With short-sale offer refused, foreclosure may end up the best option

By Ilyce Glink and Samuel J. Tamkin
Friday, March 18, 2011; 7:23 PM

Q. We built a spec house in 2007 as the market declined. We've tried to do everything to get it sold and recently received a short-sale offer on the home.

At first, our bank agreed to change the loan into an interest-only loan to help with cash flow, but we can't manage to cover those payments. Then our bank went out of business and was taken over by another bank.

We approached our new lender with the short-sale offer and agreed to pay most of the difference between the amount offered by the buyer and the amount owed to the bank by using our retirement savings. But they declined to accept the offer because of a loss-sharing agreement they have with the government.

Now my husband has stage 3 cancer, and he's unable to work. All our cash reserves have been depleted to keep up our payments.

We are in our 50s, have always been fiscally responsible and want to do the right thing. Foreclosure is not an option for us because of what it would do to our credit. We feel the bank has acted very irresponsibly and this loss-share agreement is working against the taxpayer and for the bank. The bank has no incentive to work with us.

Do you have any suggestions, and do we have any recourse for complaints?

A. We read your letter and felt sick. It reminds us of a story that was circulating a year or two ago that showed that buyers of banks that went under were raking in millions by taking over those failed banks.

They weren't making this money as a result of their wise lending or better skills in making loans, but in large part from guarantees made by the U.S. government to the banks taking over the failed lenders. The worse a loan performed, the more money the bank made. It didn't quite make sense to set up a situation that allowed banks to make billions of dollars with no risk, but it seems to follow directly with what you are saying.

In your situation, you could make the bank whole (or very nearly whole) by having the buyer put up most of the money owed on the loan while you put up the difference. Yet if the bank forecloses on you and gets half that amount from the sale, the bank might make out better.

How would that work? Well, if your bank purchased the loans on the books of the bank at, say, 70 cents on the dollar, and the government has a formula to guarantee the difference or a formula on the basis of the difference, your bank might make more money taking the loss than being made whole by you.

If your loan balance were $500,000 and you got the buyers to offer $400,000 plus $50,000 from you, the bank would get close to the amount it was owed. At that point, you'd think the bank would be ecstatic to get this lousy loan off its books. But the bank might get more money by foreclosing and having the government pay them the difference.

It's awful to think that the financial system actually works that way, but strange things have happened in the bank bailout.

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