NEW YORK ( TheStreet) -- Short sales activity declined sharply in the first quarter, a sign that banks may be re-evaluating their strategy for resolving troubled mortgages amid rising home prices. According to the latest Foreclosure & Short Sales report from RealtyTrac, non-foreclosure short sales fell 10% from the fourth quarter of 2012 and were down 35% from a year earlier. This marks a shift from a trend of increasing short sales over the past two years. In a typical short sale, a bank allows an underwater borrower behind on his mortgage loan payments to sell his home for less than the amount owed and generally forgives the remaining balance on the mortgage. The short sale process has been touted as a better alternative to foreclosure, which has proved to be a time-consuming, costly and onerous process for banks.
Borrowers have also preferred short sales over foreclosures as it allows them time to adjust to their new circumstances and find alternative accommodations. Short sales are also thought to be less damaging to borrower credit scores, although the borrowers will likely have to wait before applying for a new mortgage. For the more than 10 million homeowners who still owe more than their homes are worth, several million of whom are at high risk of default, short sales may still make sense. Still, the increase in home prices is likely changing the equation for borrowers and banks. "Rising home prices in many markets are stunting the continued growth of short sales by reducing incentive for both underwater homeowners and lenders," according to RealtyTrac Vice President Daren Blomquist. "Underwater homeowners may be willing to stick it out a few more months or even years in the hope that they will be able to walk away with money at the closing table and without a hit to their credit rating, and for lenders a failed short sale may no longer translate into bigger losses down the road given that average prices of bank-owned homes are rising -- at a faster pace than non-distressed home prices in many markets."