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The pain of short sales: banks want homeowners to “share the loss”

by Mike on September 20, 2008

Losing your home? Most homeowners facing a mortgage default have already come to grips with that consequence or at least they know it’s a very likely possibility. But may don’t realize that, long after losing their home, they might still end up paying against the debt for years, even decades.

The false promise of loss mitigation

When the mortgage lending industry hit the iceberg, all those brokers and real estate agents who had pocketed so much money during the boom suddenly found their empty pockets in need of refilling. Where’s the demand now? “Loss mitigation,” or helping homeowners find solutions for their home loan defaults. Unfortunately, real loss mitigation options are very limited: almost no one qualifies for a re-finance, and unless you choose to fight your foreclosure, almost every option involves losing the home.

Short sales: Not a silver bullet

One pitch that loss mitigation specialists have hit on is the “short sale.” There are two parts to the short sale: first, that it’s a sale of the home to some third party. Second, the sale price is less – often, much less – than the total loans on the property – that’s the “short” part. In order to make a short sale work, the lender or lenders have to sign off on the deal.

The main benefit to the lender on a short sale is that they get some cash, now, instead of the mere possibility that they might someday recover some amount of the loan. The main benefit to the borrower is that they achieve some finality – they get to settle their debt and end the worries that the bank will pursue them for years to pay on a loan for a home they no longer own. (This is a possibility in many foreclosures, in states like Florida that allow for “deficiency judgments” if the foreclosure sale doesn’t cover the amount of the debt.)

Lose the house, keep the pain

Now, the New York Times has reported, banks are calling a halt to the short-sale party.

Reluctantly, banks are agreeing to let some short sales go through. But instead of writing off the unpaid portion of the debt, they want homeowners to sign a note promising to pay some or all of the balance due.

As short sales become more popular, pitched by loss mitigation consultants looking to make a cut on the transaction, banks have become more sour on the idea. They are now demanding that homeowners carry substantial debt with them for as long as twenty years. One bank, slapping a last-minute condition on an already-approved short sale, told the homeowner, “When you are ready to participate in the loss, feel free to call me.” One lender actually demands that homeowners commit to repay the full debt, as far as thirty years into the future.

Credit scores: the hits keep on coming

One other potential benefit claimed by short-sale pushers is that a short sale is somehow less bad for your credit score. Unfortunately, this just isn’t true:

People in the industry say banks sometimes tell borrowers that their credit will take less of a hit if they agree to sign a promissory note than if they default. It is not true. In both cases, credit agencies consider the homeowner to have failed to live up to a solemn obligation.

Like any other credit obligation, it’s the timely payment that keeps your rating up. Missing a payment, even if you later make up every dime, is the damage to your credit report. A foreclosure filing, or even a pre-foreclosure default, are what affect your score, not your proficiency in negotiating a way out of the problem.

Short sales: not for everybody… in fact, darn near nobody.

If you’re a homeowner and behind on your mortgage, you’re going to start getting pitches from short-sale “specialists.” Unless you’re in a very unusual situation, you should probably tell them to take a long walk off a short pier.

Hat tip to Calculated Risk for the story.

Want to know more? Contact us at Ricardo & Wasylik, PL.

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