When modifications fail, short-sale providers could be a strong aide

Kathy Van Sleen, co-founder, JK Short Sale

As published in Scotsman Guide's Residential Edition, January 2010.

Government programs aimed at easing the housing crisis have centered on getting people out of bad loans through loan modifications. In theory, this seems like an ideal solution because it allows homeowners to stay in their homes with lower mortgage payments.

Unfortunately, expecting loan modifications to be a comprehensive solution to the foreclosure crisis isn't realistic. In light of this, short sales -- in which a home is worth less than its borrower's outstanding balance, which lenders discount in exchange for sales proceeds -- increasingly represent the foreclosure-prevention option of choice.

Why not loan mods?

Loan mods must be affordable, a tall order when dealing with many loans made before the downturn with products that were interest-only or provided for negative amortization. In addition, job losses or other economic misfortunes also can put loan mods out of reach for many homeowners.

Moreover, for homeowners who negotiate a modification successfully, the recidivism rate is alarmingly high. Without a principal reduction, modifications often don't address the negative equity created by declining home values.

Negative equity is one of the biggest hindrances to successful loan mods because lenders generally intend to keep unpaid principal balances intact. This past summer, Deutsche Bank estimated approximately 14 million U.S. homeowners had negative equity and projected 25 million homeowners could be in that camp by the first quarter of 2011. The considerable size of the problem -- as many as 48 percent of mortgages could eventually be upside down, according to the report -- mandates solutions other than loan mods. Conservative underwriting criteria add to this need by stilting homeowners' ability to realize effective modifications.

For homeowners unable to achieve meaningful modifications, short sales could be the best bet. Because of this, mortgage brokers can benefit from understanding how to find success with short sales and short-sale providers.

Short sales and risks

The 2009 announcement of the Obama administration's Foreclosure Alternatives Program validated short sales as a viable and desirable alternative to foreclosures. Among other things, the program establishes incentives for servicers and others to complete short sales.

The National Association of Realtors also has taken up the short-sale cause, providing training and guidance to its real estate agents. According to a CNNMoney.com article from May 2008, lenders have lost an average of 40 percent of a mortgage's value on loans that go into foreclosure compared to 19 percent of the value on short sales.

Despite these statistics and growing support for short sales as a viable solution to the foreclosure crisis, short sales have an appalling close rate. Two of the most commonly cited pitfalls are:

1. Lender delays that ultimately result in losing the buyers; and

2. Inexperienced real estate agents unable to manage the process and effectively negotiate with the lender.

These factors could make many mortgage brokers understandably cautious about such transactions.

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