Loan Modification or Short Sale: Selling a Bad Property vs. Modifying a Bad Loan

At the beginning of the real estate crisis, loan modification became the buzzword to fix all failing mortgages and to stop foreclosure. More than a year into the process, many banks and borrowers found that their loan modification failed. Borrowers may not be able or willing to pay the reduced debt amount or borrowers may need additional time at reduced interest rates to continue to make payments. Troubled borrowers should consider short sales in conjunction with their decision to modify their loans.

Real Estate Short Sale Pros and Cons

The biggest pro of a short sale in real estate is the freedom from a bad investment. Borrowers, who execute a short sale, no longer have to pay a high mortgage rate/payment and no longer have to worry about the potential damaging hit of a foreclosure on their credit rating. While their credit rating might take a small hit, it is nowhere near as bad as having to file bankruptcy or having their property repossessed. The public embarrassment alone of the auction of a home could be enough incentive for borrowers to at least pursue a short sale vs. a loan modification.

Shorts sale are tough, however. Banks do not want to grant short sales because it means they will have to report a loss, probably a rather significant one, in their next quarter on this loan. In this vein, banks put borrowers through the ringer before they even consider granting a short sale. Buyers must provide extensive financial information and must prove to the bank that without a short sale, they will not be able pay the bill or that their home is so far underwater the mortgage will not be recouped for many years. Both burdens are on the borrower and short sales are at the lender’s sole discretion. The major cons of the short sale is simply getting it done and of course, the displacement from a family home.

Loan Modification Pros and Cons

Loan modifications require similar proof, but since they are the flavor of the month, it is much easier to obtain a modification. Borrowers, who truly cannot pay their mortgage or who are behind 30-60 days, should immediately call their mortgage company. More than likely these buyers will be able to obtain a loan modification. Modifications come in all shapes and sizes. While debt forgiveness is rare, many banks will allow the borrower to only pay the interest for a set amount of time or even to pay nothing for up to six months.

The con to the modification approach lies in the fact that it is only a modification and it is only temporary. After a year the borrower could be right back at the beginning with an even higher mortgage and an even lower property value. Loan modifications can be effective in markets where property values and employment rebound fairly quickly. In markets where property values remain depressed and people have a hard time finding work, modifications only serve to delay the inevitable. In many instances, borrowers would be better served to pursue a short sale.

Borrowers often try to stay in their home at all costs. Many first seek to modify their home loan in hopes that property values will increase or their ability to pay will materialize. These borrowers should critically analyze a short sale, in addition to a modification.