When you become delinquent with your payments both you and the lender are distressed. Remember they are in the business of making loans and are not in the business of repossessing properties. When a borrower defaults, the loan becomes a nonperforming asset, at which time it is no longer earning interest. If the loan is not earning interest, it is not producing income for the lender.
This is bad for the lender.
In addition to not generating interest income, nonperforming loans actually cost the lender more money because of the lost earning power of the assets and the legal and administrative costs associated with collecting the loan or repossessing the property.
Example: (If the lender has a $200,000 nonperforming asset, then they are required to keep 6 to 8 times that amount in reserves which is $1,200,000 to $1,600,000.) Therefore if the lender would take a discount of $160,000 for the $200,000 loan, it allows them to put back into circulation the $1,200,000/$1,600,000 allowing them to collect interest making up for the $40,000 short sale that they took on the $200,000 loan.
A study conducted in 2002 by Craig Focardi of the Tower Group estimated the entire costs of a foreclosure to the lender was $58,759 and took 18 months. You can understand why the loss of a short sale is less than the cost of foreclosure.
(Copyright © 2007 By Dan Forbes, All Rights Reserved.)
