A Shortage of Short Sales: Explaining the Underutilization of a Foreclosure Alternative

64 Pages Posted: 26 Feb 2019 Last revised: 29 Apr 2020

See all articles by Calvin Zhang

Calvin Zhang

Federal Reserve Banks - Federal Reserve Bank of Philadelphia

Date Written: 2019-02-20

Abstract

The Great Recession led to widespread mortgage defaults, with borrowers resorting to both foreclosures and short sales to resolve their defaults. I first quantify the economic impact of foreclosures relative to short sales by comparing the home price implications of both. After accounting for omitted variable bias, I find that homes selling as short sales transact at 9.2% to 10.5% higher prices on average than those that sell after foreclosure. Short sales also exert smaller negative externalities than foreclosures, with one short sale decreasing nearby property values by 1 percentage point less than a foreclosure. So why weren’t short sales more prevalent? These home price benefits did not increase the prevalence of short sales because free rents during foreclosures caused more borrowers to select foreclosures, even though higher advances led servicers to prefer more short sales. In states with longer foreclosure timelines, the benefits from foreclosures increased for borrowers, so short sales were less utilized. I find that one standard deviation increase in the average length of the foreclosure process decreased the short sale share by 0.35 to 0.45 standard deviation. My results suggest that policies that increase the relative attractiveness of short sales could help stabilize distressed housing markets.

Keywords: foreclosures, short sales, externalities, home prices, mortgage servicing

JEL Classification: D14, G01, G21, R31

Suggested Citation

Zhang, Calvin, A Shortage of Short Sales: Explaining the Underutilization of a Foreclosure Alternative (2019-02-20). FRB of Philadelphia Working Paper No. 19-13, Available at SSRN: https://ssrn.com/abstract=3339383 or http://dx.doi.org/10.21799/frbp.wp.2019.13

Calvin Zhang (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States

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