Our banks have become home owners! As you know, our local Orange County real estate market is driven by bank foreclosures. But did you know that the other major factor driving down real estate prices right now is real estate “short sales?”

So what on earth is a short sale? A short sale, or “short payoff”, is a negotiated settlement between lender and borrower that allows a property to sell without the normal requirement for the mortgage loan(s) to be paid in full. If you are having trouble making your mortgage payments, a short sale may be a viable alternative to foreclosure.

Here’s a practical example: a buyer purchases a home somewhere in Orange County back in late 2005 for $1 million. The buyer also takes advantage of the lenient and generous loan terms available, and borrows $950,000 with only a $50,000 downpayment. Let’s now assume that the price of the home has corrected 25%, and that the home is now worth $750,000. But in order to sell this home, the owner must now contribute more than $200,000 in cash to bridge the difference between what the home is worth and what is owed to the bank.

Such a large out-of-pocket expense is not so easy a task for most people, especially in a slowing business environment. And unfortunately, many homeowners who can afford to pay off their loan choose not to do so, and let their properties go to foreclosure. That’s where the negotiated short payoff fits into the picture. Rather than foreclosure, the property is sold through conventional means subject to the lender accepting less than the full amount owed. Why would a lender cooperate? Based upon current market values, upon genuine hardship of the borrower, and the inevitability of foreclosure, the bank will often cooperate with a borrower and accept a short payoff. By doing so, the bank avoids becoming a home owner. We have always asserted that banks lose more money when they foreclose and resell a home, than when they accept a reasonable short sale. The seller avoids a foreclosure, the neighborhood avoids yet another “fire sale”, and perhaps, the market rebounds faster without so many bank foreclosures.