Why Do Banks Seem to Prefer Foreclosures to Short Sales?

When a seller owes more to his mortgage company than his house is worth, he needs his mortgagor's approval to sell the house, because the mortgagor will not be repaid what the seller owes it from the proceeds of the sale. This is called a short sale, but there is nothing short about it.

Mortgagors are very reluctant to accept a short sale, and the request for short sale approval drags on for several months. The seller and his real estate agent must repeatedly submit the same documents because the mortgagor loses them or the documents become outdated while the seller waits for short sale approval.

Often, after keeping a seller and a prospective buyer waiting for a response to a perfectly reasonable short sale offer for several months, the mortgagor will decide to foreclose on the property. Then the investor in the mortgage, usually Fannie Mae, Freddie Mac, or HUD, lists the property for sale with a different real estate agent at a much lower price than what a buyer had offered as a short sale.

It would seem that the mortgagor would lose money by doing this, wouldn't it? Yet the banks are enjoying record profits. How do they do it?

The secret may be that the lender forecloses so they can get paid for their loss by mortgage insurance. Borrowers sometimes pay for this insurance, but sometimes the lenders pay for it themselves. Because they won't get the mortgage insurance pay out if they agree to a short sale, the lender considers the costs of foreclosure--attorney's fees, property tax, insurance, homeowner association fees, utilities, repairs, real estate commissions--and if they will net more by foreclosing, collecting the mortgage insurance, and selling the house quickly at some below market price, they will.

Lenders don't seem to have made the connection between selling foreclosed prices at low prices, and the depression of prices of nearby houses that weren't underwater until the foreclosed house sold in the neighborhood. This is the real mystery to me. It's been four years since the real estate market imploded, and the banks still don't see that their actions are preventing a housing recovery.