Buying a Short Sale? Find Out What's on Second

February 18th, 2010

“Who’s on First?” is one of the greatest comedy routines of all time. Performed by the famed duo Abbott and Costello, the routine sets out to inform Bud Abbott the names of the players on the St. Louis baseball team, starting with Whose on first and Whats on second.

While it is no joke to be involved in a short-sale transaction, it is very important to anyone thinking of making an offer on a short sale to know what’s on second: namely, if the seller has a second mortgage on the property. Knowing before writing an offer if there is a second mortgage, what the outstanding balance of the mortgage is, and how the balance calculates into the overall math of the transaction for the seller is critical to whether or not to write your offer.

Many Short Sales Today Involve Second Mortgages

At a recent conference for the American Securities Forum, Laura Goodman of the Amherst Securities Group gave a report on the second mortgage market. Over 50% of the properties with first mortgages also have a second mortgage on the property. The outstanding balances on second mortgages, including home equity lines of credit, is over $1 trillion. Many of the second mortgages that are outstanding are on properties that are underwater. In turn, many of those properties are on the market as short sales.

How Home Equity Loans Affect Short Sales

Second mortgage holders are able to stand in the way of loan modifications and successful short sales. A homeowner may be able to negotiate with their primary mortgage holder to reduce loan principal and allow a short sale, but unless the second mortgage holder agrees to the terms, the sale is off. Many second lien holders are holding out for greater payoff amounts, using the potential foreclosure losses to the first lien holder as leverage.

Here’s an example: John owes $250,000 on a primary mortgage and $35,000 on a second mortgage. He has an offer at the home’s value for $235,000. Assuming the costs of sale are 8% of the sales price, or about $18,000, there is $217,000 left for the mortgages to be paid off. If there were just a first mortgage, the bank could take the offer and the $33,000 loss. But for the short sale to go through, the second lien holder must now also sign off. Knowing they are risking getting no money if the home goes to foreclosure, the second holder also calculates what the primary mortgage holder would net should the home go through the foreclosure process.

After lost interest, back taxes, legal fees, and costs of holding and selling the property, the first mortgage holder may net through foreclosure $180,000 or less. Knowing this math allows the second mortgage holder to approve the short sale only if it is paid some of what the first lien holder will not be losing by avoiding foreclosure.

Sound complicated? It is. And it is also very time consuming. The real estate industry has seen many short sale transactions take months for approval due to negotiation between the first and second lien holders, often between different divisions of the same company. If you are a buyer whose short sale offer is taking months, you are losing opportunity costs–of other properties that come on the market or of potentially higher interest rates– and risk another long negotiation if the appraisal results in more price confusion.

Thinking of purchasing a short sale? Find out What’s on Second before deciding whether or not to make your offer.

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