Short Sale vs Foreclosure

Now more than ever, a short sale trumps a foreclosure as the Feds jump into a new program – pay owners to leave.

It’s happening everywhere. You can’t pick up a newspaper without reading about the absurd number of homeowners who are “underwater” and are choosing to simply “walk away” from what is probably the most important asset they have – their home.

“Underwater” means that the homeowner owes the bank more than the home is worth. If the owner has to sell due to circumstances in their life (divorce, job transfer, job loss etc.) that they can’t control, they find themselves in a quandary. What do you do? Many, in my opinion, are making bad choices – they’re walking away from the home and letting the bank foreclose. In most cases this is the worst decision they can make.

Let’s look at some other options:

One of those options is a “loan modification.” A loan modification is a change to one or more terms of a borrower’s existing mortgage(s). The idea is to keep the homeowner in his home by making the monthly payments more affordable. Loan modifications do happen – people have been helped. But in a volatile market that’s shifting on a daily basis, the level of willingness to make these changes on the part of lenders is inconsistent at best. The current administration’s efforts to help the housing industry by getting borrowers into loan modifications have been only moderately successful.

Another option is the “short sale.” By now, most homeowners who are in trouble have heard of the term “short sale”. A “short sale” means that a house is being sold for less than the seller owes on it. In other words, the sales price doesn’t cover the mortgage. The difference between the sales price and the amount owed is how much the property is “short.” The lender takes the loss on the loan when the house is sold. The homeowner sells the house and walks off into the sunset. It’s a little more complicated than that, but first, let’s ask the obvious question:

Why would a lender consider a short sale where they receive less than they are owed?

The obvious reason is that they will lose more if they foreclose. A foreclosure can cost a lender an extra $40,000-$60,000 in attorney fees, trustee fees, holding costs and maintenance outlays on every foreclosed property. And a foreclosed property won’t fetch any more $$ on the open market than a property that has been sold short. In fact a foreclosed home that is vacant will usually sell for less on the open market. So let’s not kid ourselves – banks are motivated to sell homes short.

And yet many homeowners opt to walk away and let the bank foreclose. Why?

Misinformation mostly. A lot of it comes from the bank that they’re dealing with. Many owners just don’t understand that there are options other than foreclosure…even if the bank tells you they are going to foreclose, you have other options. If you get behind on your mortgage and you contact your bank, there is no one at the bank who will take the time to evaluate your situation and give you a list of options. For this reason alone, many owners feel the only path to take is the one leading to default.

That situation is changing as the San Diego real estate market must move toward solving its problems of default and mounting debt. Banks are looking at other paths, other outcomes. Financially strapped owners are learning this and now the “short sale” has become the “transaction du jour” in domestic real estate. That’s a good thing because in almost every instance a short sale is a better outcome than foreclosure to a troubled homeowner and to the bank.