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February 12, 2019

What is the Difference Between a Foreclosure and a Short Sale?

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What is the distinction between a foreclosure and a short sale? Foreclosures and short sales are each choices for homeowners that have fallen behind on their mortgage payments, however it is vital to grasp the distinction between these two processes.

So if you are having trouble paying your mortgage and are not sure what to do, read this primer on foreclosures vs. short sales and then call the pros at Huggins Homes.  Here's what these items are, their pros and cons, and a way to tell whether or not a short sale or foreclosure is the better choice for you.

What is a short sale?

A short sale happens once a home-owner owes more on the mortgage balance than the market price or sale price of the property at the point the owner needs to sell. For a short sale, the home-owner is actually asking the mortgage lender (typically a bank) to simply accept a lesser amount than the full mortgage owed.  For instance, if the home-owner sells the house for $250,000, however the remaining loan balance is $300,000, the seller is actually $50,000 "short" on paying the lender back.  That is a short sale.

If the lender accepts the short sale terms, the loan debt will be settled and therefore the borrower discharged from any future liability once the short sale has closed.

Like other homes for sale, a short sale property is going to be listed by a real estate agent.

For the seller, one factor you will need to look out for is a deficiency judgment.  A deficiency judgment is when after the completion of a short sale, the creditor seeks to recover the "deficiency" (the cash it lost during this home sale) through a judicial writ.  This writ will insert a lien on the former borrower for more money (so in this case, a mortgage lender acts as a lien holder). Some states outlaw this practice, however it is highly advised for you to ask, just so you are not blindsided by it later.

What is a foreclosure?

Foreclosure is a legal method that happens once a borrower is unable to make their mortgage payments for a significant period of time.

After 3 to 6 months of missed payments, a lender can issue a Notice of Default with the County Recorder's office.  This notice is to let the borrower recognize he is at risk of foreclosure—and that once the foreclosure goes through, they will be evicted.

After receiving the Notice of Default, borrowers may try and settle their loan debt with their lender, either through a short sale or by paying the mortgage balance they owe. This period is known as the "pre-foreclosure period" and might last anywhere from thirty to a hundred and twenty days once the borrowers have received the Notice of Default.

If the debt isn't recouped, lenders can step in and foreclose on the property. To foreclose, they will schedule a foreclosure auction to sell the house to a 3rd party.  Foreclosure auctions may be publicized in local newspapers or online and are usually held at either the property or the local courthouse.

If nobody buys the house at auction, the lender becomes the owner of the property.

Another option to avoid foreclosure is to try and do what is know as a "deed in lieu of foreclosure."  This is where a home-owner transfers title and possession of the property to the lender in exchange for having their loan debt erased.

What is the difference between a short sale and foreclosure?

Short sales and foreclosures are similar in that they are each financial options for people who own homes however find themselves in financial distress.  Each also has a negative impact on your tax return, credit score and credit report, and future prospects obtaining a loan.

Further Reading:  How long it takes to be able to get another loan after a foreclosure, short sale, or bankruptcy.

Short sales and foreclosures have significantly different procedures.  A short sale transaction happens once the mortgage lender permits the borrower to sell the house for less than the amount owed on the mortgage. The foreclosure process happens once lenders repossess the house, usually against an owner's will.

They also take a different amount of time to complete.  Short sales can take up to at least one year to close, whereas foreclosures typically move at a much quicker pace as a result of lenders are focused on recovering the money they are owed.

Furthermore, a short sale may be less damaging to your credit score than a foreclosure.  Both methods will make it harder to obtain a new mortgage.  A foreclosure can also be your credit report for seven years and you may and many lenders will want to wait until that foreclosure is five years old before giving another loan to you.

If paying your mortgage has become a true challenge, the best thing to do is to speak to your lender to discuss your choices.  Your lender should be able to supply the most effective plan of action based on your specific scenario and also the laws in your state.

How short sales and foreclosures work for buyers

Short sales may be a decent deal for bargain hunters, however shopping for a short sale can be a headache.  Both are not recommended for first time home buyers due to the added complexities, time periods and risks involved.

The average short sale takes around ninety to a hundred and twenty days, and maybe even longer.  Why?  Mortgage lenders usually will not approve the sale unless the buyers agreeing to its demands, like paying for fees that would normally be a seller's expense.  Because the bank wishes to limit its losses, they pass these prices off to the buyer.

Other than the involvement of the bank, a short sale can proceed very like other sales.  Buyers will get a mortgage and have the ability to perform their due diligence inspections.

Foreclosure sales are another animal altogether.  For one, foreclosure properties can only be purchased with cash.  There is no ability to obtain a traditional purchase loan to finance the home.

In addition, homes sold at foreclosure auction carry additional risks.  You are not able to enter the homes before purchasing them and homes are sold with no guarantee of being in a livable condition.  You may end up buying a home where you have to evict the prior owners, which can take months and thousands of dollars.  Once you get possession, you may have a home that has structural issues, mold, infestations, or a myriad of other problems.  Just watch any episode of your favorite house flipping show to see what problems may await you.  In addition to all that, certain liens (like tax liens) transfer with the property and become YOUR responsibility to pay!

Have More Questions?

If you have any questions regarding short sales or foreclosures and would like our expert advice, please reach out to us at 805.905.4000.  You can also check out our other articles on this topic.

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