What is Causing the Decline in Short Sales?

Consequences stemming from the expiration of the Mortgage Forgiveness Debt Relief Act may be surfacing, according to a perspective piece written by CoreLogic’s Kathryn Dobbyn. The piece found that throughout 2012 and into 2013, short sales had been steadily declining, partly due to rising home prices.

Dobbyn is careful to note that, “While two data points do not make a trend, this negative trajectory appears to have picked up pace in 2014 with short sales dropping 0.6 percentage points from 5.2 percent of total sales in December 2013 to 4.6 percent in January 2014.”

Preliminary February data would suggest that short sales will continue to decline, quite precipitously to 2.2 percent.  However, REO-sales have not declined in a similar fashion, moving instead with normal seasonal patterns, according to the CoreLogic analyst.

Dobbyn attributes the decline, not to home price appreciation or other factors, but to nascent effects of the expiration of the Mortgage Forgiveness Debt Relief Act.

“This act, which has been subsequently renewed and extended twice, allowed borrowers to exempt the amount of forgiven mortgage debt from their income, making the short sale a more attractive option for borrowers trying to avoid foreclosure,” Dobbyn said.

Dobbyn writes that the expiration of the act, which would create hefty taxable income for a borrower if they proceeded with a short sale, likely made borrowers considering such a move think twice.

Expiration of the act had other consequences as well. “With the forgiven debt now taxable income, a loan modification with a principal reduction presents a more complicated decision for both the borrower and the servicer,” the piece said. The increased taxable income could place more stress on an already distressed homeowner, leading servicers to look for other avenues to help trouble borrowers—actions such as a rate reduction or principal forbearance.

While Congress could still decide to extend the act further, with legislation pending in both the House and the Senate, the uncertainty of the extension is putting negative pressure on the volume of short sales and principal reductions.