Short Sales vs. Foreclosures: An Overview
Becoming a homeowner is a dream for many people. It requires a lot of saving and a lot of discipline and it never hurts to have a great credit score. But sometimes, there are factors that can turn a person's dream into a nightmare. You may lose your job or another income in the family, interest rates may shoot up, or you end up having to take on more debt. So what do you do to keep yourself in check?
There are two options you have as a homeowner if you get behind on your mortgage payments, if you have a home that's underwater—or both: A short sale or a foreclosure. There are different reasons for why a homeowner would opt for a short sale versus a foreclosure. The owner is forced to part with the home in both cases, but the timeline and other consequences are different in each situation.
A short sale is a voluntary process that happens when the homeowner sells the property for an amount that is far less than what is owed on the mortgage. So a homeowner may end up selling a home for $175,000 even though there's still $200,000 on the mortgage. The remaining amount on the loan—in this case, the $25,000—less any costs and fees associated with the sale are the deficiency. A foreclosure, on the other hand, is involuntary. In this case, the lender legally seizes the home after the borrower fails to make payments. This is the last option for the lender, since the home is used as collateral on the note.
- Short sales and foreclosures can get homeowners out of paying for their mortgages.
- Short sales are voluntary and require approval from the lender.
- Foreclosures are involuntary, where the lender takes legal action to take control of and sell the property.
- Homeowners who use short sales are responsible for any deficiencies payable to the lender.
- Short sales allow people to repurchase another home, while foreclosures affect a borrower's credit score.
Before the short sale process can begin, the lender who holds the mortgage must sign off on the decision to execute a short sale. Additionally, the lender—typically a bank—needs documentation that explains why a short sale makes sense. That's because there is a chance that the lending institution could lose a lot of money in the process.
If approved for a short sale, the buyer negotiates with the homeowner first before seeking approval on the purchase from the bank. It is important to note that no short sale may occur without lender approval.
Once the short sale is approved and goes through, the lender receives the proceeds of the sale. However, the homeowner is still required to pay the deficiency—that is, whatever is left remaining on the loan.
Unlike a short sale, foreclosures are initiated only by lenders. Mortgagors who fall behind on their payments—anywhere from three to six months—may be subject to foreclosure by their lenders unless they bring their loans up to date. Foreclosure proceedings vary by state including what types of notifications the lender must provide, as well as what options the homeowner has to bring the loan up to date. Laws also stipulate how long a bank has to sell the property.
The lender initially takes legal action to take control of the property to force the sale of the home. By doing so, the lender moves against delinquent borrowers, hoping to make good on its initial investment of the mortgage. Also, unlike most short sales, many foreclosures take place when the homeowner has abandoned the home. If the occupants have not yet left the home, they are evicted by the lender in the foreclosure process.
Once the lender has access to the home, it orders its own appraisal and proceeds with the sale of the home. Foreclosures do not normally take as long to complete as a short sale, because the lender is concerned with liquidating the asset quickly. Foreclosed homes may also be auctioned off at trustee sales, where buyers bid on homes in a public process.
Short sales don't damage a person's credit rating, while foreclosures can stay on a person's credit report for seven years.
Short sales and foreclosures have consequences to homeowners. Both require homeowners to give up their properties—well before they may be ready to do so. But that's where the similarities end.
Short sales tend to be lengthy and paperwork-intensive transactions—sometimes taking up to a full year to process. The foreclosure process, on the other hand, tends to be very quick. As mentioned above, banks normally want to sell the property quickly to recoup as much money as possible.
While short sales are not detrimental to a homeowner's credit rating, foreclosures are. A homeowner who has gone through a short sale may, with certain restrictions, be eligible to purchase another home immediately. A foreclosure, though, is kept on a person's credit report for seven years. In most circumstances, homeowners who experience foreclosure need to wait a minimum of five years to purchase another home.