Thursday, August 12, 2010

Why Do Banks Prefer Foreclosure to Short Sale or Home Loan Modification?

I have long wondered why banks reject perfectly reasonable offers on houses that need a short sale. The banks take months to respond to an offer on a house, they refuse to do repairs required to make the sale happen, and they cut the agents' commissions at the last minute. They really seem to prefer to foreclose on the house, rather than work out a home loan modification with the underwater home owner, or accept a short sale offer at market value. When the house goes to foreclosure, it typically sells for far less that it would have by a short sale. What gives? How can the banks stay in business by willfully choosing to foreclose, and thereby receiving much less than they need to?

The guys at Think Big Work Small think they have it figured out. The FDIC seized the assets (bundled mortgages) of some inept mortgage lenders, and then sold the assets to other lenders at a deep discount. Then when the new lenders foreclose, FDIC compensates the new lenders for their losses, but not for their actual losses, but for the loss the lender would have incurred if the new lender lost the difference between the original mortgage amount and the foreclosure price. Of course, the new lender is not really losing that amount, because they bought the mortgages for less than was owed!

If this scenario is true, the FDIC is using tax-payer dollars (or I should say, increasing our deficient and borrowing against future tax-payer dollars) to enrich the lucky, well-connected banks that bought the assets of defunct banks. All these unnecessary foreclosures drive down the values of the neighboring properties, making it impossible for neighbors to refinance or to sell at a fair price. As long as the FDIC pays banks to foreclose rather than do a short sell or a loan modification, market value of all houses will be unjustly dragged down by the value of the foreclosed houses.

Are you horrified yet?

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