Mortgage Lenders Prefer Foreclosure to Short Sales

When a home goes into foreclosure, the homeowner is not the only party that loses money. The mortgage lender also takes a financial hit, albeit one that is much less damaging. A short sale, in which an owner sells his home for less than what he owes on it, could lessen the blow to lenders by several thousands of dollars. Historically, however, banks are highly resistant to such sales.

Lenders often flatly deny a short sale, but have several other tactics that make a sale procedurally impossible for a homeowner who is already stressed out and stretched thin. In order to qualify for a short sale, a homeowner must be delinquent on their mortgage, and must first apply for a mortgage modification, regardless of the (generally slim) chances of approval. Banks are known to stall this process, and a complicated and unpredictable application system generally follows. And this process is only successful if a homeowner has a buyer – a significant hurdle in itself.

Banks resist short sales for any of a number of reasons. Although Fannie Mae, the mortgage finance company with federal backing, uses cash incentives to encourage short sales, these amounts are generally less than the high fees banks receive from foreclosures. Lenders may also use a foreclosure to collect on private mortgage insurance.

Often, banks suspect that a homeowner is attempting a short sale for fraudulent reasons, and these concerns are not completely without merit. According to a recent real estate industry report, short sale fraud occurs in more than 2 percent of sales, costing banks approximately $300 million each year. For example, a homeowner may make illegal attempts to make a short sale to a relative, with the intent that the home be sold back to the original homeowner.

However, according to Diane Thompson of the National Consumer Law Center, these concerns are largely overblown. “Banks are historically reluctant to do short sales, fearing that somehow the homeowner is getting an advantage on them,” she said. “There’s this irrational belief that if you foreclose and hold on to the property for six months, somehow prices will rebound.”

Source: New York Times, “Short Sales Resisted as Foreclosures are Revived“, Michael Powell, 24 October 2010