When a mortgage loan enters default, the bank conducts an analysis to determine the property’s value in relation to the outstanding loan balance. The bank’s goal is to minimize losses by achieving the maximum recovery on the defaulted mortgage loan; therefore, the bank will establish the amount of money it believes it will collect through either a foreclosure or a short sale. While both processes will help the bank recover outstanding funds, foreclosures offer several advantages.
If there are junior liens against the property, the foreclosure process will eliminate them from the property’s title report. There is no title-clearing event with a short sale; therefore, all junior lienholders must agree to release their liens in order to provide clear title to the new property owner. Unless a junior lienholder will agree to a lien release without receiving full payment, these liens could prevent a short sale from happening.
At the foreclosure sale, the bank will either become the property owner or successfully sell it to the highest bidder. If the bank becomes the owner, it may be able to immediately start marketing the property at the fair market value, and can facilitate a timely sale. If the highest bidder becomes the new property owner, the sale proceeds can be applied against the defaulted loan immediately. A short sale involves a significant amount of work and time to complete, potentially causing the loan to fall even deeper into default.
A bank is interested in recovering its defaulted loan balance, as well as any fees or costs associated with collecting the debt. If the bank has decided to foreclose, the possibility exists that it could recover the entire loan balance. By nature, a short sale means the sales proceeds will fall short of paying off the loan balance in full; therefore, if a bank agrees to a short sale, it will experience certain loss.
Foreclosure laws vary by state, so the bank must determine which type of foreclosure it can initiate: judicial or non-judicial. Judicial foreclosures involve the court system, and the lender may be able to obtain a judgment against the defaulted borrower for any loan balance remaining after proceeds from the foreclosure sale are applied. Non-judicial foreclosures may move faster because they don't require going through the court system, but depending on state law, the bank may not be allowed to sue the borrower for any deficiency balance after the foreclosure. In a short sale, the bank may formally agree to accept less money than what is outstanding without further recourse against the defaulted borrower.
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