(For more about short sales, see “What is a Short Sale? The Short Sale Process In Washington Explained”. For more about REOs, see “REO or Bank owned Homes Explained: Buying REO Property“.)

WHAT IS A HARDSHIP LETTER?

First, some background: When a lender considers a short sale, it must take into account both the big and the little pictures. As to the little picture — the specific proposed sale — the bank will probably benefit from any short sale that is even close to fair market value of the property. Otherwise the bank will have to foreclose on the property, only to probably take it back at the foreclosure auction. The bank will then have to sell the property itself. All the while, until the property is actually sold and the bank recovers the principal (or a portion of it) the bank is incurring a loss based on the “time-value” of money. Plus, the bank incurs substantial costs in the foreclosure process and again in selling the property to an eventual buyer. These costs are avoided if the bank approves the short sale.

BANKS ENCOURAGE FULL REPAYMENT

On the other hand, the bank also has a big picture concern as well. Quite simply, the bank wants to strongly encourage borrowers to remain good for the debt if they can afford it. Otherwise, the bank — all banks, really — will be even more overwhelmed with defaulting borrowers.

Accordingly, a bank will typically approve a short sale only if the owner has some sort of hardship that makes it difficult or impossible to make the mortgage payments. That is why banks require a hardship letter when requested to approve a short sale.

Thus, a hardship letter is a written statement from the owner about why the owner cannot afford the mortgage. While short sale standards vary from lender to lender, and while they also evolve over time, the hardship letter is generally an important part of the short sale application. Any owner looking for an approved short sale should take the time to draft a compelling hardship letter.

HOW TO WRITE A HARDSHIP LETTER

In drafting the letter, think creatively. Identify any possible hardship that has had a negative impact on your ability to pay the mortgage. Have you lost your job, or are you about to? Has somebody in your family incurred substantial medical bills? Is there any other unusual or unanticipated expense that impairs your ability to make the mortgage payment? Play up those hardships.

That said, there are of course limits. It is a very serious federal crime to make a false statement to a bank. Accordingly, while you can “play up” a hardship, you cannot lie or misrepresent the truth. Its a fine line, and its important to remain on the right side of it.

If you take the time to write a well thought out and compelling hardship letter, you will be taking a big step towards a successful short sale.

As always, this post is NOT legal advice. For legal advice, you must consult an attorney about your specific situation.

I tend to agree with Professor White. It seems to me that people are held to an unfair standard of “morality” when it comes to business decisions, a standard that is not applied to a business entity. For example, if a corporation stands to benefit from breaching a contract, you can bet your bottom dollar that the corporation will avoid its contractual obligations. Nobody will bat an eye.

A person, however, is held to a different standard. When a person enters a contract — including a mortgage — it is assumed that the person has given his “word,” his solemn moral promise. Even where the person stands to lose money by performing his contractual obligations, many people think that the person simply must soldier on and must comply with the contract or he has acted “immorally.”  Don’t believe me?  Check out these comments.

From my perspective, people should do what is in their best self interests. If defaulting on a mortgage is the best course of action, all things considered (including damage to credit score), then the borrower should default. The lender took a risk when it loaned the money, a risk reduced but not eliminated by securing that loan with the house at issue. Thus, the lender — just as much as the buyer — took a risk that house values would decrease, thus jeopardizing the security for the loan. The lender, then, should be prepared for the consequences.

I think Professor’s point is a good one: people don’t default because of social pressures to not do so, social pressures that are applied only to borrowers and not lenders.  This exacerbates the burden on people, to the benefit of the lenders, as a result of the market implosion.