales have combined to define the market, seriously impeding any semblance of a housing recovery.

Appraisers will tell you that if there’s a distressed sale or two in your neighborhood, they are viewed as an outlier and consequently not appropriate for use as a valuation comparable. However, there is a point at which the numbers of distressed sales are no longer the exception, rather they become the rule.

Regionally, the most troubled area for short sales and foreclosures is Prince Georges County. During the first six months of 2011, 47.7 percent of all Prince George’s County homes sold through the multiple list system were foreclosures. Another 16.5 percent were short sales, making a total 64.2 percent of the homes sold in that county distressed sales.

And this only reflects the properties listed and sold by real estate brokers. The actual number of foreclosures is probably higher, since some of these properties never make it to the multiple list system and end up getting sold at auction.

By comparison, the foreclosures sold in Anne Arundel County came in at 19.9 percent of total sales, and short sales made up another 8.6 percent, less than half the rate of Prince George’s. In the well-heeled suburbs of Fairfax County, Va., the third wealthiest county in the nation, foreclosures accounted for only 9.6 percent of all sales; short sales were 13.8 percent.

Skip off to the even more exclusive enclave of Falls Church City, Va., and you’ll find that foreclosures and short sales are indeed a rarity. This year they’ve only had two foreclosures and three short sales.

There are many theories about how foreclosures and short sales will affect the housing market over the next several years.

For home buyers and real estate agents, short sales are an especially difficult transaction. Banks are constantly changing procedures, the length of time it takes to get to settlement is considerable (four to six months), and even as you near the finish line, there’s a good chance that the whole sale will go south, when a lender changes their mind about approving the forbearance of principal.

As a result, many properties start out as a short sale, only to end up becoming a foreclosure. If the short sale process was more accommodating, it would likely save the banks money by eliminating the cost of foreclosure, and also help mitigate the deleterious effects of bringing additional foreclosed homes to market.

Albeit in a well-meaning way, government attempts to forestall foreclosure are also gumming up the works. Rather than saving someone from foreclosure, these programs frequently make matters worse and end up only delaying the inevitable. Nationally, it is estimated that 1 million foreclosures that should have taken place in 2011 will now be pushed into 2012.

If the housing market is to truly recover, we need to take our medicine in one big gulp and not sip on it, only to prolong the agony. The sooner foreclosures and short sales flush their way through the system, the quicker reasonable market forces will allow the housing sector to stabilize and resume a more sustainable pattern of growth.

Bob and Donna McWilliams are practicing real estate agents in Maryland with more than 25 years of combined experience. Their email address is McWilliams@BobDonna.com.