In some circumstances, homeowners can find themselves in a difficult position when it comes to their mortgage, whether they are struggling to make payments or the value of the mortgage exceeds that of the actual home. Two processes that commonly take place in these cases are a foreclosure or a short sale. This article will explain the differences between the two and assist with choosing the best option between foreclosure or a short sale.
A foreclosure occurs when a homeowner has fallen behind on their mortgage payments and after a certain time has passed (typically 3 to 6 months) the lender will send a notice that the home will be put in foreclosure and sold.
The owner then has a period to pay back the balance owed, with the length of time varying from state to state. If that time passes without the homeowner catching up in payments the lender will then sell the home at auction, with the winning buyer usually having to pay in cash within 24 hours.
The impact of a foreclosure can be significant on the homeowner as not only will they lose their home but they will also face significant financial implications. Credit scores take a significant hit (200-400 points) and the foreclosure will remain on a credit report for 7 years. Purchasing a new home later is difficult also, only allowed after 5 years with some restrictions, or 7 years with no restrictions.
A short sale can occur if payments are in default or in situations where the homeowner finds themselves with a mortgage worth more than the home but is still current on payments. While the sale is managed by the homeowner the lender has to approve both a short sale being made and actually approve the offer once it has been received. Depending on the terms negotiated with the bank the homeowners may still have a balance remaining to pay the lender, or they may get relief for the loan balance.
The impact of a short sale is still significant for the homeowner but less so than under a foreclosure. Credit scores will take a hit (50-150 points) and if the debt is written off through the agreement the lender may notify credit reporting agencies, showing this negative item on credit reports. A key difference from a foreclosure is that after a short sale the homeowner can buy a new home immediately and not have to wait several years.
For banks and homeowners, a short sale can often be preferred as it typically results in more funds being received for the home. Foreclosures can often see homes being sold at a significant discount to market value, due to the auction-based nature of the sale. The downside to a short sale is that it can often take far longer to close and execute the sale of the home, lenders can often hold the process up if they don’t like an offer or take a long time to approve it. The impact on credit scores and future ability to buy a home is also a major incentive for the homeowners to prefer a short sale.
As a buyer, you can typically get a far better purchase price in an auction but there are risks attached to this discount. Often the purchase will be “as is” so if there are any major issues or repairs required you will have to pay them yourself. Additionally, as payment is usually required within 24 hours the buyer doesn’t have time to have the home inspected professionally. The last major concern is that there are some mechanisms where redemption laws allow a homeowner to re-claim their foreclosed home, potentially seeing you lose the home later.
Short sales also come at a discount for buyers, though usually not as steep of a discount. One downside with short sales is that they can take a long time, and most buyers don’t want to wait up to a year to complete the process. Additionally, if the selling homeowner has obtained additional loans with the home as security but hasn’t listed them those lenders can make a claim on the home after the purchase.
Considering these issues and the points above will ensure that as a buyer or a seller you are better prepared when approaching the foreclosure vs. short sale decision.