What Could Force More Short Sales

Despite a government program designed to streamline and incentivize the process, short sales have not even come close to keeping up with foreclosure sales.

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That may be about to change.

If banks see higher losses from foreclosures than from short sales, they may put more resources into approving these deals, where the borrower is allowed to sell the home for less than the value of the loan.

"Loss severities on distressed U.S. residential mortgage loans are likely to increase an additional 5-10 percent from current levels due to higher loss mitigation and foreclosure expenses and weakening home values," according to a report from Fitch Ratings.

Fitch: The anticipated increases for each sector’s average loss severities are expected to be as follows:

  • Prime loans: currently 44%, increasing to 49%-54%;
  • Alt-A loans: currently 59%, increasing to 64%-69%;
  • Subprime loans: currently 75%, increasing to 80%-85%.

We are already seeing home prices double dip in many markets, and that is expected to continue at least through the first half of 2011. One way to mitigate the losses is through short sales. "Short sales generally experience recovery rates about 10 percent higher than foreclosure sales," according to Fitch.

Will this be enough to push the banks? Unclear.

Servicers actually rake in a lot of money from fees surrounding foreclosures, and so far the government's "Home Affordable Foreclosure Alternative," program, which pays servicers cash incentives for doing short sales, has had pretty poor results, really still in the hundreds of loans. Second liens pose a big problem, but many big bank servicers also hold the second liens.

It's all about where the math comes out. If home prices fall far enough, the equation may tip from foreclosure to short sale.

Questions? Comments? RealtyCheck@cnbc.comAnd follow me on Twitter @Diana_Olick