photo credit: Ruin Raider

A loan modification is definitely the best option for underwater homeowners, but if the borrower is not able to get a loan modification, a short sale is the next best thing. Short sales make it possible for banks to allow an owner to sell their home for less than the amount currently owed on the existing mortgage.

Borrowers who short sell their home still experience blemished credit, but they're far less damaging than going through a foreclosure. Both short sales and foreclosures skyrocketed in 2010, but it's heartening to see that the amount of short sales have grown by 26,000 this year and the amount of foreclosures dropped by 255,000. There are some states in America that allow lenders to chase a homeowner down for the difference between the monies due on a mortgage and the sale price at foreclosure auction. But an owner who short sells their home has the chance "to negotiate away the lender's right to sue for that judgement."

Short sales are better for lenders as well because the banks will make more money from a short sale than they will from letting the home be sold at a foreclosure auction. RealtyTrac, an online company that tracks foreclosures, reports that the average price of a foreclosed home was $164,217 in the second quarter of 2011; the average short sale price was $192,129.

Banks and other mortgage lenders will also save costs if they allow a short sale to go through instead of allowing the property to head to foreclosure. Loan servicing companies also have to spend more time and money on due diligence.

Karen Dynan, the co-director of the Economic Studies program at the Brookings Institution, explains, "Servicers and lenders are being heavily scrutinized right now so they probably are more worried than ever about making a mistake in a foreclosure that could subject them to legal liability in the future." Short sales serve neighborhoods better than foreclosures, too. Jed Kolko, the chief economist at the real estate website Trulia.com, said that, "...foreclosed homes often sit vacant while short sales are re-occupied more quickly...short sales tend to depress neighboring property values less than foreclosures do." Foreclosed homes also stand more chance of being vandalized -- either by angry homeowners themselves, or simply opportunistic criminals. Dean Baker, the co-director of the Center of Economic and Policy Research, explains, "It's often not a friendly process so you frequently have cases where people deliberately vandalize homes."

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