The concept of Loss Mitigation is to look at multiple options (each of which is considered painful) and determine which of these options will “hurt the least.” In the context of the mortgage industry, the Banks are looking at each Borrowers individual situation (equity, cash flow, type of loan, assets, payment history, etc.) and making a business decision on which course of action will involve the least amount of loss for the Banks bottom line.

For example:

• Borrower owes $500,000.00
• Home Value: $450,000.00
• Monthly Payment: $3,000.00
• Borrower is behind on payment (2 months)

The Bank has 2 main choices:

a) Enforce the contract (Note) - The Borrowers did indeed sign a contract when the loan was originated. The Bank can refuse to work with the Borrower if desired. This option is likely to lead to Foreclosure (assuming the Borrower cannot comfortably make the monthly mortgage payments, and cannot sell their home due to lack of equity)

b) Modify the existing contract – In an attempt to increase the probability that the Borrower will catch up on their payments, make future payments on time, and remain in the home, the Bank might choose to modify the terms of the contract in the Borrowers favor.

From a Loss Mitigation perspective (from the Banks eyes), let’s examine those 2 options a bit closer and forecast the potential outcomes (options will vary with each situation):

a) Enforce the contract - Since the Bank refused to work with the Borrower, the Borrower stopped making his/her monthly mortgage payment. After a few months, the Bank began the foreclosure process. Due to the back-log of foreclosure filings, it is presumed to take several months to actually get the Borrower out of the house. In this case, when all was said and done, it took 8 months (from the day the Borrower became delinquent) to get the Borrower out of the house.

· The Bank has already lost $3,000.00 (monthly payment) x 8 months, which equals $24,000.00.

· Factor in another $5,000.00 - $10,000.00 in Attorney fees.

· Then analyze the “human factor” that states that people who are forcibly removed from their home tend to “mistreat” their home as a way to “get back” at the Bank (this would result in an unknown dollar amount devoted to repairs, and may significantly delay the resale of the subject property)

· In a declining value market (which we have been in for over 1 year), the value of $450,000.00 (when the Bank first looked at their Loss Mitigation options) has potentially dropped by another $20,000.00 (to $430,000.00)

· Real Estate Agent commissions must also be paid (to sell the house to another Buyer). $430,000.00 x 5% = $21,500.00 (or 6% = $25,800.00)

· If the Property Taxes have not been paid, the Lender may also have to pay them to the County Assessor (approximately $2,000.00 - $3,000.00)

The Bank now has a trashed house valued at $430,000.00, with roughly $100,000.00 in “negative equity” in a real estate market flooded with inventory, thereby further reducing the probability of being able to sell the house quickly (without discounting the price further).

(If only the Bank had considered Option B!)

b) Modify the existing contract – This option still hurts the Bank financially (but often much less than Option A).

· The Bank has thoroughly reviewed the Borrowers current financial situation and ability to repay their loan

· Upon this review, the Bank will typically make an offer to modify the loan terms in accordance with what the Borrower can afford to pay back (within a reasonable level of loss to the Bank)

· When done correctly, the Borrower remains in the home, pays the mortgage on time, and minimizes the overall loss the Bank will have

• Loan Modification – As mentioned previously, the Bank agrees to modify the terms of the existing loan (payment, interest rate, principal balance, term, or a combination of these items).
• Short Sale – Often a Homeowner simply “wants out” of their home, but owes more on their mortgage(s) than the current market value of the property. When this option is presented, the Bank will allow the Homeowner to sell their home at the current market value (even though the sales price is less than the amount of the current mortgage) and “forgive” the difference. This causes the Bank to “come up short” on their payoff…thus the name Short Sale.
• Short Refinance – This concept is the same as a Short Sale, but the Bank agrees to “forgive” the difference in the form of a refinance.
• Forbearance – Typically considered when a temporary loss or reduction of income has been experienced. The Borrower will be granted a small period of time to reduce the amount of their payments, but will “make that amount up” (plus interest) in subsequent payments.
• Deed-In-Lieu of Foreclosure – This option allows the Bank to accept title to the subject property without going through the process and expense of a foreclosure. The Borrower is typically enabled to “walk away” from the home without a foreclosure on their credit report.
• Repayment Plan – This option is similar to a Loan Modification & Forbearance in that the Bank will work within the Borrowers budget to formulate a Repayment Plan.
• No Offer At All – As mentioned previously, the Loss Mitigation Staff at the Bank might decide to enforce the contract that the Borrower had previously agreed to (most commonly when a Borrower can already reasonably afford their payments).

Real estate attorneys at the Lugash Law Center can help you review your options and find the best one for your situation. Click here to contact the Lugash Law Center.