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Why the lender may not OK your short sale?

Most of my time is spent negotiating loan modifications, stopping foreclosures and also negotiating short sales. Today a friend and good colleague of mine in the business (Larry of www.RealOptions1.com) were discussing why a short sale might not get approved or what type of potential problem could come up that most sellers or investors may not think about too often. In the course of our discussion we both agreed that short sale transactions are being approved and closed these days.

But what about the short sale offers presented to lenders that do not get approved. Many of these offers are substantially more than what the lender may see a year from now when they receive a property back in foreclosure. So when a short sale approval does not occur, the question posed by many sellers, investors and real estate agents is “What are they thinking? Are the lenders crazy?”

Well, at first glance it may not look at all financially and monetarily sensible when a lender rejects a short sale offer on the face of it. Or some offers are just bad or plain insufficient offers. But what about offers that are substantial and can be corroborated through comparables he and I pondered? Well you have to look further for the answer to this question; you have to take a look at the Pooling and Servicing Agreement (PSA) that a particular loan could be a part of.

As many of us now know or are finding out, most mortgages were sold on the secondary market the “day after” closing and pooled with a group of mortgages held in trust as collateral for the issuance of a mortgage-backed security. Some mortgage-backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae are known as “pools” themselves. These are the simplest form of mortgage-backed security. These assets were pooled together so that Wall Street could package them as Mortgage Backed Securities. Each of the pools of mortgages are governed by this pooling and servicing agreement (PSA) we just mentioned.

Most of the agreements have provisions for when an asset goes into default. The servicer, must elect to identify the asset as non performing and place it into the foreclosure process. I found out that once this is done the servicer is now entitled to receive two times its servicing fees. It also opens up a multimillion dollar escrow fund that the servicer can reach to for payment of foreclosure attorney fees upfront. Could this be the reason that that attempt at workout via short sale, a deed in lieu of foreclosure or a loan modification never get anywhere but foreclosure?

Another reason that the short sale can be denied is because of competing interests and private mortgage insurance at the investor level. Many of the securities sold have different terms for different beneficial interests or Tranche as they are known in the business. Some are high risk with possible great returns and others are low risk conservative returns.

Investopedia defines a certain type of Tranche as: “A special type of bond class in a sequential pay collateralized mortgage obligation. This class of bond does not receive any interest or principal payments until all other Tranches have been completely paid off. In a Z-tranche, the interest that is not paid is accrued and added to the principal for future interest calculation purposes.”

Now many of the more senior beneficial interests, or Tranches, may have mortgage insurance to look to for payment in the event of foreclosure. So for them a workout seems a moot point if they can look to insurance to pay them instead.

Now the lesser beneficial interests may not be able to look to insurance but rather a pro rata share of the proceeds from a sale. This means that within the pool there is conflict among the beneficial interests as to how to proceed: Short Sale or foreclosure?

Now you know one of the reasons.