Do Banks Make More on Foreclosures or Short Sales?

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Question: Do Banks Make More Money on Foreclosures Than Short Sales?

A reader says: "I've been trying to buy my first home but in the price range I'm looking, all the homes seem to be short sales. My agent is trying to talk me out of buying a short sale because she says banks would rather foreclose than do a short sale. Is that true? Do banks make more money on foreclosures than short sales?"

Answer: The question of whether a bank makes more money on a foreclosure than a short sale depends mostly on the individual bank and / or the investors. We have weathered a real estate market since 2005 that saw foreclosure notices filed in unprecedented proportions. It was crazy. Moreover, at least half of the loan modifications that were made went back into arrears shortly after they were granted. The market was a mess.

To further complicate matters, in some states such as Arizona, banks can't sell a property for more than its mortgage. Each state has its own regulations. In California, for example, if a homeowner takes out a home equity loan after closing escrow and then defaults, that junior lender may have a right to pursue a deficiency judgment, regardless of whether the home was sold on a short sale or the loan was wiped out through a foreclosure by the first lender.

Why Would Banks Prefer a Short Sale over a Foreclosure?

Banks are run like a business because they are a business. They are in the business of making a profit. If it costs more to do a foreclosure over agreeing to a short sale, the bank is very likely to favor the short sale.

Some experts predict that banks may actually make 20% to 30% more on a short sale over a foreclosure. However, in some states such as Florida, it costs very little to file a foreclosure and see the process through to the end.

If a bank receives an offer that is close to market value, the bank may be more likely to accept that offer instead of foreclosing. The reason is after foreclosure, if the bank wants to sell the home, it is unlikely to receive a higher offer than the short sale offer on the table. On the other hand, if the bank feels the real estate market may appreciate, a foreclosure may be a more profitable venture for the bank.

Service Providers May Decide Whether to Grant a Short Sale or Recommend a Foreclosure

According to the National Consumer Law Center, about two-thirds of the loans made since 2005 have been securitized. Securitization is a process that involves gathering hundreds to thousands of loans into one package and selling that package in the secondary market. Often, the purchaser is a trust. Trusts are comprised of investors.

After the loans are pooled and sold, the trust hires a service provider to collect monthly payments and distribute that money to the investors. That securitization agreement is called a pooling and servicer agreement or PSA.

It matters little to service providers whether the home's value falls or the home goes into foreclosure because the service provider gets paid regardless. Service providers make money a number of ways such as receiving a service fee, default fees, floated interest and and / or from investment interests in the loans the provider services.

The National Consumer Law Center says service providers often prefer a short sale because service providers are paid several times more in compensation to do a short sale than a loan modification.

Tip: If the short sale bank is Wachovia, which purchased World Savings, that bank prefers to do a short sale over a foreclosure. An insider at Wachovia told me the bank makes more money on a short sale than a foreclosure. Wachovia is a portfolio lender, which means the loans remain in-house. I've received short sale approval for a few Wachovia short sales in Sacramento in as little as 7 days.

For the most part, banks are unlikely to reject a short sale if the sales price is near market value.

At the time of writing, Elizabeth Weintraub, License #00697006, is a Broker-Associate at Lyon Real Estate in Sacramento, California.