Banks Prefer Short Sales to Foreclosures, Even If It Costs Them

Increasingly, banks are offering struggling homeowners wads of cash to allow their homes to go into a “short sale” and avoid foreclosure. Here’s why.

Author:: Brian O'Connell
Publish date:: Feb 8, 2012 2:09 PM EST

NEW YORK (MainStreet) – Banks don't mind using the stick to get delinquent homeowners out of their houses, but that doesn’t mean they don’t use the carrot, too. One example: Increasingly, banks are offering struggling homeowners wads of cash to allow their homes to go into “short sale.”

Bloomberg News reports that banks are offering up to $35,000 to late-paying homeowners to enter into a short sale and thereby avoid the foreclosure process that has held the housing market down for years.

Short sales are home sales where both the bank and the mortgage holder to agree to sell the home for less than it’s worth. Short sale volumes tripled in 2009 and 2010, according to housing monitor CoreLogic, and that trend continued in 2011.

With short sales still very much active in the housing market, why would banks and mortgage lenders have to pay homeowners to kick-start a short sale? After all, banks historically have been slow to resort to a short sale, often holding up permissions in the hope that the homeowner will get his or her financial act together, or betting they can cut a better deal on a home if it goes into foreclosure rather than into a short sale.

But as Bloomberg points out, banks have ultimately decided that short sales are faster and cleaner than foreclosures, allowing them to dispose of “bad debts” on their accounting ledgers – a good thing for a bank’s bottom line.

A big part of the reason for that shift in mindset is that foreclosures are taking longer than ever. Data from LPS Applied Analytics notes that in 2007, the average foreclosure took 253 days to close, and today that number is 674 days.

Given the long time that foreclosures take, one can understand the need for banks to “nudge” delinquent homeowners to engage in short sales with cash offers, as well as pre-approve short sale deals and agree to write-off a portion of the mortgage debt owed by the homeowner just to get a short sale done.

All in all, it’s just cheaper for banks to go the short sale route than to pursue a foreclosure. According to Moody’s Investor Services, losses stemming from foreclosures are 15% higher than for short sales, which is why short sales account for 33% of all distressed property deals in 2011, compared to 24% in 2010.

In the end, the move to offer homeowners financial incentives to agree to a short sale is all about business. In one fell swoop, banks and lenders can get rid of a toxic line on their balance sheets and bestow some goodwill on homeowners who may get back on their feet some day and once again become a mortgage customer.

That sounds like a good deal for everyone involved – banks, homeowners and the housing market as a whole, which wants more “sold” signs on the front lawns of American homes than “foreclosure” signs.

If you're eagerly awaiting a recovery in the housing market, this year might be the one when things turn around. Check out MainStreet's look at 5 Housing Booms Coming in 2012 for more!