Will Short Sales Finally Save the Housing Market?

This is the first article in a series spotlighting short sale trends in early 2012, which seem to indicate that short sale volume is on the rise while short sale prices are trending lower — a good mix  for prospective buyers and investors. This series is largely based on a short sale report issued by RealtyTrac for a special live broadcast hosted by the Charfen Institute on April 19. Download the full RealtyTrac report.

Short sales, where a distressed property (often in foreclosure) is sold for less than what is owed on the mortgage, have long been viewed as an elegant solution to the nation’s foreclosure problem — at least in theory.

A short sale, in theory, provides a win-win-win for the buyer, bank and even the seller. The buyer purchases a house they want at a price they can afford, the bank gets the best price for its distressed asset, and the seller walks away from a mountain of debt, free to get a fresh start.

But short sales have never quite lived up to the hype, probably because what works well in theory does not always work well in practice. Sales of properties in the foreclosure process, or pre-foreclosure sales, started to spike in late 2008 and early 2009. The quarterly peak was more than 128,000 in the first quarter of 2009.

Then came a new presidential administration with a new approach to the foreclosure problem and a sharp drop in pre-foreclosure sales — which are typically short sales.

Since the second quarter of 2009 and through the fourth quarter of 2011, pre-foreclosure sales have averaged about 89,500 per quarter, with a couple spikes above 100,000: in the second quarter of 2010 and in the second quarter of 2011.

But banks have recently been given additional reasons to opt for short sales rather than foreclosure over the past 18 months. During that time, banks were raked over the coals for questionable foreclosure practices, including allegedly forged paperwork and insufficient documentation to support the right to foreclose. That additional scrutiny on lenders culminated last month in a court settlement between five of the major lenders and 49 state attorneys general.

The settlement encourages lenders to agree to foreclosure alternatives, including loan modifications and short sales. And it lays down a clear set of guidelines for a properly executed foreclosure. Lenders may not be able to meet all the requirements set forth in these guidelines for a proper foreclosure, at least for a portion of the distressed loans in their portfolios. That will make the short sale option look even more attractive to lenders going forward — and could result in a surge in short sales in 2012.

Data from the first month of the year indicates that such a short sale surge is in fact on its way. We’ll talk about that more in the second article in this series on short sales.

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