Nearly 5 million people around the country are seriously delinquent on their mortgages. Some may be able to save their homes if they can negotiate a loan modification with a lower payment from a lender. But others simply don't have enough income even for that.
For many of those troubled homeowners, a "short sale" is a better alternative than foreclosure.
Here's how a short sale works: A bank agrees to sell a house at the current market value without foreclosing, allowing the owner to simply walk away because the bank forgives the rest of the debt.
The federal government is launching a new program Monday to encourage more short sales. The Treasury Department will offer lenders and homeowners incentives totaling more than $3,000.
A Short Sale In Boston
On a busy street in Boston's Dorchester neighborhood, real estate agent Curtis Howe walks up to a brick townhouse that was rehabbed about 10 years ago. It's in a part of town where properties got way overvalued during the housing bubble. Howe says the outstanding mortgage was about $540,000; the property eventually sold for $275,000 in a short sale. That is a huge drop in value, and the lenders who were on the hook for that loan lost a ton of money. But there's still an upside for lenders.
"When a property goes into foreclosure and becomes vacant, it's vandalized, you have plumbing issues if the property isn't winterized, and there's nobody to maintain the property," Howe says. And, he adds, a short sale typically gets a higher price than a foreclosure.
A Complicated Short-Sale Process
Banks can cut their losses by doing short sales, and homeowners can do less damage to their credit. A homeowner also avoids the ordeal of a foreclosure, which can include eviction.
But often obstacles can derail short sales or make the process drag on. With the house in Boston's Dorchester neighborhood, Howe says, "It was a long process and it was just a little less than two years to get short sale approval and sale."
Laurie Maggiano, a director of policy at the Treasury Department, says: "There have been many, many delays and lots of complications with the short-sale process."
Some people don't like the idea of more bailouts for banks — or for homeowners, some of whom bought houses that they just couldn't afford.
"We're not here to make moral judgments about borrowers; we are here to stabilize the mortgage market," Maggiano says. She says the major cause of default and foreclosure right now is unemployment. Short sales, she adds, are less damaging to the housing market than foreclosures because there aren't vacant homes blighting neighborhoods.
Nicolas Retsinas, a housing economist at Harvard Business School, says second loans such as home-equity loans have been a major problem for short sales. That's because banks that made those home-equity loans have to sign off on any short sale, and they can end up squabbling with the first mortgage holder about who should get how much money.
"They can try to capture and turn their power to sign off into some kind of modest payoff for that second mortgage," Retsinas says.
Meanwhile, mortgage industry executives are talking about how big the government program might become.
"We'll have to get into the summer months to see how this takes off," says John Jelavich, a vice president with PMI Mortgage Insurance Co. "But it could be just another program out there."
Jelavich says one challenge will be to make sure that the homeowners who get to do short sales are people who really can't afford their homes. It shouldn't be a program, he says, for people who could afford to keep paying but want a way to sell their house if they owe more than it's worth.