Short Sales vs. Foreclosure, That is the Question?

By mark-slade December 30, 2011

Short Sale Vs. Foreclosure: A Short Sale Always Wins

Today’s ever changing real estate industry has brought upon some very challenging questions from our clients. We as “advisors,” want to put forth the best, non-emotional advice that we can, in hopes that we can help our clients and their families navigate the rough waters of the short sale process.

The most prevalent question and one that continues to permeate the industry is:
“Why should a seller go through the short sale process rather than letting their house be foreclosed upon?”

While we cannot speak to every client circumstance, we can say one thing with complete conviction. In almost all instances in which a potential seller is contemplating whether they should short sell their house or let it go through the foreclosure process, a short sale is the better option. The following are examples to consider:

Ironically, the game of Monopoly can provide some interesting insight into the dilemma. Much like the below example:

You buy your Home and pay $220K for it. But, when you are upside down and owe more to the banks than what it is worth in the current market and can no longer afford to pay the mortgage on your home you have 2-3 choices.

Just like the above example in Monopoly, when a home is distressed it is worth far less than when it isn’t. The following details help to put this into perspective.

Example A- Short Sale

Mr. Smith owns a home in which he has a mortgage balance of $220,000 and a current market value of $150,000. Mr. Smith has elected to short sell his property. His Realtor successfully obtains a buyer who puts forth an offer price of $120,000 (80% current market value according to Realty Trac Foreclosure Report 5/26/2011). After reviewing the buyers offer and the financial hardship information from Mr. Smith, Mr Smith’s bank agrees to accept the short payoff of $120,000 which would leave a deficiency balance of $100,000.

The transaction closes and is final. Mr. Smith then pulls his credit report 30 days after the transaction takes place. On the report he notices that the mortgage trade line states “Mortgage debt was settled for less than full” and the balance on the mortgage is $0. Mr. Smith is now on the road to financial recovery and may have been eligible for a Government Granted Moving Allowance, if you qualify.

It is generally understood that, provided you are gainfully employed and find a home that you can afford to buy, you can probably buy said home in 2-3 years time from when the Short Sale was processed.

Example B- Foreclosure

For the ease of illustration we will use the same value and mortgage debt amounts as in Example A. However, Mr. Smith has elected to forgo the short sale process and let the bank foreclose on the property. The bank holding his mortgage facilitates the proper legal procedures to foreclose on the property, all of which are costly. Mr. Smith is notified and his property foreclosed upon of which is taken back by the bank to sell as an REO.

Six months later, the bank finally sells Mr. Smith’s home only they sell it for $90,000 (60% of current market value according to Realty Trac Foreclosure report dated 5/26/2011). Remember, as a short sale, the home would have sold for $120,000 keeping the deficiency to $100,000. In addition to the deficiency now being $130,000, the bank has elected to add on legal costs of $15,000 and asset preservation costs of another $5000 for a total deficiency liability of $150,000. Mr. Smith pulls his credit report 30 days after being notified that the bank has sold his property and of his liability.

On the report he notices that the mortgage trade line states “Foreclosure” and the balance is $150,000. Because of Mr Smith’s choice to choose foreclosure vs. short sale his road to financial recovery has taken a major detour. He not only has a foreclosure on his credit report but now has a much larger deficiency balance in which the bank, in most cases, will report on his credit report as a balance owed.
This Option is very similar to Filing for Bankruptcy where you can expect to have a 7 year impact on your credit.

Therefore, The Best Option is Clear:

While the financial and credit advantages are clear when choosing a short sale over a foreclosure, other advantages are sometimes overlooked. The most important of all of them is maintaining the seller’s dignity and peace of mind. We have heard too many stories of families having to leave their homes because of a Sheriff’s order or some other type of legal action. The short sale process alleviates this negative social impact. The process puts the control back in the seller’s hands so that they can get back on the road to financial recovery and start providing for their families. In the battle of the two evils, a short sale always wins!!!

There is also a third choice: Deed in lieu of Foreclosure. The borrower avoids further damage to their credit if the lender is willing to accept the deed in lieu of foreclosure as well as insulating themselves from possible exposure to a deficiency judgment. If the lender and borrower agree to this arrangement early on the borrower can avoid the embarrassment of having a Notice of Default recorded and published in a local newspaper. One drawback for the borrower is they forfeit any potential proceeds they might otherwise pocket if the property went through foreclosure. If the borrower elects to pursue this alternative, a clear written agreement canceling the note and deed of trust should be executed between the lender and borrower.

Why take a CHANCE? As an SFR–Short Sale and Foreclosure–trained Realtor, I am most happy to meet with anyone needing any advice and will keep our conversations discreet! And rather than acting like an ostrich…

You might actually find you qualify for a Loan Modification.

Mark Slade
Keller Williams
Mid-Town Direct Realty