The question of whether a bank makes more money on a foreclosure than a short sale depends mostly on the individual bank or investors.
By definition, a short sale is granting the homeowner permission to sell their property for less than what they owe the bank. As a result, the bank automatically loses money on it.
Key Takeaways
- Generally, banks lose more money on a short sale than on a foreclosure, but there are still times when a short sale is a better option.
- Sometimes the process of foreclosure is more expensive and involved than the bank wants to handle.
- If the short sale price is close to market value, the bank will be more likely to accept that offer.
Banks Look To Recover the Most They Can
“If the bank ends up getting the same or less than they would have with a short sale, they will suffer a big loss,” said Mark Bello, an attorney in West Bloomfield, Mich. “Assuming foreclosure is imminent, the bank will only reject a short sale if their own market sale will recover more of their money.”
For the most part, banks are unlikely to reject a short sale if the sales price is near market value.
Foreclosure filings increased dramatically from 0.6% in 2006 to 1.8% in 2008.Moreover, over 40% of the loan modifications in 2008 became delinquent or went into foreclosure within eight months of being granted. But since then, the market has rebounded. Data by year shows that 45% of all properties in foreclosure as of the end of the first quarter in 2018 were due to loans secured from 2004 to 2008, according to ATTOM Data Solutions. Overall, a total of 624,753 U.S. properties were in foreclosure by year-end 2018, which was 8% less than in all of 2017 and 78% less than the nearly 2.9 million in 2010.
“There aren't as many serious examples of situations where people are extremely underwater on their mortgages so there's less and less need for short sales,” according to Bello.
Depending on the state, a bank may not be able to sell a property for more than its mortgage. For example, in Arizona, banks can't sell a property for more than its mortgage and in California, if a homeowner takes out a home equity loan after closing escrow and then defaults, the lender may have a right to pursue a deficiency judgment regardless of whether the home was sold on a short sale or the loan was wiped out through a foreclosure by the first lender.
Why Banks Would Prefer a Short Sale Over Foreclosure
Banks are businesses and, just like any business, they are seeking to earn a profit. If it costs more to foreclose over agreeing to a short sale, the bank is very likely to favor the short sale.
With foreclosure, a bank takes possession of the house, then resells it at a mortgage auction to the highest bidder. If a bank receives an offer that is close to market value, it may be more likely to accept that offer instead of foreclosing. After foreclosure, if the bank wants to sell the home, it is unlikely to receive a higher offer than the short sale offer on the table. On the other hand, if the bank feels the real estate market may appreciate, a foreclosure may be a more profitable venture.
Securitization of Bad Debt
Of the $600 billion in subprime loans that were originated in 2006, over 75% were securitized according to the Financial Crisis Inquiry Commission. Securitization is a process that involves gathering hundreds to thousands of loans into one package and selling that package in the secondary market.
“Companies that acquire bad debt do so at a substantial discount,” said Bello. “They look to collect more from this bad risk than they paid for that debt because bad debt can be purchased for pennies on a dollar.”
Often, the purchaser is a trust composed of investors. After the loans are pooled and sold, the trust hires a service provider to collect monthly payments and distribute that money to the investors. That securitization agreement is called a pooling and servicer agreement or PSA.
It matters little to service providers whether the home's value falls or enters foreclosure because the service provider gets paid regardless through service fees, default fees, floated interest, and investment interest on the loans the provider services.
Further, the National Consumer Law Center found that service providers often prefer a short sale because they are paid several times more in compensation than a loan modification.
“The difference between a loan modification and a short sale is you’re not rid of the property,” said Bello. “You’ve just kicked the can down the road.”
FAQs
Key Takeaways. Generally, banks lose more money on a short sale than on a foreclosure, but there are still times when a short sale is a better option. Sometimes the process of foreclosure is more expensive and involved than the bank wants to handle.
Is a short sale more profitable than a foreclosure? ›
Short sales can be beneficial for all parties involved. They provide a greater return on investment for home buyers and minimize the financial repercussions that both lenders and sellers would face if a property went into foreclosure.
Why do banks prefer foreclosure to short sale? ›
Short sales tend to be lengthy and paperwork-intensive transactions—sometimes taking up to a full year to process. The pre-foreclosure process can also be quite lengthy, but once the lender has seized the property, the sale usually happens very quickly so that as much money as possible can be recouped.
Do banks lose money on foreclosures? ›
The primary reason for bank walkaways is that a bank expects to lose money by foreclosing – when proceeds from a foreclosure sale are expected to be insufficient to cover the cost of the foreclosure itself, together with securing, maintaining, and marketing the home for sale.
How much of a loss will a bank take on a short sale? ›
If the bank approves a short sale, they forgive the difference owed to them on the property. In some instances, the amount can be upwards of a million dollars. So you get to sell the house for what it's worth and the difference of what you owe is gone.
Who loses money on a short sale? ›
Put simply, a short sale involves the sale of a stock an investor does not own. When an investor engages in short selling, two things can happen. If the price of the stock drops, the short seller can buy the stock at the lower price and make a profit. If the price of the stock rises, the short seller will lose money.
Who benefits from a short sale? ›
Short-Sale Benefits For Buyers
Although the short sale property will be priced according to market value, the lender is highly motivated to sell to cut the bank's losses. As a result, buyers can often get a better deal on the home than they would if they purchased it in typical fashion.
Do banks negotiate on short sales? ›
While it's possible to negotiate the purchase price for a short sale, there's no guarantee the seller's mortgage lender will approve the price. It's also unlikely the seller will be able to make concessions or assume additional closing costs.
What's the most common alternative to a short sale? ›
Foreclosure is the last option for the lender. In such cases, the lender repossesses the home, hoping to eventually make good on its investment in the mortgage. Unlike in most short sales, many foreclosures take place after the homeowner abandons the home.
How much should you offer on a short sale? ›
If it's below value, that is generally acceptable. Just not excessively below. Think of your offer as being “within shot.” For example, a Seller that has an FHA loan trying to get short sale approved, a common number the bank is willing to approve is a minimum “net” 88% of the bank's appraisal price.
You will still owe the balance. As a lender I always tried to be sure there was enough equity in the house to safe guard against the payments stopping and going into foreclosure. This is a legal process. There will be a good that taxes are not paid, utilities are unpaid, legal costs, selling cost, etc.
What banks have the most foreclosures? ›
10 banks foreclosing on the most homeowners
- Bank of America. Loans in foreclosure: 96,319.
- Wells Fargo. Loans in foreclosure: 84,903. ...
- J.P. Morgan Chase. Loans in foreclosure: 54,325. ...
- U.S. Bancorp. Loans in foreclosure: 44,881. ...
- Deutsche Bank. Loans in foreclosure: 33,608. ...
- Bank of New York Mellon. ...
- Citigroup. ...
- HSBC Holdings. ...
It's better to try to work something out, and be turned down, than to give up your home without any effort to save it. Foreclosures are extremely costly to banks. They do not make money when they take over your home and sell it in foreclosure. In fact, they usually lose quite a lot of money.
What is the maximum loss on a short sale? ›
The potential price appreciation of a stock is theoretically unlimited and, therefore, there is no limit to the potential loss of a short position. In addition, shorting involves margin. This can lead to the possibility that a short seller will be subject to a margin call in the event the security price moves higher.
Can a bank come after you after a short sale? ›
In many states, the lender can seek a personal judgment against you after the short sale to recover the deficiency amount. To avoid any nasty surprises following the short sale, you should determine what will happen to the deficiency before completing the transaction.
What are the pitfalls of a short sale? ›
Disadvantages Of A Short Sale:
- Must meet specific requirements to be eligible.
- More complicated and a lengthier process.
- The sale must be lender approved.
- The bank or lender could pursue a deficiency judgment.
- Your credit score will likely drop.
- You WILL lose your home.
Short sellers bet on and profit from, a drop in a security's price. Short selling has a high risk/reward ratio, offering big profits, but losses can mount quickly and may result in margin calls.
Does the seller make money on a short sale? ›
Key takeaways. A short sale is when a mortgage lender agrees to allow a homeowner to sell their home for less than what they owe on the mortgage. A short sale can help you get out of an underwater situation, but you won't profit from the sale, and it'll impact your credit score for some time.
What is the downside of a short sale on a home? ›
For the Seller
You are losing your house and possibly equity. You might not have the entire debt eradicated and could be responsible for the difference between what you owe and the sale price, called a deficiency judgment. If the difference is forgiven, you could be taxed on it. It is a significant credit hit.
Why do sellers choose a short sale? ›
In many cases, short-sale homes are in reasonable condition, and while the purchase price might be higher than a foreclosure, the costs of making the home marketable can be much lower and the disadvantages to the seller can be less severe.
