Why Do Banks Do Short Sales?

by Vena Jones-Cox

Question:

What makes a bank decide whether to take a discount on a defaulted mortgage or not? And what formula do they use to decide how much to take? Some banks I’ve talked to have just said no to a discount right away, and others seem perfectly happy to negotiate any offer, even if it’s a fraction of the loan amount. What gives?—D.D., Houston

Answer:

There are a number of factors that go into a lender’s decision about whether (and by how much) to discount a loan gone bad. Some are obvious; some involve the vagaries of the lending market.

The first step in getting a particular lender to consider YOUR short sale offer is to have your own ducks in a row. Before the lender will even discuss an offer with you, you’ll need a signed purchase contract and a letter of permission from the seller allowing the bank to discuss his loan with you).

You’ll also need to make sure that you’re talking to the right person at the right bank—sometimes the place that the seller is sending his payments is not the lender at all, but just a loan servicer.

And there’s usually only one person within a given institution who’s empowered to take offers to the board, so discussing your offer with anyone else is a dead end. And don’t even bother to call the attorney who’s handling the foreclosure—there’s absolutely nothing he can do for you.

Assuming you’ve done your homework and are talking to the right paper-pusher, there are a number of other factors that could affect how open the lender is to your offer. One is where the loan is in the foreclosure process.

If the borrower is just a few months behind—or if the auction is happening in 3 days—the bank might not be terribly motivated to take a major discount.

In the first case, they may assume that they can work out a payoff with the owner: in the second, they’ve already invested a great deal of money in legal fees, and may feel that it’s better to take their chances on getting the property back and reselling it on the open market.

Another issue is the condition of the property. Most lenders are hesitant to take back a property that needs major work, or that has building orders, or that could become an “attractive nuisance.” In other words, the nastier the house, the better the chance that the lender will deal.

Of course, the lender’s position as creditor is another big factor: 2nd and 3rd mortgagors are usually much more willing to discount—and discount BIG—than a 1st mortgagor. Think about it: the seller may have no equity thanks to a 75% 1st mortgage and a 30% 2nd, but the 1st mortgagor has 25% equity if he has to take the property back.

The requirements of the lender’s private mortgage insurance company or of FHA and VA insurance also influence its decision about how much to discount, as does the housing market, difficulty of foreclosure in a particular state, number of bad loans the bank is dealing with, likelihood that the owner will declare bankruptcy, and many, many more variables.

So the short answer is, there’s no short answer. Make your best offer, keep following up, and don’t get discouraged!

Reprinted from the Real Deal, a monthly newsletter for Real Life Real Estate Investors with permission of Vena Jones-Cox. Get a free 3-month trial subscription by clicking here. One per household, please.