Many homeowners still fall behind on their mortgage payments and often, this isn’t intentional. This may be due to a cascade of wrong financial decisions a major negative life change (i.e. getting laid-off or getting sick). As we all know, plenty of factors working against their favor may arise in their mortgage’s lifetime, hence the falling behind.
As homeowners fall far behind their repayments, they have an option to foreclose the property. But before succumbing to foreclosure, owners may still have another option, called the ‘short sale’.
Today, we’ll explore the difference between a short sale and a foreclosure, as well as the benefits of one over the other.
Short Sale VS Foreclosure
What is a short sale?
A short sale is when an owner sells his home for less than the remaining mortgage amount. Homeowners are forced to go with a short sale if they’ve struggled with keeping up with repayments. They, at the same time, also failed to get a high enough price for the property that they can use to pay the remaining loan.
Although technically it’s still a ‘sale’, with a short sale, the buyer needs the approval of the seller before the sale pushes forward. The lender has to agree since he will be getting [much] less than what is owed. In the simplest sense, you’ll be ‘short’ in paying your lender, hence the ‘short sale’.
For instance, Tom still owes his lender $300,000 but with a short sale, he can only produce $260,000 to pay his loan. If the mortgage company agrees to the short sale, the amount is short by $40,000.
What happens during a short sale? Will it sell my house fast?
In a nutshell, if your lender accepts your short sale terms, you will be debt-free once the sale has closed. As to whether the short sale will help sell your house fast or not, it depends, as with any real estate transaction.
Once your lender agrees to have a short sale, you may list the property in the market with the help of a real estate agent. The sale process is basically the same as any real estate sale, although your lender will have to approve the transaction first. Also, the proceeds of the home sale will go to your lender as payment for your outstanding debt.
However, in a short sale, watch out for a ‘deficiency judgment’. In some cases, lenders may seek the ‘deficiency’ money after a short sale, usually through a court order. Although this is outlawed in several states, clear this up with your lender before putting the property up for a short sale. The point of having a short sale is for you to be able to get out of debt, so make sure to check if your lender considers giving a deficiency judgment after the home sale.
What is a foreclosure?
A foreclosure, on the other hand, is a harsher solution than a short sale. When an owner falls behind his repayments and the property goes into foreclosure, the lender repossesses and evicts the borrower.
Unlike the short sale process, a foreclosure happens swiftly and often, the homeowner has very little time to prepare.
What happens in a foreclosure
Once you default or miss 3 to 6 months’ worth of repayments, you will receive a Notice of Default. When you receive this notice, it means that you are at risk of foreclosure. You have the option to settle the debt with the lender either by paying the amount or through a short sale and within 30 to 120 days (after receiving the notice) depending on where you are.
If you’re unable to settle your account with the lender, the property will go into foreclosure. The lender is at liberty to hold an auction (called a foreclosure auction) to sell the property to interested third parties.
However, if the lender fails to sell the home, the lender will repossess the property and become the owner. A foreclosed property repossessed by the lender is called REO or a real-estate owned property.
In any case, you can always check some online guides to find some tips for buying a foreclosed home. Foreclosed properties may be cheaper than short sale ones, as lenders try their best to dispose of the properties to recover from their losses. Also, foreclosed properties may only be purchased in cash, not through a mortgage.
Differences Between Short Sale and Foreclosure
Both short sales and foreclosures end with the owner losing the property and there are no ‘real’ benefits to them. A short sale and a foreclosure negatively impact your credit score and having either one will affect your credit score, tax return and your future loans.
However, while the ideal scenario is the owner being able to pay off the mortgage and keep the home, in some cases choosing between a short sale and a foreclosure can’t be helped. For that reason, it’s still necessary to check the ‘benefits’ of one over the other.
Short Sale Benefits
Sellers may consider having a short sale instead of going into foreclosure for the following reasons:
- Less damage to credit score. Unlike with a foreclosure, a short sale is more forgiving to your credit score than a foreclosure. Although it will affect your score to some extent, a short sale won’t reflect in your credit history (although it may be denoted in other ways, like “settled for less” or “paid in full for less than agreed”), unlike with a foreclosure mark, which remains in your credit report for 7 years.
- No fees to worry about. Your lender will foot the expenses incurred by the short sale, whether closing costs, repairs, agent commission, and others.
- More dignified exit. In a short sale, the lender allows the homeowner to stay in the home until the sale is completed, unlike with foreclosures where the former owners are forced to evict.
There are no real benefits to a foreclosure, for both mortgage lenders and borrowers. The foreclosure process takes a toll on both lender and owner; the foreclosed property just adds to the lender’s pool of foreclosed properties. Usually, these properties get disposed of at a discount so the lender can recoup his losses.
For the borrowers/former homeowners, foreclosures take a toll on their credit score. If you’ve had a foreclosure, this can make it difficult for you to purchase a new home in the future. With foreclosures, the borrowers often get forcibly evicted in a short period of time.
However, there is a less painful option once you’re in foreclosure. As a last resort, you can willingly surrender the home through a deed in lieu of foreclosure. This deed in lieu relinquishes you of all debt to the lender in exchange for surrendering the property.