Short sales and foreclosures are both alternatives for property owners who consistently fail to make mortgage payments. Though they may seem similar, there are some important differences when it comes to short sale vs foreclosure. If you are a property owner struggling to pay your mortgage, you need to have a good understanding of short sale vs foreclosure in case you end up facing either scenario. If you are a real estate investor looking to buy a short sale or foreclosure property, the knowledge of these differences is also crucial. In this blog, you are going to learn about the meaning of these two processes and the main differences between them.
Short Sale vs Foreclosure: What Do These Terms Mean?
What Is a Short Sale?
A short sale usually occurs when a mortgaged property has considerably depreciated in value since its purchase and the homeowner is unable to pay the mortgage balance. So, how does a short sale work? When the mortgage balance is more than the sale or market value of the mortgaged property, the homeowner can initiate a short sale. The homeowner is basically requesting that the mortgage lender accepts an amount lower than the total mortgage owed. The short sale process starts when the lending institution approves and allows the homeowner to sell the property on his/her own for less than what is owed on the mortgage.
A short sale functions just like a traditional home sale. A real estate agent will list the property and find potential buyers. However, you won’t have the final say in who gets to buy the property. Since the lending institution is accepting a loss on the mortgage, they often set a price tag at which the home can be sold. Once the home is sold for the agreed price, the mortgage lender will call it even. The homeowner will now be free of any financial responsibility for the property.
For instance, if a property owner sells a home for $250,000 when the mortgage balance is $300,000, it would be a short sale since they will be coming up short by $50,000. This remaining balance owed to the mortgage lender is waived. However, that is not always the case. At times the mortgage lender can decide to file a deficiency judgment to recover the loss. However, most state laws are against this practice. Nevertheless, it’s good to carefully read over the paperwork for your short sale approval to verify that you won’t be personally liable.
Learn More: What Is a Short Sale in Real Estate Investing?
What Is a Foreclosure?
Unlike a short sale, a foreclosure is initiated only by the lending institution. It is a legal process in which the mortgage lender takes possession of the property (kept as collateral) when the mortgagor consistently defaults in making outstanding payments. In the foreclosure process, the homeowner’s right to the property is revoked and the lender puts the foreclosed home for sale at an auction to recover the loan balance. Real estate buyers can then bid on it.
How does a foreclosure work? After 3 to 6 months of missed mortgage payments, a lender will file a Notice of Default to let the homeowner know he is at risk of foreclosure. The homeowner (borrower) will have a chance to settle their mortgage balance owed by paying it, thereby redeeming the property. A short sale is one of the last alternatives that borrowers can explore before foreclosure. This period is called a pre-foreclosure. It can be anywhere between 30 and 120 days after an owner receives the Notice of Default. If the mortgage debt is not recouped after this period, the lender will foreclose the property by scheduling an auction to sell the home to a third party.
Earnings from the sale of the foreclosed home are first used to repay the loan. If there is any amount remaining, it is handed over to the borrower. If the proceeds from the sale are lower than the entire debt amount, the borrower remains liable. In the event that the foreclosed home is not bought at auction, it remains in the mortgage lender’s possession until it can be sold.
Learn More: What Is a Foreclosure? How Can You Invest in One
Short Sale vs Foreclosure: What Are the Main Differences?
To get a better understanding of short sale vs foreclosure, here is a comparison in terms of the key aspects:
The foreclosure process is used by mortgage lenders to take back a property after the borrower has failed to make mortgage payments. As opposed to a foreclosure, a short sale is an agreement between the mortgage lender and the borrower to allow the borrower to sell the property for less than what is owed on the property.
Initiated and Sold by
The initiation of the foreclosure process and the sale of the property is carried out by the mortgage lender. With a short sale, the borrower is the one who initiates and sells the property. Playing an active role in the sale of the property gives homeowners the opportunity to properly market the real estate property. Therefore, they are able to get the best offers and considerably reduce the balance owed.
Short sales generally take much longer to close due to the many levels of approval and a lot of paperwork. The process can take up to a year. For a foreclosure, the lender wants to find a way to quickly recover as much of the money they are owed as possible. Therefore, proceedings tend to move swiftly.
Effect on Credit Score
Foreclosure is more damaging to your credit score than a short sale. In fact, if a property is in foreclosure, the borrower will have to wait up to seven years to get a new mortgage. With a short sale, the borrower can purchase another house without having to wait.
Short Sale vs Foreclosure: How They Work for Real Estate Buyers
For real estate buyers, both short sales and foreclosures have their own pros and cons. Generally, you can get properties below market value when buying through short sale or foreclosure. With a short sale, homeowners are desperate to sell the mortgaged property since they have missed mortgage payments. With a foreclosure, the lenders are looking to quickly recoup the money owed. Nevertheless, both processes are likely to be more complicated than acquiring property on the open market. This often leads to purchase delays. The advantage of this is that buyers will face less competition since many try to avoid them.
Let’s take a look at each buying process in detail:
Buying a Short Sale Property
Buying a short sale property can be frustrating. Due to the extra paperwork and multiple approvals, a short sale can take up to 120 days, sometimes even longer. Therefore, buying a short sale home might not be suitable for first-time buyers. If you want to purchase an investment property within a short period of time, you should probably skip short sale properties. Another shortfall is that you may be rejected by the lender after waiting on the deal for a long time. However, one advantage with short sale properties is that buyers usually have the opportunity to seek an inspection.
Are you looking to find short sale properties for sale? Most short sale properties are listed on real estate websites and by real estate agents. Be sure to use Mashvisor to find the best short sale investment properties in the US market. With the help of Mashvisor’s Rental Property Calculator, you can calculate the potential return on investment in terms of cash flow, rental income, cash on cash return, and cap rate.
Buying a Foreclosure Property
Buying a foreclosure is quite different. For example, foreclosure real estate can typically only be purchased with cash. It can be difficult to be granted a traditional loan. While buying foreclosure investment property can be a great deal, it is also risky. A foreclosed property sold at a courthouse is bought without inspection or warranty. You will basically be buying the property without seeing it. If there are any code violations, liens or title issues tied to the foreclosed property, you will also assume them. Buyers should do their research to find out if there are other costs associated with the property before placing a bid. The advantage of foreclosure real estate is that they usually sell for a little less than short sale properties. This is because lenders are trying to quickly liquidate the property to recoup the debt they are owed.
You can also use Mashvisor to find foreclosures for sale.
The Bottom Line
It is imperative for both homeowners and real estate investors to have a good understanding of short sale vs foreclosure. The main short sale vs foreclosure difference lies in the fact that they are used at different times, initiated by different persons, take different times to close, and having different impacts on credit score. Though you lose your property in both processes, taking the initiative to get out of the situation through a short sale is often a wiser option. It may be paper-work intensive and take longer to close but you will avoid the undesirable consequences of a foreclosure. When you start struggling to pay your mortgage, make sure to talk to your lender to discuss your options.
For real estate buyers, both of these types of real estate have a price advantage because they are usually below market value. However, to decide on the best real estate investment strategy for you in terms of a short sale vs. foreclosure, you need to look at all their pros and cons. Most buyers opt for short sale properties. Under the best circumstances, buying a short sale property can save you a lot of money and allow you to quickly build equity.
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