We’ve seen a dramatic drop off in short sale activity over the past year, and the decline continued in the first quarter, with short sales falling from 84,860 in Q1 of 2013 to 33,900 in Q1 of 2014, according to HOPE NOW.
There’s a lot of speculation about the reasons for this huge drop. An article in National Mortgage News suggests that a primary reason is the expiration of a law that eliminates federal tax on debt forgiven in a short sale. Typically, the IRS treats debt forgiveness as “ordinary income,” which means that a borrower is liable for taxes due on the amount of debt forgiven. This could easily add up to tens of thousands of dollars in taxes, something most distressed borrowers probably aren’t in a position to handle.
I believe that the expiration of the tax exemption is a factor, but it’s not the only reason we’re seeing short sales fall off. There are three other fairly significant factors contributing to fewer short sales.
First, rising home prices. Zillow recently reported that underwater borrowers represent 18.8% of the market today, down from a peak of 34% a few years ago. Logically, fewer underwater loans means fewer short sales. It probably also means that fewer borrowers are looking to exit properties, since they can see a path towards neutral or even positive equity.
Rising prices also make it more likely for lenders to sell properties at foreclosure auctions (the one type of distressed property sale we can probably expect to increase over the next couple of years), and to repossess and sell properties as REO homes. There’s much less difference today in the discounts between REO sales and short sales today than there was even a year ago.
Second, there’s the end of the National Mortgage Settlement. All of the large servicers subject to this agreement have fulfilled their financial obligations for principal balance reduction. Much of this obligation was fulfilled via short sales, as opposed to outright debt forgiveness on existing loans. But now that the $25 billion requirement has been met by the servicers, there’s less incentive to execute short sales.
Finally, we’re seeing more loan modifications. According to HOPE NOW, there were more than 144,000 loan mods in the first quarter of 2014. Improving market conditions make successful modifications more likely in the long run—and generally, most lenders and borrowers would probably prefer to go this route.
Prior to the foreclosure crisis, short sales occurred very rarely, and certainly weren’t an often-discussed part of the real estate market. As the crisis expanded, short sales became a better alternative to foreclosures for underwater borrowers, mortgage servicers and lenders alike. But as the market gradually heals, it’s likely that we’ll continue to see the number of short sales decline, until they eventually settle back into more normal levels by 2017.
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This post was originally posted by Rick Sharga on Auction.com. Rick Sharga joined Auction.com in 2013 as Executive Vice President. He has over 30 years of experience in real estate, mortgage and technology marketing. Most recently, he was Executive Vice President at Carrington Mortgage Holdings, a privately held company that owns and operates multiple businesses covering virtually every aspect of residential real estate transactions. One of the country’s most frequently-quoted sources on real estate, mortgage and foreclosure trends, Sharga has appeared on the CBS Evening News, NBC Nightly News, CNN, ABC World News, CNBC, FOX and NPR.