In 2009, the Wall Street Journal estimated that over 25 percent of American households with mortgages were worth less than the total debt secured by the property. For most upside down homeowners, a successful short payoff transaction is a better option than simply allowing their home to go into foreclosure. Not all upside down homeowners are in financial trouble. Yet for some significant portion of upside down homeowners, continuing with their existing mortgages in their existing home is no longer an option. Some no longer have the ability to service the debt. Others must move to find employment. Few of these owners have the ability to bring funds to closing to make up the difference between the mortgage debt and the property’s fair market value.
Upside down homeowners who need to change the status quo essentially have four options: (1) loan modification, (2) deed-in-lieu of foreclosure, (3) short payoff, (4) allowing the home to go into foreclosure.
As of March 2010, the success rate of loan modifications has been low. Deed-in-lieu of foreclosure transactions tend not to be practical for at least two reasons. A substantial percentage of upside down homeowners have second mortgages. A deed to a first lender in lieu of foreclosing that mortgage does not extinguish the second lien. Secondly, lenders generally prefer receiving the proceeds of a short sale versus obtaining an REO property through a deed-in-lieu. Generally, if a borrower would qualify for deed-in-lieu, he would more easily qualify for a short sale. This leaves us to compare short sales versus foreclosures.
Short sales reduce a lender’s losses, therefore reducing the seller’s/borrower’s potential losses and tax consequences. The credit rating damage from a short payoff is less than the damage from a foreclosure. For many borrowers, there is tremendous psychological satisfaction in having avoided losing their home through a foreclosure. A short sale is perceived as a more honorable way to give up a home.
For what type of person does a foreclosure tend to be better than an attempt at a short sale?
Owners who won’t qualify for short sale. Some upside down homeowners have the ability to make their mortgage payments in spite of daunting negative equity. Yet, for a variety of reasons, they choose to “Strategically Default” on their mortgages. As part of qualifying a property owner for a short sale, the lender is looking for financial hardship. As part of the process of applying for a short sale, the borrower will provide updated financial information to the mortgage servicer and lender. If the short sale request is denied, the lender will have better information with which to garnish wages, garnish bank accounts and otherwise collect against the debtor who might later strategically default on the mortgage. Homeowners who are unlikely to qualify for short sales should not try as a failed attempt may enhance the likelihood that the lenders come after the borrower for the lender’s post-foreclosure losses.
Property owners who will be made homeless by the closing on a short sale. Many insolvent homeowners seeking short sales have already moved out of their home. For them, the closing on a short sale has few disadvantages. For others, however, the closing of the short sale causes the homeowner to pay rent elsewhere. Not all of them have the ability to pay rent. For homeowners who have been made indigent by our “Great Recession,” it is sometimes better to simply let their home go into foreclosure so that they might live in it longer.
Other factors complicate the analysis such as the lender(s) track records for bidding deficiencies at foreclosure auctions and suing for losses, whether the property’s value fully covers the first mortgage, and whether the owner is an occupant or an investor. Because brokers have a commission at stake, brokers should avoid making the choice for the seller. If the seller has any torment about whether to pursue a foreclosure or pursue one of the other options, the owner should talk to his own attorney.
